We have repeatedly been told home ownership leads to a better life. While low interest rates have improved one aspect of affordability, it is wise to run the numbers before making that commitment as there are many variables.Â
We recently counseled a young couple, Matt and Jen. The desired house was $200,000 and they settled upon a 30 year mortgage at 5% interest. Principal and interest payments would run $1,100 per month. They could cover the payment, but not much else.
As we assessed the young couple’s project, we realized they failed to include property taxes.
The average property tax rate in Texas is about 2% per year. That adds about $4,000 per year or $333 per month. Furthermore, this would increase almost automatically reflecting inflation.
Additionally, they would need insurance. Although the national average for homeowners insurance is about $950 per year, Texas and the other Gulf Coast states, are quite a bit more. As such, the average homeowners insurance in Texas is about $1,660 per year or $140 per month.
This number varies a fair amount depending upon size, customization, upgrades, zip code, number of floors, coverage for rare or unusual contents and loss of use.
Then Matt made an interesting comment as he said, “We don’t think we’ll live here more than two years.”
This concerned us as there are a variety of closing costs for a mortgage. Expected costs run between 2% and 5% and Texas is usually at the high end of the range.
Furthermore, this expense is a sunk cost. You won’t get it back. Rather, you must hope your home appreciates in value or payments decrease the amount owed. Otherwise, you could end up owing money back when you sell.
As we explained this, Jen said surely two years’ worth of payments would more than cover previously paid closing costs.
To the contrary, it takes about five years paying on a home before the average owner overcomes closing costs.
Although this disappointed the couple, they were glad they knew this now. It also brought up a good conversation about how long it takes to build equity in a home.
A $200,000 mortgage at 5% on a 30-year fixed amortization requires 15 years of payments before your monthly principal reduction is larger than your interest payment. After 20 years, you still owe $100,000 on the mortgage—and that is before factoring in property tax or insurance.
Additionally, any homeowner needs to recognize they will incur maintenance costs. Obviously, this varies depending upon the age and condition of the home. However, a good budget figure is between 1% and 4% per year. For a $200,000 home this means a maintenance budget between $165 and $660 per month.
After reviewing this, Matt and Jen realized that although the mortgage payment itself was $1,100 per month, the additional carrying costs of about $900 per month took them to $2,000. This was beyond their budget.
Then the conversation shifted as they looked for alternatives.
Consider downsizing. The average house size today is about 2,600 sq. ft. Thirty five years ago the average was only 1,700 sq. ft.—and we had much larger families. For most couples 1,100 sq. ft. is plenty of home.
Increase down payments or make extra payments. A larger down payment or making extra principal payments will build equity more quickly. If Matt and Jen paid an extra $200 per month their 30 year mortgage is reduced by nine years!
Rent. We see more people renting either early in life or in retirement. The cost can be lower without the headaches of having to maintain the property. According to Trulia.com rental prices in San Antonio, Austin, and Houston range from median monthly rentals of $450 to $700 per bedroom. As such, a three bedroom might run $1,300 to $2,100. The older I get the more that renting appeals to me. Evidently, the glamour of fixing toilets and cleaning gutters has lost its excitement.
As with any major financial commitment you must evaluate not only the cost of purchase, but the holding costs, too. There is often a large difference between being able to pay for an item versus truly being able to afford it. With the benefit of an honest evaluation you will be able to determine if conventional wisdom is truly wise.