Adulting 101: Pros and Cons of Buying a Residential Home

As a young professional establishing your career, you may start to consider buying a house. Before you make a decision on whether to buy a home or keep renting, weigh the pros and cons listed below:

Pros: Buying a home can help you….

1. Purchase an asset that can increase your net worth. One of the perks of buying a home is that it is usually considered an “asset.” Unlike cars which depreciate or go down in value each year, homes tend to appreciate or go up in value. Clearly, things can change, as many people painfully saw during the housing market crash in 2008, but that is not the norm. Plus, even when there are rare “down years” the housing market usually recovers shortly afterwards. If you buy a home there is a fairly high chance that in a few years, that house will be worth more than you originally paid for it. As the home appreciates in value, your net worth increases.  

2. Build equity (or value) in your own investment. Many people like the idea of owning a home. They would rather send in a monthly check towards something that is “theirs” and feel like renting is “throwing money away.” Although I disagree with this statement, I understand where they are coming from. When you rent, your money goes to the landlord and someone else uses that money to build his or her net worth. In contrast, when you buy a home, the money you pay the bank each month is used to pay off your mortgage. As you pay off your mortgage, you decrease your debt. Each payment you make to decrease your debt, decreases the percentage of the home the bank owns and increases the percentage of the home you own. Thus, you are able to increase the equity (or value) you have in the home, which again increases your net worth.

3. Potentially save money in taxes. When you buy a home you usually take out a mortgage (aka a home loan) from the bank. As you pay off this mortgage each month, you are paying back a portion of the amount you borrowed (the principal) and the fee the bank charged you when they gave you the loan (the interest). The first few years you pay a mortgage the majority of your payment is interest. According to the tax law, you can actually deduct the part that is interest from your taxes each year which can save you money.

   Keep in mind, you can only use this tax deduction if you “itemize your taxes.” Many young professionals don’t itemize their taxes because they opt for the standard deduction which saves them even more money. My point is that buying a home has the potential to save you money on taxes if you happen to have a very high income, are already planning to purchase an expensive home, or have to itemize your taxes for some other reason.

4. Achieve that feeling of accomplishment. Let’s face it. Many people like the idea of owning their own home. It’s a major part of the American Dream many of us want to achieve. Plus, it makes us feel like we’re finally maturing and have reached true “young professional status.” While I may not be able to quantify the “feeling of accomplishment” that comes with homeownership, its value is definitely there. If you are established in your career and plan to stay in same area for at least 5 years, homeownership is viewed as the next step and often provides internal and external validation of our life choices.

Cons: Unfortunately, if you buy a home you will have….

1. Less mobility. Unlike signing a one year lease to rent a house or an apartment, purchasing a home is more binding. When you take out a bank loan to purchase a home, you sign an agreement to pay back that loan (aka the mortgage) over 15-30 years. Although you can sell the home if you decide to leave the area, it is not as easy as you may think. In fact, most people who buy a home plan to stay in that home for at least 5 years (I talk about why that’s the case in a previous post). If you are going to stay in a home for at least 5 years you have less mobility than if you would have simply rented an apartment or a home using a one-year lease. If you change jobs or have to move to a different state, it is much easier to break a rental lease than it is to put your home back on the market and sell it in a reasonable amount of time.

2. More debt. Perhaps the biggest disadvantage to purchasing a home is that you have to take a large loan in order to do so. The vast majority of people don’t have $300,000 lying around to spend on a home so they put down a small percentage of the purchase price (usually 3-20%) and get the rest of the money from a bank in the form of a mortgage. While there is nothing inherently wrong about getting a mortgage and making a payment each month towards it, you cannot ignore the fact that doing so puts you in a large amount of debt.

   Although a mortgage is considered “good debt” since you are purchasing an asset that can go up in value over time, you may not be in a position to do so right now. Many young professionals already have credit card debt, car payments, and a large amount of student loans they already have to pay back. Taking on another $200,000 in debt may not be ideal. Plus, the more debt you take on, the longer it will take you to pay it all back. The longer you take to pay back your debt, the more money you waste in interest payments and the harder it becomes to dig yourself out from under this pile of debt to actually build your net worth.

3. High upfront costs- I talked about the added costs associated with buying a home in a previous post, but in case you missed it let me state it again. Buying a home is expensive. The transaction costs (or closing costs) associated with buying a home are an estimated 3% of the entire purchase price. So, if you buy a home for $250,000 expect to spend another $7,500 in transaction costs. Along with this expense, you also have to purchase furniture and appliances. Lastly, you have to factor in decor items and moving expenses. Those who rent don’t usually have to worry about the majority of these high upfront costs.

