#Buy or Rent a House
Meet Stephany. Stephany has been renting an apartment with her wife Olivia for the past seven years. Recently, Olivia has made it clear to Stephany that she wants to move to the suburbs where there are better schools for their twin girls. While this appeals to Stephany, there’s just one problem. She’s just not sure whether or not she should buy or rent a home. What should they do? Luckily for Stephany, we’ve got her covered. The first thing Stephany needs to understand is that buying a home is often more expensive than renting one. Stephany is stunned.
Why is that? Well, the reason is simple. In addition to a hefty down payment, large monthly mortgage costs and the one-time closing fees associated with buying a home, you’ll also have to foot the expenses your landlord is currently covering, like maintenance, property taxes, and insurance. As you can imagine, this can lead to a pretty expensive monthly payment relative to renting. Plus, residential real estate isn’t really a very good of an investment. From 1890-1990, home prices on average only increased about 0.3% a year after inflation. To put this in context, the U.S stock market returns about 7% a year after inflation on average.
This huge difference allows a renter to build wealth more easily than a buyer. All the renter needs to do is take the cash they’d save by renting and invest it with a robo-advisor for a 7% post inflation return. If that sounds difficult, don’t worry, our two videos “How to Invest” and “401(k) and IRA 101”, will teach you everything you need to know. By now, rather understandably, Stephany is confused. Everyone has always told her that buying a home is a great move.
Were they all just wrong? The response is simple. Of course not. Homes do have value: their loan interest is tax-deductible, they can provide a stable place to raise a family, and they can provide their owners with flexibility and a strong sense of pride. The trick is to avoid deluding yourself into thinking buying a home is always a slam-dunk financial decision. It’s just more complicated than that. That’s why we highly recommend calculating the financial tradeoffs using our recommend calculator. That way, you’ll be able to understand the full scope of the situation and make an informed decision. Hopefully you and Stephany now better understand the rent vs. buy decision. Be sure to check out our next video, which covers the basics of mortgages, and be sure to check out our website, where you can find great real estate agents, mortgages, and more educational content.
# Mortgages 101
Meet Stephany. Stephany has been renting an apartment with her wife Olivia for the past seven years. Recently, Olivia has made it clear to Stephany that she wants to move to the suburbs where there are better schools for their twin girls. Stephany agrees with Olivia, and has just watched our video “Rent or Buy a Home?”, and understands that buying a home is the right choice for her.
There’s just one problem: Stephany can’t afford to buy a house on her own. What should she do? Well, luckily for Stephany, there exists a ready-made solution to this problem: mortgages. Mortgages are just loans, and like most loans, they offer Stephany a fixed amount of money at a certain interest rate for a set period of time. However, unlike most loans, mortgages come in three distinct flavors: Fixed-rate, which have fixed interest rates. ARM, which have adjustable interest rates. And hybrid ARM, which have fixed rates in the beginning of the loan, and then adjustable rates by the end. Mortgages are also unique in the fact that they’re always collateralized by a house, which the bank can take if Stephany doesn’t repay her loan.
Finally, mortgages also come with three rather unique expenses. The first is closing costs: a group of fees charged by the lender when creating the loan. These fees generally range between 2 to 5% of a home’s purchase price, but can be even more if you chose lower your loan’s interest rate by buying what are called discount points, each of which are worth 1% of the loan balance.
The second expense is property tax, which is a tax based on a percentage of your home’s market value. For example, if your local property taxes are 3%, and your home is worth about $100,000, you’d pay $3,000. The last expense is insurance, and it comes in two forms. The first is homeowner’s insurance. This insurance is required to get a mortgage, and will protect Stephany in the event that her home is damaged, or someone is injured on her property.
For more details on this, be sure to check out our video “Homeowner’s Insurance 101”. The second form of insurance is private mortgage insurance, or PMI. This is a monthly fee lenders charge to offset the risk of the borrower not repaying the loan. While that can get expensive, PMI is not a universal requirement; as only those with less than a 20% down payment are forced to get it. But wait, hold up. What is a down payment? Well, generally when purchasing a home, lenders will require people to use a combination of both their own money, called down payment, and debt.
For example, if Stephany wanted to buy a house worth $100,000, and was asked to put 20% down, she’d pay $20,000 and the lender would cover the rest. While this certainly sounds expensive: a 20% down payment remains the gold standard in the industry for three good reasons: One: You’re far more likely to be approved for a mortgage. Two: You can avoid the monthly PMI fee.
And three: Lenders will offer you a lower interest rate. However, if Stephany can’t afford a large down payment, she can still apply for a FHA loan. These are loans issued by private lenders but insured by the government, which translates into much lower credit score and down-payment requirements, as little as 3.5%. Hopefully you and Stephany now have a better understanding of how mortgages work. Be sure to check out our next video, where you learn how to actually get a house and a mortgage, and be sure to check out our website, where you can find great real estate agents, mortgages, and more educational content.