Renting vs. buying: Where do you land?

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You’ve always been told that owning a home is the ultimate American dream.  Imagine renovating your master bath into a mini spa or choosing your favorite appliances for your dream kitchen. Or just getting to repaint whatever room you want. Plus, there’s the potential for financial gain when you own. But renting has its own advantages: flexibility, a smaller financial commitment and the chance to try before you buy. So when do you know it’s time to take the plunge on a purchase? Answer these questions to see which side of the rent vs. buy debate you might land on: Why do you want to buy?Sure, owning a home might be the great American dream — but is it your dream? For some, the idea of a home where you can raise a family, be close to schools and build a community is enticing. For others, buying is a great investment. But for many, it’s about freedom: the ability to keep pets, renovate and be independent. Will you stay in the area?No one has a crystal ball — but knowing how long you plan to live in an area can help as you consider the pros and cons of buying. Generally, longer stays align with purchasing.  If the thought of travel fills you with more passion than the idea of settling down in your dream property, you may not be ready for your forever home. But there’s always the possibility of turning your house into an investment property.  What can you afford?While renting usually costs less in the short term than purchasing property, owning a home can build long-term net worth. A rent vs. buy calculator can help you understand the costs of each option. Don’t have the deposit for your dream home now? That doesn’t mean you can’t buy. We can work together to find affordable homes, and there are plenty of low or no down payment mortgage options. Have questions about buying or financing your purchase? Let’s discuss your next steps.

Invest in Equity Build-up

Equity build-up could be one of the biggest advantages to buying a home.  There are two distinct dynamics that take place to make this happen: each house payment applies an amount to reduce the mortgage owed and appreciation causes the value of the home to go up.

It is easy to make a projection based on the type of mortgage you get and your estimation of appreciation over the time you expect to own the home.  Even conservative estimates can produce impressive results.

Let's look at an example of a home with a $270,000 mortgage at 4.5% for 30 years and a total payment of $2,047.55 payment including principal, interest, taxes and insurance.  The average monthly principal reduction for the first year is $362.98. If you assume a 3% appreciation on the $300,000 home, the average monthly appreciation is $750 a month.

The total payment of $2,047.55 less $1,112.98 for principal reduction and appreciation makes the net monthly cost of housing, excluding tax benefits, $934.57.  If this hypothetical person was paying $2,500 in rent, it would cost them $1,565.43 more to rent than to own.  In the first year, it would cost them over $18,000 more to rent.

Together, the items in this example contribute over $1,100 to the equity in the home .  This is one of the reasons a home is considered forced savings.  By making your house payments and enjoying increases in value, the equity grows and the net cost of housing decreases by the same amount. 

In this same example, the $30,000 down payment grows to $133,991 in equity in seven years.  While this is equity build-up, the extraordinary growth is attributed to leverage.  Leverage is an investment principle involving the use of borrowed funds to control an asset.

To see what your net cost of housing and the effect of leverage will have on a home in your price range, see the Rent vs. Own.  If you have questions or need assistance, contact me at (256) 705-0733.

America Still Considers Real Estate the Best

35% of respondents, in a recent annual Gallup poll that dates back to 2002, identified real estate as the best long-term investment option compared to 27% who identified stocks.

The top choices included real estate, stocks, savings accounts and gold.  Even with the remarkable prices of the different U.S. stock indices recorded in 2019 through April and May, homes have the highest confidence in the minds of the respondents.

This seems to be based on the stability of the housing market and the expectation that home prices will continue to rise.  Homeowners build equity from both appreciation as well as reducing principal with each payment made. These same factors exist for investors of rental homes in predominantly owner-occupied neighborhoods.

Real estate has another dynamic working to produce favorable investment results due to leverage.  Leverage occurs when borrowed funds are used to control an asset.  When the borrowed funds are at a lower rate than the overall investment results, positive leverage occurs which can increase the yield from an all cash investment.

Gold and savings accounts must be funded with cash.  The maximum borrowed funds allowed for stocks is 50% and generally, at a rate higher than typical mortgage rates.

Homes are a particularly attractive investment because you can enjoy them personally by living in them.  The interest and property taxes are deductible and gains on the profit are excluded up $250,000 for single taxpayers and $500,000 for married taxpayers filing jointly. 

Many people consider an investment in a home for a rental property an IDEAL investment: Income, Depreciation, Equity Build-up & Leverage.