4. Additional monthly/annual expenses. Along with high upfront costs, there are recurring expenses you must add to your monthly budget if you buy a house. Every homeowner must factor in the cost of property taxes and homeowners insurance. Some people even have homeowners association (HoA) fees they must consider as well. Plus, when you own a home you are responsible for any repairs. This means you have to put aside additional money each month to cover these inevitable costs. Altogether, the cost of property taxes, homeowners insurance, and repairs typically add another 40% to your monthly costs. For example, if your mortgage is $800 a month then you can estimate spending an additional $320 a month ($800x40%) on top of that $800, in added homeownership fees.

To summarize, before you buy a home as a young professional, there are several things you must consider. By purchasing a home, you are able to buy an asset that increases in value and build equity in an investment that can increase your net worth. You also have the potential to save money on your tax bill while experiencing that feeling of accomplishment knowing you are making boss moves in your life. On the other hand, purchasing a home gives you less mobility in the event that you need to relocate. It also causes you to take on a large amount of debt (in the form of a mortgage), has high upfront costs, and adds additional expenses like property taxes, homeowners insurance, and repair costs to your monthly budget. Before you purchase a home it is important to consider these pros and cons to ensure you are making a sound decision.  

If you are unsure whether to buy a home or keep renting you can refer to my post “Should you buy a home or keep renting part 1 (and part 2) and use to the New York Times’ rent vs buy calculator as a guide.  

Should you buy a home or keep renting? Part 1: Ten questions to ask before you decide to buy a home

The real answer to the rent-vs-buy question is “it depends.” There are several advantages and disadvantages associated with buying a home. Figuring out the right choice depends on a lot of factors that are unique to your situation.

Oftentimes, young professionals who have recently finished college choose to rent an apartment. Signing a single year lease with an apartment complex gives them more mobility in case they change jobs and allows them to better enjoy the perks “city life.” As their income improves and their job stabilizes, they may begin to wonder if it is time for a change. The high amount of taxes they pay and the need for more space in a less congested area makes them strongly consider moving on to bigger and better things. They realize other people in their late 20s or early 30s are starting to purchase real estate and all of a sudden buying a home becomes the next item on the young professional “List of Things To Do to Prove You’re Finally “Adulting.”

Although the idea of buying a home makes you feel like you are progressing in life, you need to truly evaluate whether buying a home makes financial sense for you at this point in your life. You cannot simply compare the average mortgage price to the average rental price and make a decision.

Here are 10 financial questions to ask yourself before you decide to purchase a home:

1. Do you have money for the down payment? Buying a home is expensive. The average house in my home state of Florida is nearly $200,000. I don’t know about you, but I haven’t stacked that many coins in my piggy bank just yet. While it is true that the vast majority of people don’t pay the full price of the home when they buy it, most banks like for you to have at least 20% of the money for a home before they agree to give you the mortgage. Before you make up your mind to buy a home, you need to check your savings and make sure you have enough money to cover the down payment on a house.

   Fortunately, many banks will still allow you to purchase a home when you don’t quite have the 20% down payment. In order to do this, they make you pay something called “private mortgage insurance.” Private mortgage insurance is a small insurance policy banks make you pay in order to protect themselves. (In the event that you fail to keep up your monthly mortgage payments, the private mortgage insurance will refund the bank part of the money you owe.)

   I should mention that medical doctors have access to physician loans which allows them to buy a home with no money down and without having to purchase private mortgage insurance. Many banks have realized that doctors finish medical school with high debt burdens but still have very high incomes and rarely default on loans. As a result, they give doctors preferential treatment. If you are a physician, or will be one soon, this a great deal. However, it does not make the decision to buy a home a “no-brainer.” There are many other factors to consider. Keep reading.
   

2. Have you saved enough money to cover the “transaction costs?” The process of buying a home is more than just giving the bank a down payment and securing a mortgage. There are several “transaction costs” (also known as “closing costs”) that can be quite expensive. Some examples of transaction costs are: the appraisal fee (to have a professional determine the actual value of the home), the processing fee (to have someone evaluate your loan application and prepare any other necessary documents), title insurance (to make sure that the home is actually in your name and ensure there are no problems when the seller transfers it to you), escrow fees (the third party that holds the money from the buyer and the home from the seller until all of the inspections and concessions have been completed), etc.

   Typically, these transaction costs amount to about 3% of the total price of the home. So if you are buying a home for $200,000, then expect to spend an additional $6,000 in “transaction fees.” Occasionally, banks may offer a “no-cost-closing” to certain buyers who have great credit but do not have the cash to pay for the closing. A “no-cost-closing” simply means that instead of making you come of up with $6,000 in cash for transaction fees to buy that $200,000 home, they will instead charge you a higher interest rate on the mortgage and/or add those closing costs to the total cost of the mortgage (both options usually increase your monthly payment).  
   

