Advice request: Homeownership
So I’m probably about two months from owning a home. (Realtor says we might close within a month; experienced friend says 3-6 weeks; I’ll be vaguely surprised if it’s not done by August.)
This is exciting, and also more than a little daunting. My near-mode brainbits don’t know quite what to make of it; this is my first time owning anything on nearly this scope (I don’t drive, so I’ve never owned a car), and also my first time taking on any large amount of debt. It’s pretty obviously a good thing overall—my mortgage payment should be not much more than half of what I’ve been paying for my apartment, and I’ll be in an area that’s better by several relevant measurements, and I’ll have more space and more freedom—but it’s still a rather large change.
So, on behalf of those near-mode brainbits, which are mostly going aaaaaaaaah what have you gotten us into, I’d like to request any advice that you might have for a soon-to-be new homeowner.
(More information is available, but I’m not even sure what’s important enough about the situation to mention.)
Think a lot about the kind of mortgage you will get. Mortgages are even more complicated than cell phone contracts but with, obviously, higher stakes. Shop around for the best deal, different mortgage brokers’ contracts are not homogeneous commodities. Make sure you take into account all fees and ask the broker what be the total amount you will be paying each month. To make sure that they are including all taxes, fees, and insurance requirements asked them what will be the amount you will be writing on your monthly check. Some brokers will allow you to lock in an interest rate for a few weeks without having to pay a fee if you change your mind. This can give you some option value on whether interest rates will rise.
When deciding how long to make your mortgage consider taxes. If you have lots of high interest rate debt and are not maxing out your tax preferred retirement accounts then have a low payment each month by getting a long term mortgage.
In the United States at least there is massive uncertainty over the long-term value of homes, the long-term tax treatment of mortgages, and most importantly the long-term inflation.
I’m not certain about the validity of this next piece of advice. If you live in the United States you’re going to have to decide whether to get a fixed or variable rate interest loan. Remember that the banks are setting rates based on what they think will happen and it’s extremely unlikely that you have better information about long-term interest rates than they do. But, in the United States at least, you have the option to refinance loans. Lots of people don’t do this even when it’s rational to do so. Banks take this into account. The ability to refinance has a greater expected value with fixed-rate loans because then you have option value on the fluctuation of nominal interest rates. This might mean that if you will refinance when it’s rational to refinance then you will get a better deal with fixed-rate loans.
My next piece of advice is that given the probable long-term state of the US housing market think of a home as more of a consumption good than investment.
Finally, if you think there is a significant chance of there being a singularity within the next 30 years then you should get a thirty-year mortgage because the singularity will either effectively wipe out your debt (perhaps by killing us all or otherwise eliminating the value of money) or make you so rich that paying off the debt becomes trivial.
This is an excellent way to phrase that concept. I am now going to use it frequently in real estate-related conversation.
Is 30 years the practical limit, then? Buying a house sounds like a horrible idea to me, but if I couldn’t persuade someone else such than it’d be nice to give them advice conditional on their buying into a good chance of either economic collapse or technological singularity. (I know absolutely nothing about mortgages, what an APR is, etc.)
This is exactly the case. I’m buying it because I want to live in it. It’s not “exactly what I’ve always wanted in a house”, but it’s rather close all things considered, and a very good fit for my lifestyle.
In the United States, mortgages with fixed rates are better right now (if you stay in your house) because interest rates are extremely low right now. If you take an ARM, you will lose if you stay in your house, because interest rates are bound to rise.
If you select a 30-year mortgage, you will pay more overall. But it turns out that you only need to beat a 2-3% annualized return (assuming you took out a fixed-rate loan at interest rates right now) with the extra money you save every month in order for a 30-year mortgage to beat a 15-year mortgage. Of course, that’s assuming you have the willpower to set aside that money every month and the time and effort required to invest it.
If you select a 30-year mortgage, you always have the option of paying extra each month. In fact, if you paid 45% extra each month, you would finish it off in 15 years, and it would in fact be equivalent to a 15-year mortgage, except costing only 8% more overall (or a mere 0.5% per year). The reason a 30-year mortgage costs more is not mainly due to the higher interest rate—it is because most of your initial payments go towards the interest, as opposed to the principal—the interest isn’t reduced at first, and it also has 15 more years to compound.
Consider getting a 30-year mortgage if you expect any sort of volatility in your financial situation, as the price for such convenience is quite cheap. Note that this only applies if you have either the willpower to pay the extra amount every month, or the energy to find a superior investment with the extra money you are saving. A 15-year mortgage would be better for someone with e.g., severe akrasia issues.
