4 Questions For Home Buyers: Part 1

Even thinking about buying a house is an exciting prospect. Actually going about purchasing a home is equally exciting, but perhaps with a few other emotions mixed in. This MFG blog post is meant to help you think through the process a bit and at least help you to start answering four important questions: 

  1. How long am I going to live there?
  2. Do I qualify for government credits?
  3. After I make the down payment, do I have enough savings left?
  4. What home value can I afford?

For the moment, let’s focus on the first question: How long am I going to live there?

Many of us often hear that renting is just throwing away money and that it is better to start building equity in a home. That is true for some, especially after considering how large some rent payments are or the affordability of homes for some individuals and couples. However, even if buying is feasible, we still must consider how long we might stay in a home we purchase. 

According to the Bureau of Labor Statistics, the average employee stays at a job for 4.4 years. Baby boomers stay for seven years on average, but millennials tend to 'job hop' a bit more. A 2012 PayScale report found that millennials stay in their job for less than two years.

In addition, for those who own already, but would have to sell, it is important to note that selling a home is costly, especially considering the six percent realtor fee for Iowa home sellers. To help wrap our heads around the cost of selling a home, let’s work through an example of someone who buys and then sells the home in five years:

     Assumptions:

  • Purchase price: $220,000
  • Down payment: $20,000
  • 30-year mortgage: $200,000
  • Interest rate: 4%
  • After five years
    • Home value has increased 3.5% per year to $261,291
    • Mortgage has been paid down to $180,895

On the surface, $80,396 equity (the worth of the home after five years plus the amount of mortgage paid off) is tantalizing. But, let’s look at the costs of that equity:

     Costs after five years:

  • Total interest paid: $38,184.86
  • Opportunity cost of down payment (if you had invested the $20,000 and earned 5% per year): $5,525.63
  • Sunk cost of insurance and property taxes: $27,955
    • Average annual homeowner’s insurance in Iowa City: $1,511 per year
    • Mortgage insurance (if you did not put 20% down): $1,080 per year
    • Property taxes in Iowa City: $3,000
  • Realtor fee: 6% of $261,291 = $15,677.46
  • Total costs: $87,342.95

On paper equity is $80,396, but the costs of selling a home after five years is $87,342.95. Those costs are driven by interest, realtor fees and the sunk cost of property taxes and insurance.

In sum, if you do not plan to live somewhere for well over five years, buying a home may not be the best choice, especially considering this exercise did not account for the upkeep and renovations on a home (ex. water heaters, furnaces, carpet, paint, etc.).

If you are considering buying a home, but aren’t 100% sure on whether the move is right for you, feel free to reach out to us at MFG. We can help you work through the decision-making process and give you the information needed to make the choice that is best for you.