3. Is your credit score good enough to get a decent loan? Once you have money for the down payment (or opt for a physician loan) and figure out how to cover the transaction costs, you need to make sure you can actually secure a good loan from the bank. Unless you have $200,000 lying around, you are going to need to get a mortgage from the bank in order to purchase the home. Typically, the bank loans you the money and you agree to pay them back over the next 15-30 years. However, the bank isn’t going to loan you an unlimited amount of money and the money they do loan to you will not come free. Just like the government charged you interest to take out a student loan and set a limit on the total amount of money they would let you borrow, banks charge you interest to take out a home loan and set a limit on how much money they will give you as well.

   The amount of money banks loan you and the percentage they charge you in interest for that loan is largely dependent on your credit score. I talked about credit scores in a previous post, but essentially anything over 760 is really good and you will be able to secure a mortgage with a decent interest rate. A credit score under 500 is pretty bad and you will have a hard time getting a bank to even consider your loan application. A score between 500 and 760 is on a sliding scale. The higher the credit score, the more money the bank will loan you and the lower your interest rate will be. Keep in mind, if you are married and your credit score is good but you spouse’s credit score is not (or vice versa) you may still be able to get a mortgage but the person with the better credit score may have to purchase the home is their name first (and add the spouse’s name on the title at a later date).
   

4. Can you afford the monthly mortgage payment? If you have decent credit score and show a genuine interest in wanting to purchase a home, your real estate agent is going to do everything in his (or her) power to help you in this endeavor. Oftentimes, they make the home seem more affordable by pitching you on the idea that you can secure a 30-year mortgage from a bank. The benefit of 30 year mortgages is that it reduces your monthly mortgage payment (since you are paying back the loan over 30 years). The bad part about 30 year mortgages is that you end up paying tens of thousands of dollars in added interest payments over the life of the loan.

   The rule of thumb for most people seeking to become financially stable in a reasonable amount of time is to get a 15-20 year mortgage. While this saves you a ton of money in interest it increases your monthly mortgage payment. If you decide to opt for a 30 year mortgage in favor of the lower monthly payments, make sure the bank won’t charge you a “prepayment penalty” if you decide to pay off the loan sooner. Although the decision to pursue a 15, 20, 25, or even 30 year mortgage is a personal one, make sure you ask your bank what your monthly mortgage payment would be (when you factor in interest) so that you can determine if the monthly mortgage payment would be affordable.
   

5. Do you have a stable job with a steady income? Because of all of these added fees, in addition to your mortgage, lenders want proof that you can truly afford to purchase a home. Before they approve your mortgage loan, they will verify your income and work status. If you are employed, they will make you verify your income by submitting W-2s, pay stubs, proof of any bonuses, and reports of any additional cash flow. If you are self-employed or own a business, they will likely ask for even more documents. If you have a good credit score, but your income appears unstable, then you may not be approved to purchase a home.
   

6. How much debt do you have? Along with considering whether your income is steady, it is vital to also consider any other debt you have. For many young professionals this means taking a hard look at your existing credit card debt, car payments, and student loans. If you already have a significant amount of debt, many banks will be reluctant to lend you a couple hundred thousand more dollars for a house. The more debt you have, the bigger the chance you could have a problem paying it all back. The ideal debt to income ratio for most banks is about 35%.

   Nevertheless, there are exceptions to every rule. For example, many physicians have a lot of debt after graduating from medical school but banks will overlook this debt because their income potential is so high. While this is a great perk for physicians, it may be a financial disaster. Having nearly $200,000 in student loans and adding another $250,000 for a mortgage (in addition to all of the other home-buying expenses), isn’t exactly a recipe for financial freedom. In fact, one of the biggest wealth killers for many physicians is buying a home before they are truly able afford to one. If you are a medical student or healthcare provider you can review my post on why buying a home may not be the wisest decision right out of training here.

7. Have you factored in the cost of property taxes and homeowners insurance? Many people assume that buying a house is much better than renting because they know friends or family members whose monthly mortgage is similar to their current rent price. They figure that if they are going to pay the same amount each month then they might as well put that money towards their own home. Although I can understand this thought process, it is flawed.

   There are other monthly/annual costs on top of the mortgage that you must consider. Two of those costs are property taxes and homeowners insurance. Unlike renting, people who own a home must pay yearly property taxes. The amount they pay in property taxes varies by state and is listed here. It ranges from 0.27% of the home value in Hawaii to 2.44% of the home value in New Jersey, with the average being around 1%. For example, if you bought a home valued at $200,000 in my home state of Florida (where property taxes are 0.98%), then you would have to pay $1,960 annually (which is an extra $163 dollars per month) in property taxes.

