When you’re deciding on the home that’s right for you, you can never ask too many questions.
Do you think you’ve accounted for all your monthly expenses? Better not forget hidden costs. Have you decided you can live with a shorter-term, higher-cost mortgage? Remember that emergencies can crop up and devastate your finances.
Did you see a house that you can’t live without, no matter what the cost? Keep in mind that you may have to ratchet down your lifestyle to afford it.
“Buying a home is an emotional issue and an economic issue,” says John A. MacIntyre, a financial planner at Armstrong, Welch & MacIntyre in Washington, D.C. “You have to separate the two. Before you run away with your emotions, you need to look at your dollars.”
So how can you be sure a home is the right deal for you?
What works for a young, childless couple won’t necessarily work for a single, highly mobile salesperson, an established family with children or a couple of empty-nesters looking to retire.
But investment advisers agree there are common questions you should ask, no matter what your situation. Here’s a look at a few:
– Buying or Renting?
Conventional wisdom holds that buying is always better than renting. Rent is money thrown down the drain, while ownership generates valuable home equity and offers tax breaks.
But buying isn’t always the best bet, at least in a strictly financial sense, experts say.
Take the situation of the first-time home buyer. Ownership bears hidden costs that can strain household finances, including insurance, maintenance, lawn care and trash service. A new house also has to be furnished.
Kathy Stepp, a financial planner in Overland Park, Kan., recommends adding an additional 15 percent in miscellaneous expenses to monthly payments when considering finances.
Aside from lower monthly costs, renting also frees you from a big down payment. That money can then be put to work in other investments.
Other factors can also tip the scales toward renting.
“If you have a great rental, modest rent and a great location, and it’s perfect in all other respects, you’re smarter not to get into fire insurance and replacing water heaters and all the other things that eat into your take-home pay,” says Diane P. Blakeslee, financial planner and president of a brokerage firm in San Diego.
Instead of assuming buying is better, prospective homeowners should look at their needs, financial advisers say. Buying a home may make sense for a person or family planning to stay for a considerable length of time in the same city. Also, home ownership ensures families a permanent place if they find a neighborhood with the schools and atmosphere they want.
Financial planners also urge clients not to look at their homes the way they look at their retirement plans or stock portfolios.
“It’s not an investment,” says MacIntyre. “It’s the biggest purchase you’ll ever make, but don’t bet on it to make money.”
Why not? For starters, consider home prices, which are tied to isolated local whims as well as to national economic trends.
While the entire nation could see healthy numbers, one business closing or zoning change in your area could be enough to wipe out any appreciation. Even new-home developments nearby could stem housing demand.
Despite robust economic results nationally during the past few years, New England homeowners on average still haven’t recouped home-value losses since 1990, while some unlucky Californians have seen home values drop below their mortgage balances.
The tax benefits are also questionable. Some tax experts say more-affluent homeowners should get the biggest mortgage they can, because the interest deductions are more valuable to those in higher tax brackets. But tax benefits could easily be lost if regulations change.
Plus, because of the alternative minimum tax, which applies to many affluent Americans, some taxpayers might not be able to deduct local taxes, depending on what other itemized deductions they take. And some locales might levy such low taxes that any tax benefit is negligible.
“Never let the tax tail wag the dog,” warns Blakeslee.
– How Much House?
Inevitably, home buyers want to buy as big a house as possible. But, advisers say, this attitude mainly benefits unscrupulous real estate agents and mortgage lenders, who will let home buyers overextend themselves to line their own pockets.
Financial planners recommend that both first-time home buyers and current homeowners “trading up” to a bigger house get a smaller mortgage than their lender tells them they can afford.
William J. Goldberg, a partner with KPMG Peat Marwick in Houston, says brokers often approve loans that would eat 35 percent or more of a household’s income. But, he tells clients, monthly mortgage payments, including property taxes and insurance, shouldn’t exceed 28 percent of gross monthly income.
Brokers, he notes, don’t consider a household’s need for such necessities as saving for education or retirement.
Stepp seconds the idea of thinking small.
“I’ve had clients, literally in tears, who wanted that big house and got it,” she says. But “if you’re the kind of person who needs the best car or the best stereo, you could be in tears, too, because you don’t have enough money to pay the bills.”
Apart from basic lifestyle questions, borrowers should also keep in mind that unforeseen circumstances–such as an accident or the loss of a job–could suddenly reduce income.
“Can you pay your mortgage then?” asks Goldberg.
– What Kind of Mortgage?
On this question, experts differ. Larry W. Carroll, a Charlotte, N.C., financial planner, recommends taking out a 15-year mortgage rather than the traditional 30-year loan.
While the rate of a conventional 30-year fixed-rate mortgage averaged 7.45 percent in October, according to HSH Associates, a Butler, N.J., research firm, the rate of a 15-year fixed mortgage averaged 7.1 percent.
Based on a hypothetical $200,000 mortgage with a 20 percent down payment, the 15-year mortgage would save a homeowner about $140,000.
“If you’ve got the ability to pay, the 15-year mortgage is a better deal,” says Carroll.
But the “ability to pay” is crucial. In the hypothetical mortgage, you’ll be paying several hundred dollars a month more for the 15-year.
Unsuspecting home buyers “jump into a 15-year mortgage, but they don’t realize that December is Christmas month, or July is vacation month,” says Peter Bugnacki, a Dallas financial planner. “They find themselves broke.”
Instead, Bugnacki recommends accelerating payments on a 30-year mortgage. With the hypothetical 30-year mortgage, a person could save about $50,000 in interest costs, and pay off the mortgage sooner, if he or she makes one extra monthly payment a year.
Carroll, who predicts interest rates will stay low for some time, says homeowners should also look at adjustable-rate mortgages, which track current interest rates. For homeowners who want to build some extra savings, he suggests estimating what you would have spent on a fixed-rate mortgage, subtracting your actual monthly payments from that, and investing the difference.
But that only works if rates stay low. If they go up, homeowners can get burned.
Says MacIntyre: “If Alan Greenspan doesn’t know what interest rates will do, then neither do you.”
Homeowners who don’t plan to stay in their home more than a decade, or who want relief from what they think are temporarily high interest rates, can opt for a “balloon” mortgage, which offers a flat rate for the first several years of the mortgage but adjusts afterward unless they refinance.
Evelyne Lang, a saleswoman for an environmental lab, bought her $310,000 Redwood City, Calif., home with a balloon mortgage that has a 7.25 percent rate for its first seven years. When she bought the home last year, mortgage rates were around 8.5 percent and were rising.
“Those monthly payments would have been a little higher than I wanted,” she says.
Whatever the borrower decides, financial professionals advise that home buyers shop around.
