Talk to almost any real estate agent around the country and the agent will likely tell you there’s no better time to buy that starter home, especially with mortgage rates at their lows for the year. The trouble is, that first home could be a million dollar starter home if you’re looking to locate where there are good schools, low crime and balmy breezes.
In reporting this story, MyBankTracker hasn’t lost its mind, but perhaps, the economy, or to be more specific, the real estate market has. Take Southern California, where we have a regional office. Plain old vanilla homes sell for a million or more. For example, on Aug. 8, a 2-bedroom, 1.5-bath home totaling 1,522 square feet in Arcadia, Calif., about 25 miles from the coast, sold for $1,050,000, almost a hundred grand over its asking price of $960,000.
A week earlier, on Aug. 1, a 2-bedroom house, 1-bath, 963-square-foot house in the coastal community of Santa Monica, Calif., sold for $1,125,000. The buyers got a steal because it was listed for $1,200,000. Such recent data confirms the obvious: $1 million doesn’t go very far in prime real estate locations. But the data should also make one wonder whether it wouldn’t be better to rent. So, let’s look at the the buy-versus-rent equation a little more closely. Do you buy a million dollar starter home or do you rent in a comparable area, skipping the monthly mortgage and all its associated costs?
The argument to buy
Rates are crazy low right now. They’re at lows for the year (fractionally above 4 percent), and they’re historically low (In October 1981, mortgage rates topped 18% and averaged more than 17 percent for the year). Let’s do some quick back-of-the-envelope math to show you just how much fluctuating rates can affect your monthly principal (P) and interest (I) payment on a 30-year fixed-rate loan. At 4 percent, given you have squeaky clean credit (called the best execution rate), your monthly payments would be $3,819. At 8 percent, your monthly P&I payment would be $5,870, a couple more grand each month. So, by today’s low rate standards, you can’t find a much better time to buy. Run your own scenarios below.
Uncle Sam is subsidizing your mortgage. It’s true. The U.S. government allows you to deduct the interest you pay on a first and second mortgage up to $1 million in mortgage debt. Over a 30-year term, you would be able to write off $574,956 — a lot of money in anybody’s book. The government is subsidizing your million-dollar lifestyle. Is this a great country or what!
The risk/reward investment ratio is in your favor. If you can’t continue to make the payments and you end up losing your million dollar starter home, you turn in the keys. You don’t get thrown in the slammer or hauled off to debtors’ prison, never to see your children again. More than likely, your lender will take the financial hit, not you. In a non-recourse state like California, you’re not responsible for repaying the debt. You just get your credit dinged for a few years.
However, if you continue to make the payments, when you choose to sell, you get all the financial upside. You don’t have to share a penny of your equity, unless your capital gains are so great that the IRS wants its piece.
You are the landlord, lord of the manor. Indeed, you hold the deed (unless you live in a trust deed state like California, where a designated intermediary — trustee — is entrusted with your property deed until you’ve paid off your mortgage). Instead of paying your landlord, you’re paying yourself. Think of it as embarking on a forced savings plan. Albeit nearly all of your early years’ payments go to interest, but you’ll eventually whittle your balance down.
Argument to rent
Renting gets you in the neighborhood you want, fast. Instead of having to scrape up as much as 20 percent for a down payment required on a house ($200,000 on a $1 million home), you just need to come up with first and last month’s rent and a cleaning deposit for your rental. When you buy a home in an area with good schools, convenient shopping, and gas-sipping commutes to work, you’re really buying the neighborhood or community more than the house. You’re buying quick access to people you want to associate with, without all the initial overhead costs of buying a home.
There are no property taxes to pay. Remember how we calculated principal and interest to be $3,819 a month for an $800,000 loan? Oops, we forgot to factor in any property taxes or insurance on top of that P&I payment. Conservatively speaking, that’s another $1,000 a month, based on the fact that $1 million (the cost of the house) times a property tax rate of 1 percent (.01) is $10,000 alone. So now, your monthly payment is up to $4,819 a month.
There are no property transfer taxes to pay. In California, the base rate is $1.10 per $1,000 in value on the transfer of a home from one party to another, so on your $1 million starter home, you would owe another $1,100. Many cities, however, also tack on their own tax to the transfer tax. For example, San Francisco uses a sliding scale for homes that sell between $1 million and $5 million. At $7.50 per $1,000 in sales price, the transfer tax on your million dollar starter would be $7,500.
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There are no closing costs to pay. Depending on where you live and the complexity of your transaction, closing costs can run between 3 percent and 6 percent of your purchase price. At minimum, that could be another $30,000 you’ll have to come up with to cover origination fees, escrow fees, title insurance, legal fees, courier fees, and a whole host of other charges that come with the privilege of owning a home.
No total debt-to-income (DTI) ratio hurdles to clear. The last we looked, our principal, interest, taxes and insurance payment was up to $4,819 a month, but we’re not finished with your monthly outlays. Let’s say you’re carrying another $1,000 in monthly debts for your car, student loans, etc. Again, we’re being fairly conservative. So, that would bring your total monthly debt to $5,819. Now, few lenders like to see your total debt ratios exceed 43 percent. That said, you would need a gross monthly income of $13,532 or $162,000 plus a year to afford your million dollar starter home.
Of course, we’re assuming you have the $200,000 for the down payment and enough other cash on hand (6-12 months in cash reserves) in the event you lose your job or can’t work because of a medical condition or some other reason.
Home prices are going up faster than rents. Whatever the reason — investor money pouring into the safe haven United States — home prices are accelerating faster than rents. “The gap [between buying and renting] will continue to narrow,” said Jed Kolko, chief economist at Trulia.
Flexibility is priceless. Because today’s economy is more mobile than ever, you want to be able to match strides. For instance, if your career reaches a dead stop in Los Angeles, you want the freedom to be able pick up your things and head to Houston, Texas or Bismarck, N.D., where the economy is booming. You can’t very well do that if you’re anchored to a house unless you want to let it go at a fire-sale price.
Liquidity has its advantages. Instead of stretching yourself financially to come up with the down payment, not to mention the monthly PITI payments, you have that money to invest in more liquid assets, such as stocks and bonds and certificates of deposits.
When things break or stop working in your rental, you don’t have to pay to fix them. Instead, you call your landlord to fix the leaky sink, broken window or front door that keeps sticking. But if you own the place, all the repairs and maintenance costs are on you — and, from broken water heaters to aging air-conditioning units, repair and replacement costs can add up fast.
A sure thing isn’t always so sure. If you’re over 50, you more than likely grew up in a household, where it was given that home prices would go up every year, allowing the family home to be sold for more than its original purchase price. But if you’re closer to 20 or 30, you probably saw the value of your parents’ home slashed in half in a matter of months, a crash so devastating that many families are still trying to recover from the fallout.
So, owning versus renting? What’s it going to be?
Ownership has always conveyed a certain “I’ve-made-it” attitude or mindset — an announcement to your neighbors and fellow citizens that you have your financial act together or at least to the point that you have taken a financial stake in your community. Second, ownership is a statement about personal freedom. The buck stops with you. There’s no omnipresent landlord hovering over you every second, dictating what you can and cannot do with your life or your property. But what exactly is it that you own? A million dollar starter home with two bedrooms and maybe two baths, if you’re lucky? Is that the best you or your money can do?
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