Even if you have the money and the credit rating to purchase a home, it doesn t make sense to do so if you plan to sell it in a month or two. Nor does it make sense to rent a home for 10 years. Where, then, is the saw-off point? When does it pay to buy, and when are you better off renting? In other words, how long is long enough to live somewhere before buying?
The answer depends on a number of variables, many of them personal. The personal ones consist of your goals and your finances. Other factors, however, have to do with the economy, the interest rate on the mortgage, home prices and property taxes where you plan to live. There are, however, two main constants to keep in mind. First, both mortgage interest payments and property taxes are tax deductible. Second, when you do sell the house it will cost you roughly 10 percent of the home s value to do so.
Also, when you buy a home, closing costs can amount to between 3 percent and 5 percent of the loan amount. So, in addition to other considerations, you want to be able to recover those upfront costs when you sell.
Let s start with the personal issues. First, do you really want to own a home? Some people don t. They like renting. It gives them the freedom to move more easily, and the comfort of knowing that if something goes wrong with the house or property it s the property owner s problem and not theirs. Another reason for not buying a house is that if you plan to sell it in a couple of years, you might lose money on the deal. When you rent, you generally have to pay first and last months rent, a security deposit and maybe a pet deposit. That can add up, but the deposits are usually refundable when you move out assuming the property was well maintained.
Other people dream about owning their own home. It s a sign they have made it in the world. It is a source of pride, achievement, security and part of their self-identity, the way they think of themselves, and the way they want others to think of them. To them, just being able to call their home their own is worth any money that goes into it.
Your finances coupled with the interest rate and house prices in the area where you want to live will determine if you can afford a home and the size payment you can afford to make. Making $50,000 a year might qualify you to buy a home with a small down payment in rural Pennsylvania, but in Seattle you would probably be out of luck. That sum might also do it in some parts of northern California or Arkansas, but not in Southern California or Alaska.
Go to http://mortgages.interest.com/content/calculators/ to see where you and your income fit. There you can look at the mortgage required income calculator and the mortgage loan calculator. The rent versus buy calculator might also be useful. Plug in the appropriate numbers and the math will be done for you to compare what you pay in rent to what you would pay for a mortgage.
If your income will let you buy in your chosen area, and you actually want to buy, the next question is: How long do you expect to live there? That is a major factor.
There are two ways to build equity in a house: either by paying down the loan or by having your home increase in value. In the early years of a mortgage, most of your monthly payment goes to pay interest. That s true of both a conventional loan and an adjustable-rate mortgage, or ARM. The longer you own the home, the more of your monthly payment goes toward reducing the principal -- the amount you borrowed in the first place.
Let s say, for example, you borrow $100,000 at 6.5 percent interest for 30 years. Your basic monthly payment, just the interest and principal, and not counting any taxes, insurance, fees or assessments, would be $632.07. Most of that payment -- $541.67 -- will go toward interest and $90.40 will go toward principal. After two years you would owe $97,689.69 in principal, and you would have $2,310.37 in paid equity. The rest of your equity would be determined by the value of your house. Even though history shows that the value of your home will probably have increased, thus increasing your equity, you cannot be sure that it will. Even if it does increase, no one can predict by how much.
At the end of two years, you would have more than just additional equity. You also will have paid $12,859.10 in interest , which is tax deductible. The same is true of your property taxes which, depending upon where you live and the value of your home, can be hundreds or thousands of dollars a year.
It is important to realize that you do not deduct the interest or property taxes directly from the amount of federal income tax you pay. Here s how it works. Mortgage interest and property taxes, like other local and state taxes, medical bills, charitable donations, and certain other expenses, are considered itemized deductions. You add up all the qualifying itemized deductions and then subtract that amount from your income. The savings are based on the fact that you pay taxes on a lower amount. If you make $85,000 a year and have $20,000 in itemized deductions, you would be taxed on an income of $65,000 instead of $85,000.
If you re looking for a bottom line number to make the buy versus rent decision, keep in mind that the cost of selling a home is about 10 percent of its value. When you sell your house, will your paid equity, your home appreciation equity, tax savings and property taxes cancel out the sales cost and the closing costs? That s for you and your accountant to figure out. Remember, however, that there is no tax benefit to renting, even though you are generally paying the property owner s mortgage interest and property taxes.
Buy or rent? It s a complex decision that hinges on many factors, but probably the biggest consideration is what works for you.
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