Should I Rent or Buy a Home?

Finding a home can be a long and arduous process. A person must decided whether renting or buying a home is the right choice for them. Although there is no set answer, there are several factors to take into account before you make your final decision.

First, have you saved enough for a home down payment? With banks requiring anywhere between 5% - 20% of the total home cost as down payment and the average price of a home in America being $341,000 that means you would have to have between $17,000 and $68,000 to put down on a home. Down payment requirements vary from bank to bank and your credit score will weigh heavily on them. Renting often only requires a security deposit of one to two months rent when signing a lease agreement.

Second, have you considered whether you can afford the ongoing expenses from a home ownership versus renting? Depending on where you live, your monthly rent might be smaller or larger than a mortgage payment. But when calculating your monthly expenses from homeownership, don’t forget taxes. You receive a tax deduction for the interest paid on the mortgage, but you also might owe property taxes. Include both. And, don’t forget the upkeep costs associated with home ownership that are required to maintain the house’s value. For the average home built before 1990, budget an additional $75 dollars per month for maintenance. For homes built after 1990, budget an additional $50 per month.

Third, how long do you plan on staying in the residence? If you have a job that requires moving often, it typically doesn’t make financial sense to purchase a home. Not only is your house resale price riskier over shorter periods of time, you often have to pay transfer taxes and other closing costs when you buy or even sell. Typically, renting is the better option if you plan to be in the house for less than five years. But, if you plan to stay in your home for at least five years, buying a home is a good option for building equity, assuming that the house price will likely at least maintain its value over time.

Fourth, lifestyle can greatly impact your decision to rent vs. buy. Often, rentals have strict rules regarding pets and offer less square footage. Also, rentals typically have rules on decorating and the number of people allowed to live in a rented property. Owning allows you to have more free reign over these decisions.

Renting may be a great way to get your feet wet for living on your own, creating a monthly budget and independence. But renting does not always make financial sense. It is important to take a step back, and look at all aspects of your life before making a decision.

Kent Smetters

Kent Smetters is the Boettner Chair Professor at The Wharton School of the University of Pennsylvania, the Interim Faculty Director of the Penn Wharton Public Policy Initiative, and a Faculty Research Fellow at the NBER. He was the former Deputy Assistant Secretary of the U.S. Department of the Treasury, and he subsequently served as a member of the U.S. Congress’ bipartisan Blue Ribbon Advisory Panel on Dynamic Scoring. Kent holds bachelor degrees in Economics and Computer Science from The Ohio State University as well as an MA and PhD in Economics from Harvard University. He previously cofounded a national registered investment advisory firm that built a new technology platform, grew the firm to over 50 advisors and then sold the firm to a large, publicly-traded company. Growing up in a financially poor family, Kent donates his time to “Your Money” to help families work, save and set goals in order to achieve the most in life. Kent is often cited in major news outlets.

How Much House Can I Afford?

A home tends to be on the of the biggest investments made. So when you are wondering which home to buy, it is important to know how much you can afford. It is often said that you should buy a home that is no more than two and a half times your base annual salary. However, it is imperative that you don’t use that general rule without taking your financial and personal resources into account. Many people end up struggling to meet the financial demands of home ownership. But by doing some calculations in advance, you can be assured that your home will be a source of pleasure and memories and not a poor investment.

You can use one of the many calculators online to estimate what your mortgage payment would be each month. Some of the calculators (links are provided below) will tell you how much home you can afford based on your salary, while others will estimate what your monthly payment would be. Both of these numbers are totals that you need to be both familiar and comfortable with. It is important to remember to include your Personal Mortgage Insurance (if your down payment is less than 20%), which can add upwards of $250 to your monthly payment. You also need to include your insurance payment. Obtaining quotes from several insurance companies will give you an estimate on what your payment will be. While some people choose to pay their insurance twice a year, others opt to pay the premium on a monthly basis. Some mortgage companies will even add this into your payment for you.

Once you have your base payment, you will need to figure out what your taxes will be on the home you are looking to buy. Most home listings give you a general idea of what the taxes are, however it is extremely important to confirm that figure with the tax assessor. The tax figure may include exemptions or discounts that the previous owners qualified for that a new owner may not. Taxes are usually paid to the mortgage company and kept in an “escrow” account, the mortgage company then will pay the taxes on the property from that account. Once you have an accurate number for the annual taxes, you should divide that number by 12 (months) and add that to your monthly housing payment. It is also important to

Now that you have a general idea (remember that interest rates and credit scores may make your payment fluctuate), it it time to look at the rest of your budget. Listing your monthly payments and expenses, along with the estimated mortgage payment will help you visualize if you can, in fact, afford the home you are looking at. You want to be sure that the home you’re purchasing will still allow you to make your payments and meet other financial obligations that you have. Once you own your home, is important to create a home budget (link to previous article) to keep track of and stay on to your budget.

 

Kent Smetters

Kent Smetters is the Boettner Chair Professor at The Wharton School of the University of Pennsylvania, the Interim Faculty Director of the Penn Wharton Public Policy Initiative, and a Faculty Research Fellow at the NBER. He was the former Deputy Assistant Secretary of the U.S. Department of the Treasury, and he subsequently served as a member of the U.S. Congress’ bipartisan Blue Ribbon Advisory Panel on Dynamic Scoring. Kent holds bachelor degrees in Economics and Computer Science from The Ohio State University as well as an MA and PhD in Economics from Harvard University. He previously cofounded a national registered investment advisory firm that built a new technology platform, grew the firm to over 50 advisors and then sold the firm to a large, publicly-traded company. Growing up in a financially poor family, Kent donates his time to “Your Money” to help families work, save and set goals in order to achieve the most in life. Kent is often cited in major news outlets.