Look into purchasing as many points as you can on your mortgage if you plan on staying in your house for at least 11-14 years. Do some analysis to figure out the break-even point for your situation. Note that banks profit because most people overestimate how long they will stay in their house. The average in the US is 5-7 years.
Look at the amortization formula (or use the PMT function in Excel) and run the analysis yourself—it’s too important to not bother. Put in different amounts of down pay, different interest rates, different amounts of extra monthly payments, etc., so that you gain a feel of the relative effects of the different factors.
Finally, please call it a “house”, not a “home”.
Only if you can come up with another synonym for house because it’s inelegant to repeatedly used the word “house” in a single paragraph.
I’m inclined to agree with Fowler.
Other advice:
Get an inspection. That house is a fixer-upper; you’ll want to have a good idea of everything that needs fixed. Triage that stuff in terms of safety, severity, cost, inconvenience, etc.
Even casual friends will often help you move, paint, etc. in exchange for pizza and beer. (I’m in serious danger of having a day job by then, but ought to be able to find some time nonetheless).
There will always be stuff that needs improved, altered, newly furnished, etc. Pace yourself.
Mortgage: Accept only a fixed rate with no prepayment penalties. If your interest rate is above-market (because of credit history, documentation, etc.) you will likely want to refinance within a few years, and a prepayment penalty will make that painful.
If there’s something about this house and/or mortgage that seems like a big problem, be prepared to walk away. There are others.
And of course, this.
Quite so. :D
Rent. Seriously, if you can get it at the right price, save yourself risks and headache.
Renting just means different kinds of risk and headache. The big benefits of home ownership include:
you can modify the home to suit your preferences. Lighting, paintwork, carpeting, wired home networking, beer fountain, w/e.
you can purchase nice furnishings and, say, a grand piano and not worry about having to relocate at the whim of the landlord.
Whether one or the other is better depends on the individual.
Agreed. The most relevant terminal value for me is not having to put up with other peoples’ rules and restrictions. The current situation is non-optimal in that sense in several ways—there’s the obvious stuff like not being able to paint or make changes to the space, but there’s also things like occasionally having to un-make plans on very short notice in order to accommodate the landlord’s decision to do pest control on a certain day, or having to jump through hoops to make sure that a friend can spend the night without getting their car towed.
Some of that would be mitigated by renting a house instead of an apartment, but the problem doesn’t seem to go away until I don’t have a landlord at all.
The debt is not a problem, as long as you’re not too hung up on the house being an ‘investment’. (For one, the house you’re looking at is cheaper than quite a few ordinary cars).
Here’s a scenario that approximates the worst case (it did get worse than this for people who bought during the bubble):
You buy the house with a small down payment. You make the payments (that are about half of your current rent) and live there for 5 years. You sell the house for the exact same amount you paid for it. (It’s rare to have that little appreciation in value).
The net effect would be that you lived somewhere nicer than your apartment, for half the price, for 5 years.
You would never say this for a stock, don’t think it for the extraordinarily undiversified quasi-financial asset named house.
I actually think it is rare for houses to lose value, especially over a few years. But I might well be missing something.
Yes, there was recently a housing “bubble” where many did lose value. My understanding is that the typical case there was a house that went up 40% in value from 2000 to 2007, then plummeted to its 2000 value. Sucks if you buy in 2007 I suppose.
And there are instances where an individual house can lose significant amounts of value. It could become unintentionally mobile, for example.
Because of the messed up US housing market there’s a huge glut of houses on which the owners are in technical default but the bank hasn’t yet seized or sold. A clearing of this glut would greatly increase the supply of houses and potentially cause their prices to plummet in certain areas. The housing market is in an extremely untypical situation and it’s dangerous to rely on past performance to predict what’s going to happen in the future. Plus, the enormous future US federal government debt might cause Congress to eliminate the mortgage interest tax deduction and this would devastate the housing market.
That’s not even the worst of it: a sizable part of that glut consists of houses which, legally, no one owns due to banks cutting corners with the paperwork. This video, The next housing shock, describes the situation. The market is in an extraordinarily warped state right now.
Good point. I hadn’t considered that that whole mess hasn’t shaken out yet.
That should be “it is rare for houses to lose value without a corresponding insurance payout”. Natural disasters and fires sometimes cause houses to lose value rather precipitously.
(Which is another thing to remember about house ownership: it requires insurance.)
It was much, much worse than that in Florida, where they overbuilt and there was a glut. As far as I know, there was not as much excessive building in Adelene’s city.
Note that if the Fed raises interest rates, credit will become more expensive, demand will decrease, and prices will decrease (all else equal).