“Don’t wait to buy real estate; buy real estate and wait.”
A home is the biggest purchase most Americans will ever make. A house blurs the line between “asset” and “liability,” as it is usually both. And of course, a house is more than an investment—it is “home sweet home.” This makes financial planning to buy a house quite a challenge.
It is also a key to building wealth. Done wisely, purchasing a home can make a seven-figure difference to your future bottom line. Let’s look at the why’s—and how’s—of buying a home. (Up your home-buying game ever further by reading our Ultimate Guide to Financial Planning Myths.)
Why Homeowners Are Wealthier
Homeownership rates have drifted downwards, from a high of about 70% just prior to the Financial Crisis to a current rate of approximately 64%. For many, it just seems easier and cheaper to rent—especially as real estate prices rise. And yet, the strong correlation between home ownership and wealth-building is impossible to ignore.
The Federal Reserve conducts their Survey of Consumer Finances every three years, which collects data across all economic and social groups. The latest survey data released in 2017 for the 2014-2016 period reveals a shocking trend. The 2016 median net worth of homeowners was $231,400—a 15% increase since 2013. However, during the same period, the median net worth of renters decreased by 5% ($5,200 today compared to $5,500 in 2013).
The bottom line? The average net worth of a homeowner is more than 44 times greater than that of a renter.
Why do homeowners have so much more wealth than renters? The truth is that it’s very difficult to build wealth when 37% of your income—the average chunk Americans spend on housing, according to BusinessInsider.com—is disappearing down a black hole. For many, this can add up to millions of dollars spent. This is not hyperbole.
The average U.S. rent payment is $1050/month. (Obviously, if you live in a major city, that sort of rent is a fantasy.) Let’s say you paid rent for 60 years—your 20’s to your 80’s—beginning at $1050. Allowing for just 3% inflation, you’ll end up throwing over $2 million dollars down the rent drain. We used a Truth Concepts calculator (one typically used to calculate savings rather than debt) to demonstrate the math:
Two million, thirty-eight thousand, one hundred and sixty-eight dollars gone—with nothing to show for it. Using the same conservative 3% appreciation rate over 60 years, we can also calculate what a $200k starter home would be worth in 60 years:
Instead of losing more than $2 million dollars to a landlord, the owner of a starter home could one day own a million dollar asset. (In the same way, homes bought decades ago for $40k are now worth multiple six figures.)
Not everyone can buy a home—it requires (usually) a down payment, decent credit, and sufficient income. For those who can qualify, here are some tips from Busting the Interest Rate Lies. The following is an adapted excerpt from the “The Savvy Home Buyer’s Guide” chapter found in the back of the book.
Purchasing a Home
There are many things to consider when purchasing a home. You’re not just purchasing a house or a condo, you are also (typically) obtaining a mortgage and signing a long-term financial contract.
Assessing the Down Payment
With real estate, you can control a $200k real estate asset with $40k, $10k, or even less in some cases! That’s because a mortgage allows you to use “OPM,” or “other people’s money” when you purchase a house. Whether you put nothing down or 20% down, the value of the home does not change, only your rate of return.
A surprising truth about mortgages is this: the bigger the down payment, the lower your rate of return on your investment! This is because a lower down payment allows you to increase your leverage. Real estate investors understand this, and we can demonstrate it on the Truth Concepts Real Estate Analysis calculator. (We also demonstrate this mathematically in Busting the Interest Rate Lies, along with a surprising comparison of 15-year vs. 30-year mortgages that may challenge your assumptions.)
Many financial gurus teach home buyers to not even THINK of buying a home until they save a 20% down payment. Meanwhile, the home you want could be appreciating while you’re trying to save up your 20% down payment! We recommend escaping the rent trap as soon as you are able to do so with payments you can manage.
Choosing a Mortgage
If you qualify for a zero down VA loan (Veteran’s Administration) or a nothing down USDA loan (U.S. Department of Agriculture mortgages for more rural areas), you may want to take advantage of it! These loans have low or no mortgage insurance charges and competitive interest rates.
FHA loans are easier to qualify for, credit-wise, but are unfortunately laden with fees, especially since the government got stuck guaranteeing so many failed mortgages in the Great Recession.
Conventional loans often have the lowest interest rates, as compared with FHA, VA, and subprime options. (Subprime loans are for people who don’t qualify for other mortgages and have much higher interest rates. It’s usually preferable to just wait and get qualified.)
The downside of most loans is that you’ll have to pay mortgage insurance unless you’ve saved that 20% down payment. Yet it makes no sense to waste $1050 on rent to avoid wasting $150 on mortgage insurance (and it can often be dropped in a few years.)