Creating a Home Budget

Creating a home budget is essential for keeping your finances and sanity in check. In order to create a functional budget, you have to be honest with yourself about the amount of money coming in and out- keeping a log of money spent is a good way to see where your money is going.

The first step of creating your household budget is to list all of the household income. One can do this with a simple notebook and pen, a computer program such as Excel, or an online budgeting tool that can be found by a simple keyword search. Be sure to account for all sources of income including, job salary, an unemployment or government benefits, alimony, child support, etc. Once you have all of your income sources listed, add them up!

The second step of creating your budget is to add up all of your expenses. This is the area that tends to be a true realization to people- seeing all of your expenses written out in front of you can be a true eye opener. It is important to remember all of your expenses- mortgage/rent, car payments, all utility payments, food, entertainment, etc. In addition to these obvious expenses, it is ideal to also list your smaller purchases- spending $3 a day on that coffee you grab on the way to work? That’s $15 a week,  $60 a month, or $720 a year!  Being honest with yourself will help you to create a true picture of your financial situation. Once you have all of your expenses listed, find the sum of them. Take the sum of your expenses and subtract that from your monthly income. Hopefully, your income is a lot more than your expenses.

Another necessity for any home budget is an emergency fund. When you’re taking care of a home, things break, appliances age, roofs leak and the unexpected can occur, well- when you don’t expect it. It is important to keep an emergency fund for these occurrences. While there are several theories on the amount one’s emergency fund (ranging from a total of three months worth of expenses to a year’s worth), starting with a small, obtainable goal is a smart decision. Once you have your monthly expenses subtracted from your income, you will see how much money you have left over. One should take a percentage of this money and put it into an emergency account, which is kept separate from you’re spending money, but that will accessible when it is needed.

While earning more than you spend is usually the goal, many people realize that their earnings do not always support their spending habits, but by seeing your spending tendencies on paper, it will help you figure out where to save money. Many utilities (cell phone, cable, internet), along with insurance (both home and auto) are competitively priced and by simply making phone calls to these companies to compare prices, one can save several hundred dollars per year. Lastly, another budgeting tip that works well for a lot of people is to use cash and avoid debit and credit cards. Using cash tends to make you more aware of what you’re spending, instead of mindlessly swiping a card for daily incidentals.

While creating an honest and true household budget can be a scary task, tackling it will help you realize your financial state and hopefully change it for the better.

Kent Smetters

Kent Smetters is the Boettner Chair Professor at The Wharton School of the University of Pennsylvania, the Interim Faculty Director of the Penn Wharton Public Policy Initiative, and a Faculty Research Fellow at the NBER. He was the former Deputy Assistant Secretary of the U.S. Department of the Treasury, and he subsequently served as a member of the U.S. Congress’ bipartisan Blue Ribbon Advisory Panel on Dynamic Scoring. Kent holds bachelor degrees in Economics and Computer Science from The Ohio State University as well as an MA and PhD in Economics from Harvard University. He previously cofounded a national registered investment advisory firm that built a new technology platform, grew the firm to over 50 advisors and then sold the firm to a large, publicly-traded company. Growing up in a financially poor family, Kent donates his time to “Your Money” to help families work, save and set goals in order to achieve the most in life. Kent is often cited in major news outlets.

ARM vs. Fixed Rate Mortgages

When researching and shopping for a mortgage, one major factor is the interest rate of the loan. The interest is basically the percentage of the borrowed money you must pay each year on the outstanding balance in return for the bank allowing you to borrow the money. There are two types of mortgages: a fixed rate mortgage and an adjustable rate mortgage. Being a knowledgeable consumer will allow you to save money in the long run.

A fixed rate mortgage is one that comes with an interest rate that will remain the same throughout the life of the loan. This type of loan allows the homeowner to rest comfortably, knowing that their monthly payment will remain the same, regardless of any fluctuations in the economy that cause interest rates to rise. These mortgages are simple to understand. Also, with interest rates at historic lows, using a fixed rate mortgage to lock-in a rate ensures that you will have an “inflation hedge” since your house value may rise with inflation but your fixed payment does not. An online calculator can help you estimate the monthly payment.

An adjustable rate mortgage, otherwise known as an ARM, is a mortgage whose interest rate fluctuates based on the economy. Typically, ARMs are cheaper in the beginning, allowing people to purchase more expensive homes than they could with a fixed rate mortgage. But these mortgages adjust with interest rates, so your payment could rise or fall with interest rates. ARM mortgages are also difficult to understand and their terms are often confusing to an average homebuyer.

 Why might you choose an ARM despite the risks? If you’re only planning on staying in a home for less than five years, then an ARM would make sense because the first few years of the payment are less expensive. Plus, a short term stay in a home would mean that you would probably be moving before the interest rate adjusts. However, it’s important to calculate what your payment would be if interest rates rise sharply. Would you still be able to afford the payment with a significant increase? If you answered “no” to either question, then go with a fixed rate.

Kent Smetters

Kent Smetters is the Boettner Chair Professor at The Wharton School of the University of Pennsylvania, the Interim Faculty Director of the Penn Wharton Public Policy Initiative, and a Faculty Research Fellow at the NBER. He was the former Deputy Assistant Secretary of the U.S. Department of the Treasury, and he subsequently served as a member of the U.S. Congress’ bipartisan Blue Ribbon Advisory Panel on Dynamic Scoring. Kent holds bachelor degrees in Economics and Computer Science from The Ohio State University as well as an MA and PhD in Economics from Harvard University. He previously cofounded a national registered investment advisory firm that built a new technology platform, grew the firm to over 50 advisors and then sold the firm to a large, publicly-traded company. Growing up in a financially poor family, Kent donates his time to “Your Money” to help families work, save and set goals in order to achieve the most in life. Kent is often cited in major news outlets.