   Homeowners insurance (which insures your home against unforeseen damage or accidents) works in a similar way. It also varies by state and is listed here. Generally speaking, states with a high risk for natural disasters like earthquakes, floods, tornadoes and hurricanes charge the most. For example, in my home state of Florida, which has a high risk for hurricanes, homeowners insurance is the highest the country at about $3,500 a year (which is an extra $291 a month). Thus, when you factor in property taxes ($163/month) and homeowners insurance ($291/month), most people in my home state of Florida are paying an extra $454 a month IN ADDITION TO their monthly mortgage payment.
   

8. Do you have an emergency fund for inevitable maintenance repairs? In addition to paying a monthly mortgage, property taxes, and homeowners insurance, there are other expenses you may have to pay for as well. The biggest of these added expenses is repairs. As you continue to live in the home your air conditioner might need fixing, the plumbing pipes might get clogged, or some other appliance could stop working as smoothly. When you are renting, the owner of the apartment complex covers these costs. When you buy a home, you pay these costs yourself. Unfortunately, these repairs can be expensive and put a serious dent in your pocket. The best way to prepare for these expenses is to set aside money each month in a “repair fund” to reserve for for future repairs and maintenance. Along with paying for repairs, you must also cover the cost of landscaping and general upkeep. These repair and maintenance expenses are not inconsequential and must be factored into your decision to purchase a home.

9. Do you have money saved for furniture and initial expenses? As a general guideline, more space requires more furniture. Unless your parents have extra furniture lying around or franchises with Rooms-To-Go, there is a good chance you will need to purchase more furniture and other items when you first buy your home. Although you would have had to furnish an apartment if you had chosen to rent instead, homes are typically bigger and thus require more “things.” You will need bedroom and living room furniture, decor items, and costly appliances like a washer/dryer and refrigerator. Although you don’t have to purchase all of these items at once and many people host a “housewarming party” to get their friends and family to chip in, the cost of these initial items is rather large and as a homeowner you are responsible for buying most of them.
   

10. Will buying a home actually save you money in taxes? If you are like many young professionals, you may be searching for ways to lower your tax rate. In fact, someone may have mentioned the “mortgage interest deduction” you can get when you buy a home. Although it is true that the mortgage interest deduction can save people money in taxes, this benefit is often overestimated. It certainly does not equate to the amount of money you pay in transactions costs, yearly fees, and added expenses when you purchase a home. Plus, it usually only benefits people who purchase really expensive homes. Let me explain.

    Whenever you pay your mortgage each month the payment includes the principal (the amount you borrowed from the bank) and interest (the fee the bank charged whey they loaned you the money). During the first few years you have a house, the portion of the mortgage that is “interest” is quite high and can often be around 75% of your entire monthly payment. The government allows you to deduct this interest from your taxable income. However, you can only take this deduction if you opt out of the standard deduction and choose to “itemize your taxes.” Most people don’t have an expensive enough house (or pay enough in mortgage interest each year) to make itemizing their taxes a good idea. Plus, even if you were able to take advantage of this tax benefit, it only saves you money at your marginal tax rate. I realize that this is starting to get a bit complicated so I will spare you the details. My point is that unless you are buying a really expensive home, the chance of you saving a lot of money in taxes each year by owning a home is low, especially with the recent changes in our tax code.

To summarize, the decision to purchase a home should not be taken lightly. There are a ton of factors and added costs associated with buying a house that people who rent rarely have to consider. You cannot simply compare the average mortgage price to the average rent price and think you are making a sound financial decision. You have to factor in several other costs such as the down payment (although medical doctors can usually get a pass on this) and high transaction/closing costs that are 3% of the purchase price. You also have to make sure your credit score is high enough, your income in steady enough, and your debt is small enough to get approved for a loan.

Once you’ve done this leg work, you need to factor in annual property taxes (another 1% of the home price), homeowners insurance (another few hundred dollars a month), and inevitable maintenance repairs. Lastly, you should run the numbers and see what purchasing a home really costs, keeping in mind that it may not save you as much in taxes as other people may lead you to believe. After considering all of these factors, you must be honest with yourself and ask: can I truly afford to buy a home.  If the answer is yes, congratulations! If the answer is no, re-evaluate this process next year when you are in a better financial position.

My goal is not to discourage you. I just want to make sure you are aware of all of the financial costs associated with buying a home so that you can make an informed decision for you and your family.

Tell me, do you plan to buy a home or keep renting?