Getting the Best Deal on a Mortgage
When weighing your choices, ask friends for recommendations and check with both a brokerage and a bank. Competition and options can be good for you as a buyer.
There are also usually options to lower or avoid closing costs, just as there are options to pay “points” to obtain a lower rate. Run the numbers to consider the impact over 5 or 10 years before deciding to do either, both in terms of money-out-of-pocket and how your equity will be affected. Even better… negotiate for the seller to pay closing costs!
Make it a priority to get your credit score as high as it can be prior to getting a mortgage. The difference in the mortgage interest rate you’ll qualify for with a 620 FiCO score and an 820 FICO score is enormous.
If you obtained a $200k mortgage loan at 5% interest, you might have a PITI payment (principle, interest, taxes and insurance) of about $1324. However, a borrower with poor credit could end up paying as much as 10% interest for a loan, or $1718 per month – a $570 a month difference! Over 30 years, the credit-challenged borrower will pay a stunning $141,840 more than the good credit buyer will pay.
Be sure to get prequalified before you start shopping, and stay within the price range you are qualified for. If necessary, clean up your credit to raise your score. Paying down credit card balances, making payments on time, paying off collections, and disputing negative and inaccurate information can work wonders to raise a score. If your credit history is lacking or non-existent, work to establish positive credit through secured credit cards, department store cards, and/or an auto loan.
Finding a Home
There is much to consider when buying a home! It can be overwhelming, but when you find the right one, you’ll be grateful.
This might sound obvious, but be sure to buy a house you can afford! Too many people are “mortgage poor” because they take on a mortgage that doesn’t allow them to save or take vacations, or even make needed repairs to the house!
This is another reason why a smaller down payment can be savvy… it allows you to keep more in savings so that IF you need a new toilet or even a new roof, you have the liquidity to make needed home repairs. Ample savings also allow you to handle other emergencies – or opportunities – without worrying about how to make the mortgage payment.
There is nothing wrong with “stretching” a bit to get yourself into a home, just make sure it is a stretch you can handle. Leave yourself breathing room to save and invest rather than buying the most expensive home you can qualify for.
Go For Upside Potential.
Don’t buy the best home in the neighborhood. Is the home you want larger and nicer than those around it? Unless it is an excellent neighborhood, it might not be the best investment. The surrounding home values will be less and may slow the appreciation of your home or make it hard to sell. On the other hand, purchasing a smaller home and/ or a cosmetic fixer in an excellent neighborhood gives you lots of upside potential.
Get Expert Assistance.
Some buyers think they are going to save money by finding a home themselves instead of having a realtor help them. There are risks to being a “do-it-yourself” home buyer. Practices and laws vary from state to state, but often the terms of a home listing with a real estate brokerage specify that if the buyer has no realtor, the listing agent (who represents the SELLER) receives the commission that the buyer’s agent would have received… plus the listing agent commission! The listing agent can collect both commissions, however, they can NOT represent the best interests of the buyer alone! Imagine walking into court and finding that the opposing teams counsel is also representing YOU! You’d feel like there was no one looking out for your best interests.
While real estate transactions aren’t necessarily adversarial in nature, unless you are a real estate expert, you’ll want someone on your side. It’s not essential that this person is a realtor. An experienced real estate investor, contractor, appraiser, attorney and other professionals can also offer great advice. Just make sure you have a person or a team who can help ensure that –
- You aren’t overpaying for the home or under-estimating potential problems.
- You have the proper earnest money and mortgage pre-approval in hand.
- The contract is a legal document that protects your liability (even your earnest money) should the deal not close for some unexpected reason.
- All of the appropriate inspections are done, not just an appraisal (which is for the lender’s benefit).
- Repairs are negotiated or the price renegotiated if serious issues are found, or, at the very least, you have an “out” if you no longer want to purchase the home after a poor inspection.
- You receive sound advice about the current market if you have to compete against other buyers.
Time to shop!
Now that you have your preapproval and your team, it’s time for the fun part! Make a list of what’s important to you in a home… your “must haves,” “would like to haves,” and “can’t haves” in a home. Then go house-hunting. Be open minded, consult your advisors, and listen to your gut.
How Does Real Estate Fit Into YOUR Financial Picture?
Already have a house? Beyond home ownership, investing in real estate is a powerful, proven way to build wealth. Consider these ten ways to invest in real estate to diversify your portfolio or increase your income from assets.
The second of our Principles of Prosperity is to SEE your finances from a Big Picture, or macro-economic point of view. Your home, your savings, your investments, and your insurance are all connected, because the money comes from the same wallet!
For more on our 7 Principles of Prosperity™, pick up your complimentary Prosperity Accelerator Pack today.