Should I Buy a House Now?
The housing market is a bit nuts, no?
Or, maybe you're reading this in the future when the housing market isn't nuts, in which case: Hi, future you!
Either way, this article will hopefully help you think through (a) whether to purchase a home and (b) how much home to purchase.
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Several of my clients are in the process of either buying or selling a home. The top two questions for those who are buying are:
Should I buy a house now or should I wait?
How much house can I afford?
As you may have seen if you follow me on Facebook, Instagram, or LinkedIn, I was recently on Mike Zung, CFP®'s YouTube Live show to discuss this very issue. Click the picture below if you’d like to see a recording from June 2021:
Here are some high-level thoughts on this topic:
Consideration #1: Direction of house values
Question: Do you feel like you can predict the future?
Will housing prices crash sometime soon? Are we in for a recession soon?
Well, do you feel like you can predict the future?
For me, the answer is a big ol' no, I can’t. When I think about "timing the market", I try to remember the old adage "time in the market is better than timing the market".
Too many (really smart) people have been burned over the years by trying to time the market, whether it be the stock market, housing market, or anything else. Great economists and analysts consistently miss the boat when it comes to predictions.
Having said that, do I think the housing market is overpriced?
Maybe. Maybe not. I don't know.
I think it kind of feels like it did in 2006-2007, when housing prices were running up like crazy.
But the underlying health of the market (and the consumer) is very, very different.
Back then, lenders were giving mortgages to anyone who could fog a mirror (remember NINJA loans? "No Income No Job or Assets"). But now lenders are being much more judicious with who they are lending to, as the average credit score for borrowers is MUCH higher now compared to then.
And, generally speaking, consumers' balance sheets are healthier compared to then (more assets, less debt).
So although it may feel similar, it's actually quite different.
Having said that, if & when a recession hits, of course that will affect homeowners due to lost jobs and such, and we’ll probably see downturn in the housing market.
But, regardless, I don't think someone should try to time the market by waiting to buy a home, if buying a home otherwise makes sense for them.
Read on…
Consideration #2: Timing
Question: Are you going to be staying in the same area for a good while, at least several years?
If not, you may not want to purchase now.
Buying a home is expensive. And not just the price tag. There are a lot of fees associated with buying. There are fees associated with the loan, legal fees, and other fees such as appraisals.
And you'll get hit with even more fees when selling the home. That's because you'll be on the hook to pay the commissions of the real estate agents.
So you need a good amount of time in the home in order to make all those fees worth it.
If you don't plan to stay in the home for a good long while, it's probably best not to buy.
Consideration #3: Cash flow
Question: How much can you afford on a monthly basis?
There's a good rule of thumb that says you want to aim to purchase a home that's 2 to 3.5 times your household gross income. And if you're in a high-priced area (hello there, parts of California and Washington, where most of my clients live), then you can stretch that to 4 to 5 times your income.
But that's just a rule of thumb. The real answer lies in doing some real digging.
This is all about cash flow.
(What's this "cash flow" you ask? Well, it's the flow of your cash. It basically refers to your income, your expenses, and your savings.)
What will adding a home to the picture do to your cash flow?
You want to be careful not to take on too much of a monthly commitment to where you can't save for other important goals (e.g., retirement, college savings, etc.).
The mortgage payment itself is the big one. This will be determined by the house price, the size of your down payment, and the interest rate.
Interest rates have been at historic lows lately, so that makes housing more affordable, all other things being equal.
But don't forget about other expenses, such as:
Property taxes
Home insurance
Earthquake and/or flood insurance
HOA fees
Home maintenance (a common rule of thumb is 1% of the home's value per year)
Utilities
Extra commuting costs
PMI if you don't put down a big enough down payment
And, of course, you can subtract any expenses that will go away when you buy (e.g., rent, utilities you're paying now, etc.)
Consideration #4: Emergency fund
Question: How much cash will you have left after the purchase (and other costs)?
The first part to this is: How much of a down payment will you put down?
It’s always best to avoid PMI (private mortgage insurance) if possible by coming up with a 20% down payment. (Note: There are other ways to avoid PMI, such as if you qualify for a VA loan.) But if you can’t come up with a 20% down payment, then PMI can be a helpful tool to enable you to buy a home if you can otherwise afford it on a monthly basis.
I think the sweet spot for "how much mortgage to have" is 50-80% of the home's value. You'll avoid PMI, you’ll get good rates in that range, and you won't be tying up too much cash into your home.
The second part to this is: How much cash do you have available?
You’ll obviously be using a lot of that cash for the down payment & paying other closing costs associated with the purchase. But don’t forget about costs you might incur shortly afterward. For example, you might want to buy some furniture for the new living room, or get some things fixed. People often don’t consider those costs when it comes to short-term cash needs.
The danger to spending so much cash is that you could be exposing yourself to a lot of risk by not having a big enough emergency fund left over.
I think a minimum amount of cash to have on hand after the home purchase & paying for other costs should be 30% of your annual household gross income. And perhaps quite a bit more depending on other factors, such as how reliable that income is and the size of your mortgage.
Basically, the idea is that you want to be able to support yourself, including making the payments on your new mortgage, for a decent period of time if life deals you a few rough blows.
The moral of the story is that you don't want the house purchase to bring your cash position too low.
Consideration #5: Asset allocation
Question: What percentage of your total assets would be represented by real estate?
One of the reasons why owning real estate is good for your financial health is because it balances out what might otherwise be a net worth dominated by stocks, bonds, and cash.
Real estate provides a separate asset class that behaves differently than stocks, bonds, and cash. It can be especially helpful during periods of inflation, as real estate tends to keep up with inflation.
But you can also swing the pendulum too far in the other direction, and own way too much real estate compared to the rest of your assets.
Ideally, there should be some semblance of balance between the three areas (real estate, stocks, and bonds/cash).
By the way, I include the full value of the house in this calculation, not just the equity. That's because if housing prices go up (or down) by 10%, your total assets will go up (or down) by 10% of the total value, not 10% of your net equity.
Now, it may be unavoidable that if you purchase a house, real estate will make up a huge percentage of your total assets. This will especially be true if you're younger and haven't had time to build up your net worth.
I do not think this is a reason to forego buying a home. Rather, I see it as informing what you do after buying the home.
This links back to Consideration #3 above, as you'll want to make sure you're still able to save a good amount of money each month so that you can rapidly build up your stocks, bonds, and cash to bring more balance to your overall portfolio.
Let's wrap this up, sunshine
Bringing this to a conclusion (finally you say?):
Owning real estate is inherently a good thing for your overall financial health.
I don't think trying to "time the market" is a good strategy.
You want to be careful about your monthly expenses, ensuring you have enough slack to continue to save for other priorities.
You want to ensure you still have enough cash on hand after the house purchase.
Coming back to the question:
Should I buy a house now?
My answer is: Absolutely yes, as long as it's a good financial move for you considering the above factors.