Rent vs. Own: The Benefits of Home Ownership
The classic debate of rent vs. own has surfaced again: There are benefits and drawbacks to either option; thus it is always prudent to explore your personal financial situation with the proper professionals in order to make the best and most informed decision with respect to your individual fiscal position. The foregoing opinion is a summation of my personal reasons for why I believe purchasing a home can provide far greater benefit to the client that has the ability to do so as opposed to the client that chooses the rental option ceteris paribus.
1. The Leverage Factor: Housing is one of the most commonly available investments that can be leveraged with a reasonable degree of certainty for the average buyer. Few borrowers are asking their lenders to borrow funds to purchase, options, bonds, and other investment vehicles. Even fewer is the number of lenders that will lend borrowers money at a reasonable rate that will yield a return of any equitable benefit to the client. However, clients that purchase homes are able to significantly amplify the appreciating value of their homes by a leverage factor. For example if a client purchases a home and retains a 20% equity position they stand to benefit from a leverage factor of five. For every 1% their home accrues in value they can realize a 5% return on their investment. For buyers that put less down such as 10% or 5% they stand to benefit from a leverage factor of 10 or more. Given market conditions and inflation this simple leverage factor can still competitively beat the rate of return realized on other assets.
2. The Housing Payment Catch 22: This presents the fact that regardless of whether you rent or own, you are not exepmt from paying for your housing. The difference comes depending on what side of the argument you are on. If you are a renter then your payment goes to the landlord which in turn the landlord will use to pay down their principal. If you purchase your home your debt service payment goes directly to pay down your own principal whilst building equity.
3. The Involuntary Savings Phenomenon: Irrespective of age or income, there remains at all levels, those that have trouble saving or putting aside excess funds on a regular basis. However having a mortgage payment is a huge motivator that can turn a spender into a saver in the short run as opposed to deferring their savings initiatives to another day in the future. Secondly, while out of pocket expenses may be greater when owning a home, the repayment on your mortgage creates an equity position in your home in addition to the upward value potential of the property itself. This is where homeownership adds value as opposed to incurring rental expenses that represent downside asset risk as rent payments generally adjust upwards to cover inflation and increased costs of living.
4. The Tax Advantage: An investment as significant as the investment in a home comes with upside yearend tax benefits. Homeowners enjoy the ability to deduct their mortgage interest payments as well as their property taxes from their incomes. In addition to this, there are capital gains advantages. Liquidation of capital assets that result in an equity gain often come with heavy tax implications. When it comes to selling a home, single filers can deduct up to $250,000.00 and married couples can deduct up to $500,000.00 when they sell at a gain.
5. The Ability to Hedge Against Inflation: With respect to the traditional meaning of “hedge”, an investor will make an additional investment to take a position against adverse price fluctuations in a particular asset in their portfolio. CD’s, Annuities, Savings Accounts, and Brokerage Accounts that are earning only modest returns are particularly susceptible to inflation risk, which in this example is taking the place of the “risk posing the adverse price fluctuations”. Homeowners favor ownership because their home is a built in hedge against the adverse effects of inflation. While other assets do not enjoy this benefit, owning a home offsets the risk of inflation on the asset because of the home’s average yearly accrual in value and the aforementioned leverage factor.
In conclusion: A client that is willing and able to purchase a home stands to recoup a far greater level of benefit than the same client that chooses to rent ceteris paribus.
The H&A Brokerage Inc.: Helping our client succeed through the development of their unique competitive advantage!
CORE COMPETENCIES OF A FIRST HOME BUYER’S JOURNEY TO OWNERSHIP
1: CONSULT WITH YOUR LENDER OR LOAN OFFICER EARLY IN THE PROCESS
It is important not to try and impress your lender. Do not demonstrate your perceived level of fiscal acumen as the lending process continues to grow continually more complex over time. It is not uncommon for first time mortgage clients to close credit cards, and other credit accounts. This can actually hurt your credit rating. Clients will frequently move money around from various accounts and or deposit large amounts of cash that they have saved. This type of activity raises red flags to a lender in this post-recession economy. The key to remember is that if you do not have a consistent paper trail of all funds you plan on using for the transaction, you will have significant difficulty getting approved for a loan. Even expected gift funds must be documented in advance. Some lenders will provide a specialized form for this specific purpose. Prudent first time borrowers should contact a seasoned mortgage professional and attain a pre-approval letter for a home loan and inquire on the specific do’s and don’ts from that time through to the closing. This should be done before contacting a Realtor or visiting an open house. A competent lending officer will be able to provide you with information to ensure a smooth and stress free financing transaction if they are contacted early enough in the process.