If you have questions or are curious about the process, contact me at Bob@BobGifford.com or (256) 705-0733.

Building Equity

Owning a home is the first step to building equity.  Tenants build equity but not for themselves; they build it for the owners.

Equity is the difference in the value of the home and what is owed on the home.  There are two dynamics that cause this to grow: appreciation and principal reduction.

As the home increases in value, it is said to appreciate.  Various authorities will annualize an appreciation rate based on average sales prices from one year to the next.  Since appreciation is based on supply and demand as well as economic conditions, it will not be the same year after year. 

If you looked at a ten to twelve-year period, some would be higher than others and there may even be some individual years that it is flat or even declined.  For the most part, values tend to appreciate over time.

Most mortgages are amortized which means that a portion of the payment each month is applied to the principal in order to pay off the loan by the end of the term.  A $300,000 mortgage at 4.5% for 30 years has $395.06 applied to the principal with the first payment.  A slightly larger amount is applied to the principal each following month until the loan is paid with the 360^th payment.

If additional principal payments are made, it will save interest, build equity faster and shorten the term of the mortgage.  Using the previous example, if an additional $250.00 principal contribution was made with each payment, it would only take 270 payments to retire the loan instead of 360.  It would save $69,305 in interest and shorten the mortgage by 7.5 years.

To see the dynamics of equity due to appreciation and principal reduction, look at the Rent vs. Own.  To see the effect of making additional principal contributions on your equity, look at the Equity Accelerator. 

Taxes and the Homeowner

Whether you're an owner now or expect to be one in the future, it is important to be familiar with the federal tax laws that affect homeownership.  Since personal income tax was enacted in 1913 with the 16^th amendment, homes have had preferential treatment.

The mortgage interest deduction is based on up to $750,000 of acquisition debt used to buy, build or improve a principal residence.  In addition to the interest, the property taxes are deductible, limited to the new $10,000 limit on the aggregate of state and local taxes (SALT).  The taxpayer may also deduct interest and property taxes subject to limits on a second home.

Homeowners can decide each year whether to take itemized personal deductions or the allowable standard deduction which was significantly increased under the Tax Cuts and Jobs Act of 2017.

Single taxpayers may exclude up to $250,000 of capital gain on the sale of their home and up to $500,000 if married filing jointly.  They must have owned and lived in the home for at least two of the last five years.  For gains more than these amounts, a lower, long-term capital gains rate is paid rather than one's ordinary income tax rate.

Capital improvements made to a home will increase the basis and lower the gain.  Homeowners are probably familiar that large dollar expenses like roofs, appliances or major remodeling are capital improvements.  However, many lower dollar items may also be considered improvements if they materially add value or extend the life of the property or adapts a portion of the home to a new use. 

Homeowners are urged to keep records of money they spend on the home that they own over the years so that their tax professional can decide at the time of sale what they must report to IRS.

You can download a helpful Homeowners Tax Guide that explains in more detail and includes a worksheet to keep track of the basis of your home and capital improvements.

 

Comfort Systems

Heating and air-conditioning are frequently referred to as the "comfort systems."  If one has gone out in the dead of winter or the heat of summer, lack of comfort becomes a primary concern.  Regular maintenance with a HVAC checklist is something that homeowners can do themselves to ensure that the units operate properly.

Periodically

• Change your filter every 90 days; every 30 days if you have shedding pets. 
• Maintain at least two feet of clearance around outdoor air conditioning units and heat pumps.
• Don't allow leaves, grass clippings, lint or other things to block circulation of coils.
• Inspect insulation on refrigerant lines leading into house monthly and replace if missing or damaged.

Annually, in spring

• Confirm that outdoor air conditioning units and heat pumps are on level pads.
• Pour bleach in the air conditioner's condensation drain to clear mold and algae which can cause a clog.
• Avoid closing more than 20% of a home's registers to keep from overworking the system.
• Replace the battery in the home's carbon monoxide detector.

While using this list will provide some things that may impede the comfort system's proper performance, it is recommended that you have your units serviced annually by a licensed contractor.  Furnaces should also be inspected for carbon monoxide leaks. Preventative maintenance may help avoid costly repairs.

One Loan for Purchase & Renovations
The FNMA Home Style conventional mortgage allows a buyer to purchase a home that needs renovations and include them in the financing. This facilitates the purchase of the home and the renovations in one loan rather than getting a separate second mortgage or home equity line of credit.