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Friday, August 8, 2008

Should you buy a home now?

here is a recent LA Times article : Should you buy a home now?

Here is my take on this question. Buying a home is fundamentally a lifestyle question. It's a burden of love. Buying a home brings it's own set of stress and pressures, but it might be all worth while if it's a burden carried with love.

1) Have you found a home that you love and can imagine living there for 30 years?
2) Can you expect to live in the house for 10 or more years?
3) Have you got a financing that you can afford and a plan in place even if you and/or your spouse get laid off for 6 month to 1 year?
4) Are you ready to deal with all the hassle of home ownership : yard work, repairs, upgrades, HOA, and neighbors?
5) Do you expect the mortgage interest rate to go even lower?

I consider these things the right questions to think about when purchasing a home. There are some wrong questions to consider when deciding to purchase a home or not.
1) What is the biggest / best home that I can afford?
2) Is the housing marketing price going lower?
3) When will the value of the home go up?
4) Will I save a bunch of money on taxes?

Let me explain why I think these are questions to ask.
1) Have you found a home that you love and can imagine living there for 30 years?
Besides marriage, buying a home is probably the biggest commitment you'll have to make in your life. You are tied down to a huge financial burden, and not flexible to move to another part of country for career. You better be ready to commit to a home that the whole family will love.

2) Can you expect to live in the house for 10 or more years?
No one can predict what's going to happen in 10 years, but this is a good bet if you have a stable job. The transaction cost of selling a home is huge, easily 5% to 10% of the selling price. Not to mention the stress it brings.

3) Have you got a financing that you can afford and a plan in place even if you and/or your spouse get laid off for 6 month to 1 year?
Don't commit all your cash into the down payment. Some people stretch and take on all these financial risk that they can't handle when times gets rough. You need the cash reserve for repairs, layoffs, medical issues, and all the other financial risks that can happen to any one at any time. Again, a home is a financial BURDEN and risk. Go in with your eyes wide open.

4) Are you ready to deal with all the hassle of home ownership : yard work, repairs, upgrades, HOA, and neighbors?
You home is your castle, but you neighbors and HOA really cares about how you live (at least how the house looks on the outside.) Be ready to deal with that hassle.

5) Do you expect the mortgage interest rate to go even lower?
You probably noticed this is the only timing related question. All the questions so far has been about emotional commitment or financial planning. You can do that any time, even in a down market. Most people forget, for the life of the loan, you pay more in mortgage interest than the home itself. The house market price might go up and down 10 or even 30%. That is SMALL potatoes compared to the total mortgage interest paid! One percent point change in the mortgage interest makes a big difference in the total cost of the home. Check out any mortgage calculator. Here are some number I just ran:

1) $500,000 mortgage, 30 years fixed at 7.00%. At the end of 30 years, interest paid will be 697,544
2) $500,000 mortgage, 30 years fixed at 6.00%. At the end of 30 years, interest paid will be 579,191.

And that's assuming you keep the loan, if you refinance frequently the number only gets worse.

So why are these the wrong questions to ask about a buying a home.
1) What is the biggest / best home that I can afford?
Real estate brokers, mortgage agents and anyone in the real estate business often asks this. They will say a home purchase is biggest / best investment of your life so make it count and get that dream home (even if you can barely afford it). When I purchased our first home, we had the income for a house twice as expensive. Everyone pushed us to get a bigger home in a better area. Sure, we we would have made more money consider the real estate run up. But we loved our 1st home, it was just perfect for us at the time. Even with the house purchase, we still managed to invest in 401k, and saved money to started a business.

2) Is the housing marketing price going lower?
This is an important question, but not while deciding to purchase a home or not. The purchases price is actually only a part of your total cost of ownership of a home. Adding insurance, property tax, mortgage interest, utility cost, repairs, cost of sale, the purchase price is less than 50% and it's not even the single biggest item. However, this is an important question for price negotiation. If you think the housing market price is going down then you'll make your offer appropriate to that market risk. It's the same when the market is going up. When the market is going down, people prefer cash to house. Buyer doesn't want to give up cash and seller is willing to reduce value to get cash. Just the opposite when the market is going up. You can decide to purchase a house in a down market, as long as you negotiate with that risk in mind.

3) When will the value of the home go up?
I never understood why California had such a huge run up on housing prices. It was completely out of portion to rental cost, cost of living, inflation, wage, etc. I just wanted to build out my equity in a little place that I can call my own. I don't want to pay rent forever. If you want something that will go up in value, then you should invest in stock, bond, mutual funds, and other securities. The mantra of modern financial planning is diversification. If you stretch to buy a big home then you are sacrificing diversification and making this big bet that the housing value will go up. Not very smart, instead, buy a smaller home, make sure you have a diverse set of securities, real estate, and income streams. You'll be well covered in any market condition.

4) Will I save a bunch of money on taxes?
I like tax deduction just as much as the next guy. Tax deduction is icing on the cake. I'll alway try to maximum my tax deduction but it's not smart to make big purchases because of the money you might save. Sure, you might save 40 cent for each dollar spend in mortgage interest. But you still have to spend that dollar first. In case of layoff, you don't have have 40 cent tax deduction but you still have to spend that dollar.

In summary, I don't think there is a good time or a wrong time to buy a home. What's important is that you buy the home for the right reasons and make the necessary plans to manage the financial burden.

Wow, this blog entry turned out much longer then I expected. I really enjoyed writing and thinking about it.

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