2: START NEGOTIATIONS IN A POSITION OF POWER
Often times there will be more than one party looking to purchase the same property. It is important to always bring a gun to the knife fight. First time home buyers need to find a way to show sellers that they are serious in their offers to buy. The key is to differentiate themselves from other competing buyers in order to gain leverage in the negotiating process. Many buyers make offers using standard prequalification or pre-approval letters, which are often not even worth the paper they are written on. Gain an edge on your competition by coming to the negotiation table with a fully underwritten conditional approval or a PreferredBuyer™ Advantage type approval letter.
3: UNDER NO CIRCUMSTANCES SHOULD ANY INFORMATION BE HELD INTENTIONALLY HIDDEN
Some clients feel that they are helping the lending process by withholding key information. This can include information about other homes owned, bankruptcies filed, lack of savings, liens, lack of income, etc. In this post-recession economy all of the above information is readily available to a lender and it will absolutely come to light. In addition to this, recent regulations, can result in clients being held liable for damages resulting from intentionally withholding pertinent information on a mortgage application. In order for a lender to process applications properly all information must be verified, often times more than once, during the entire transaction period before closing. Help your lender by providing them with as much information as possible upfront. The end goal of any lender is to help their clients obtain their loans. It is far easier to find a solution upfront rather than during the final approval when the clock is ticking!
4: DO YOUR RESEARCH AND USE AN EXPERIENCED LOAN OFFICER
The best loan officers are known in their markets for providing an exceptional experience for both the borrower and real estate agent alike. Their clients are loyal because of the trust earned within the community. There a major lack of any robust internship for mortgage loan officers and experience is typically gained on the job. In today’s economy, a first time home buyer can’t afford to risk “on the job training” with a newly licensed mortgage loan officer: Experience may be the difference between buying their first home and renewing the lease on their college apartment. Check the NMLS website for background on who you are dealing with.
5: MEET WITH YOUR LENDER OR LOAN OFFICER FACE TO FACE
Many of the new lending disclosures can be confusing, especially since first time home buyers are typically seeing them for the first time. Meeting face to face with your lender affords you the opportunity to fully understand the financing charges and the details of the transaction you are entering into.
6: RESPOND QUICKLY TO YOUR LENDER
Time and lack of effective communication will absolutely kill transactions! This is further more pertinent if and when you choose to lock a rate on your loan. Instead of wasting time and complaining about the documentation requested, take a step back and focus on the big picture and goal: You are going to own a new home!
7: USE SELLER CREDIT WHERE APPLICABLE
Always consider a seller credit when making an offer. This can alleviate some of the out of pocket costs on closing day. Often 1st time home buyers are working on a tight budget. They have a lot of expenses including down payment, homeowner’s insurance, various inspections, and moving expenses. A seller credit will allow for some of the acquisition costs to be financed into the loan. Your real estate agent will be able to help guide you through structuring an offer with a seller credit. You will also find it helpful to speak with your lender so you know how much credit will be allowed with your type of financing and how much of it to utilize.
8: USE YOUR OWN TRUSTED REAL ESTATE AGENT
One thing I see first time buyers doing is contacting the listing agent on a home for sale and then letting that Realtor represent them as well as the sellers in the offer. How can an agent get the highest price for the seller at the same time the lowest price for the buyer? I tell them to get another agent to represent them, for it does not cost them a penny and are only working for you.
9: BE AWARE OF VARYING GUIDELINES FROM LENDER TO LENDER
There are guidelines that all lenders must follow, however there are also underwriting requirements that can vary. Lenders also have guidelines that they set themselves based on the amount of risk they are willing to assume. Borrowers are often led to believe that they will not qualify for certain programs when in-fact they can, just not under those particular lender’s guidelines. A trusted second opinion if you have been told “no” is typically a good idea. For example, many clients are told that they will not qualify for a conventional loan because their credit score is only 620. Given strengths in areas other than just credit there are lenders that offer different programs and credit restrictions etc. that could change this seemingly impassible restriction.
