You must manage your borrowings to your benefit alongside smart saving and investment decisions in order to achieve the most of out your financial situation.
Taking on an ill-timed mortgage, running a credit card tab continuously, and even rapid repayment of your student loans could be majorly detrimental to your success in building a successful portfolio of investments.
The decision on whether or not to purchase a home should be a very long and deliberate thought process for you. This will require an extraordinary investment of money and time in order to get approved for a loan and close on the home, and you will also have taken on a very sizable illiquid investment (meaning you won’t be able to sell your home quickly if you need the money you invested in it).
Generally, you should not purchase a home if you don’t see yourself living in that location for at least five years, the longer the better. Consider purchasing a home if you have job security, are comfortable living in that location for beyond just several years, and if you have money saved for a down payment and an increased “buffer.” There is an extraordinary risk in buying a home since as seen in the past few years prices can drop significantly in the near-term. Below is a chart of a home price index for the largest 20 U.S. cities compiled by Standard and Poors:
Should you have purchased a home in 2005-2006 at the peak then in 2012 you could potentially have a loan of $200,000 on a home that is now only worth $150,000! The risk of price declines and you ending up with debt in excess of the value of your home is a good reason to think long and hard before buying a home.
Though there are risks involved with homeownership, and recent homebuyers may have been burned due to price declines, there are still many benefits of becoming a homeowner. With a mortgage payment, you are slowly but steadily paying down the principal on your loan through each monthly payment (meaning you are decreasing the amount you owe on the home). This means you are decreasing your debt levels, and thus leaving you with equity in your home (seen as the value of your home minus the amount of debt you owe on the home). The amount of your mortgage payment that goes to interest is also tax deductible up to certain limits, which means your tax bill will be lower if you take on a mortgage.
Download our spreadsheet that breaks down mortgage payments into an “amortization table” – this shows how your monthly mortgage payments are broken down into interest payments and principal payments. At the beginning of your mortgage, you are primarily paying interest to the bank, but the amount of your monthly payment that goes to paying down the principal on your loan steadily increases over time.
This spreadsheet is made so you can adjust all of the cells with blue font to fit your loan. The variables will be the size of your loan, how much of a down payment your loan requires (likely either 3 to 5% for a federally insured “FHA” loan or 20% for a conventional mortgage), and the interest rate on your loan. There is also a series of complete guesses about the future movement in home prices – adjust these variables for a worst-case scenario to see if you have any equity in your home if you buy a home and prices decline over several years. If this is not an acceptable case for you then you should continue renting or you should plan on staying in your home for a longer time to pay down more principal.
You will see that even with moderate declines in home values over several years you may still be able to see a gain on your home investment due to your slowly declining principal balances on your loan. Keep this table updated to track the number of mortgage payments you have made to follow the amount of equity you potentially have in your home.
Another huge argument for purchasing a home is the historically low level of interest rates. The following table shows a nationwide average interest rate for a 30-year mortgage as compiled by Freddie Mac’s Primary Mortgage Market Survey:
Homeownership, in the long run, is a great way to see a return on the money you spend for your living expenses instead of just cutting a check for rent, however it is risky for young professionals due to the down payments required, the potential for price drops, and the likelihood that you won’t stay in the same place for long periods of time. Also consider the many extra expenses involved with home ownership that previously your landlord would have covered (local property taxes, appliance upgrades, repairs, maintenance, gardening etc.) … these are all now yours to bear!
If you have a steady job, love where you live (and want to be there for 5+ years), find a good price on a home, and you have built up a strong “buffer” so you can afford a down payment and also ensure you won’t miss mortgage payments, then you may want to consider buying a home to take advantage of historically low mortgage rates. Whew – that’s a mouthful! Just goes to show that many pieces must be in place in order for buying a home to be a good decision.
If everything fits then approach several local banks to begin the incredibly long and detailed loan process (which we won’t try to detail here) to ensure you are getting the best mortgage. Focus on a 30-year fixed rate mortgage to lock in a low rate that isn’t subject to rate increases, and to stretch out your repayment horizon so that your monthly payment is lower, allowing you to fund other investment accounts. If anything is missing then keep saving and investing your excess money and eventually you will find a situation where everything fits.