10: KEEP YOUR BANK STATEMENTS CLEAN
One of the largest problems with first time buyers is their bank statements and the way they manage their money. Underwriters pay extreme attention to bank and investment account statements. They are looking for large deposits and other income sources not listed on the initial application. Non-disclosure of such deposits and income sources can raise major red flags.
11: THE LOWEST RATE MAY NOT BE THE BEST RATE
Lenders love to advertise the fact that they have the lowest rates possible for their products. Consumers alike are always looking for that ultra-low rate for their mortgage. The rate is far from the most important factor in the mortgage process. In many cases, depending on the total size of the loan, a rate fluctuation of even 1% can make as little as $20-30 dollars difference in your monthly payment. If this difference is significant enough to you, then maybe you should consider whether or not the loan is appropriate for your budget. Rates do not typically fluctuate up or down in extremes as high as a single percentage point within the average time it takes to close on your mortgage. Do not waste time switching lenders because of advertised rates that differ less than 1% percent from each other. This is also a good guideline to follow when it comes to locking in a rate sooner or later in the transaction process.
12: COMPARE RATES AND SHOP YOUR INSURANCE POLICY
First time buyers should shop for homeowners insurance, the same way they shopped for a lender. Their current insurance carrier may not be their best option. Make sure you have proper coverage, make sure you have enough funds set aside to meet your deductible in case of catastrophe and take advantage of multi-policy discounts. Taking the lowest monthly rate may not protect you in the way that you wish. Taking a higher overall rate can help lower your monthly payment. It is worth taking a look at single premium mortgage insurance options if it fits the budget.
13: DO NOT SPEND EXCESS CASH RESERVES
One uncommon mortgage tip is to do your best NOT to spend your reserves during the loan approval process. First time homebuyers tend to get very excited during escrow leading to a tendency to want to buy new furniture, appliances, cars, etc. However, most banks will require current asset statements within as little as 48 hours before you close on your loan. If the amount of reserves you now have is significantly less than what you started with, you may have to prequalify again, or worse, sacrifice qualification for the mortgage entirely. This can cause loan approval delays, and frustrate the seller since the contact date may have to be extended.
14: KNOW YOUR TOTAL MONTHLY PAYMENT LIMIT
Before you buy you home, best practice is to have a discussion on what your comfortable mortgage payment level is including taxes and insurance. Don not just make it about the principal and interest payment. Furthermore the qualifying amount based solely on income and debt ratios can still be higher than what you are willing to pay on a monthly basis. The end goal is to purchase enough home that is sizeable and affordable enough to leave room in your budget for emergencies, savings, investing, and for fun. No matter what the real estate agent or lender says you can qualify for, you know your personal limits better than any bank or real estate agent can be expected to know. The monthly mortgage payment is one of many other payments that includes utilities, maintenance, saving, personal lines of insurance, etc. There is a stark difference between debt to income and liability income; trust yourself on how much you can pay monthly on housing cost. Housing should always be looked at as the cost of shelter to your own capacity to own the debt. It shouldn’t be looked at as an investment first. You’re going to be going to bed and waking up in the morning with the mortgage payment each day not the value of your home which can go up and down.
15: BE AWARE OF PAYMENT SHOCK IF YOU ARE NOT CURRENTLY PAYING RENT
A large jump in rental payment to a monthly mortgage payment alarms underwriters for first time homebuyers. Those who had lived with family and are attempting to purchase their first home and have been paying no rent should be able to show some savings. While they report good and stable income, if they cannot save any funds and they are paying no rent; underwriting has authority to require reserves or deny the loan. Gift funds from family may not satisfy an underwriter’s concern over the true ability to repay the mortgage payment.
16: INQURIE ABOUT MORTGAGE CREDIT CERTIFICATES
As a first time home buyer do not miss out on a potential opportunity to get a Mortgage Credit Certificate (MCC) that will allow you to turn a percentage of your mortgage interest paid each year from a tax deduction into a tax credit. This can increase your household income yearly for the lifetime of the mortgage. You can even use this additional income on a loan transaction to help qualify for a larger purchase price.
17: BE AWARE AND CONSIDER FREQUENTLY OVERLOOKED EXPENSES
The first time home buyer is always told, “You can buy a home and the mortgage payments will be similar to what you are currently paying in rent.” That may be true, but make sure you have enough cash on hand for the following items:
I. The Down payment
i. For FHA loans the minimum down payment is 3.5% of the purchase price.
ii. For Conventional loans the typical minimum down payment can be as low as 5%. This can change from lender to lender and can be affected by other variables such as credit and income.
iii. Do not overlook other typical expenses such as surveys, home inspections, attorney’s fees, appraisal fees, title insurance fees, home owners insurance fees, escrow costs, property taxes, home owners association dues, utilities, moving expenses, and any furniture, appliances, or personal extras to make the property yours.
18: THINK TWICE ABOUT BUYING MORTGAGE LIFE INSURANCE
If you buy a home you will often be solicited to buy Mortgage Creditor Protection (MCP), often referred to as Mortgage Life Insurance. MCP is a financial product that periodically declines in value as the borrower pays more premiums to the insurer. MCP promises to payout an amount equal to the client’s outstanding mortgage debt at any point in time which is also a decreasing sum given consistent and timely payments on a traditionally amortized mortgage loan. MCP is extremely profitable to lenders and insurers and in turn is equally disadvantageous to borrowers. Think twice: MCP is a dirty secret of the mortgage industry.
19: KNOW YOUR CREDIT SCORE AND WHAT’S POSTED ON YOUR REPORT
Unbeknownst to many clients, a myriad of menial small balance collections can wind up posted on a credit report. Late payments, delinquencies, forgotten accounts, and even items that do not belong or that have been posted incorrectly are all among such items. Your credit profile is the first thing everybody looks at no matter where you go to borrow. The 5 c’s of credit are character, capacity, capital, collateral and conditions. Whether it’s a mortgage, visa, line of credit, etc. you need to know first. Do not waste you or your lender’s time and risk embarrassment because of willfully not knowing your credit score.
20: PUT CONSIDERATION ON LENDER PAID MORTGAGE INSURANCE
Prior to the market collapse of 2007, FHA was the predominant means to obtain financing for first time home buyers. However, over the last few years, FHA has drastically increased its monthly mortgage insurance premium. As a result, conventional financing with lender paid mortgage insurance has made a comeback, making it more popular. Borrowers with minimal down payments can purchase using conventional financing and have the lender buy out the mortgage insurance. Often, the payments and long term benefits are better with this strategy.
21: CLOSELY CONSIDER YOUR CO-BORROWER
When purchasing with another person whether it be spouse, soul mate, friend, or business partner be aware of the consequences if that relationship were to dissolve. Requesting and or inquiring about a refinance to remove a co-borrower from a mortgage because the partners have each gone their own directions is not typically a viable option. In many cases lenders simply cannot help clients in this position. When a property is purchased and two individuals with two incomes were used to obtain a mortgage, in most cases the partner that stays in the home won’t qualify for a mortgage on his/her income alone. Even in cases where a married couple ends up divorcing and a judge awards the home to one partner and the other person is quitclaimed off of the deed, that person is still on the mortgage, still liable, will still have the payment reporting monthly to the credit bureaus, and is responsible for the total debt if their former partner falls behind or doesn’t pay. It is always best practice to start out with a mortgage payment that is manageable and leaves your household with breathing room at the end of the month.
The H&A Brokerage Inc. is dedicated to the success of our clients and affiliates alike. We have privately compiled this guide to reflect the professional views and opinions held by us in our experience. We are fully cognizant that not all practices are applicable to all clients across the large breadth of unique home buying transactions. We have compiled these general best practices to fuel thought and consideration amongst potential first home buyers. It is in any potential homeowner’s best practice to do their own research and fully analyze their own situation before making the investment of a lifetime. We encourage potential clients to ask questions and schedule a private consultation with us today.
The H&A Brokerage Inc.: Helping our client succeed through the development of their unique competitive advantage!