Living the American Dream in your own home — A guide for Junior Developers Part 2

You are been interested in owning your own place, but are daunted by all of the complexities involved in such and intricate financial transaction. Houses (or condos, or other types of real estate) are probably the most expensive purchase you have ever contemplated making and so it is really important to understand what you are doing.

I am not a real estate professional and as with other financial articles I am introducing some points in order for you to have a better conversation with an expert. Please seek experts advice before laying the large sums of money required for real estate purchasing. Also, all of this information is only applicable in the United States of America. I have never purchased real estate in any other country and so I can’t speak on that type of experience.

Dual Goals

In your first real estate purpose there are often multiple potentially conflicting goals.

• You are looking for a place to live
• You are buying an investment

As with any choice that involves multiple goals you should understand the tradeoffs because there will be tensions that only you can resolve.

The Base Costs

In many markets you will immediately see what appears to be a serious reduction in cost from your rental, but depending on your situation you may find your house to cost much more.

The first cost is your mortgage. This consists of your loan payment which has a principle and an interest component. This is similar to all other loans. You pay X per month and some of your payment goes to the lender in the form of interest and some of it goes towards paying down your loan balance. It is typical to take a 30 year loan out to pay for your house.

The second cost is your property tax. This is money you pay to your city and/or county as the tax for owning property. This can vary between 1–4 % of your property value depending on your area. Usually you pay for this through an escrow account managed by your lender. On a monthly payment schedule you pay 1/12 of your taxes along with your other costs in a single bill situation to your lender and when tax time comes, your lender pays the government for you. It is a pretty nice deal.

The the third cost is optional and it depends on your downpayment. Generally lenders will not even loan you money unless you have 3–5% of the purchase price of the house as a downpayment. If you have less than 20% down then they ask you to provide private mortgage insurance (PMI) that will pay out if you default on your loan. The higher the downpayment the lower the cost of your mortgage insurance.

If you are a veteran of one of the US Armed Services you can get a VA Loan where the government will guarantee your loan so you can put less than 20% down (including 0% down) and still not be required to get mortgage insurance. In return the VA collects a funding fee that gets added to your loan. You can look at the VA website for current funding fees but as of right now they are between 1.5–3.3% depending on your situation.

Your monthly payment will be the total of your mortgage payment + property taxes + mortgage insurance. This is how you start to compare your new costs to your current rent.

True Costs

Your true costs are likely much higher than your monthly payment.

The first hidden cost is repairs. You have been living in the golden age where something breaks (the toilet, the roof leaks, the appliances) and your landlord magically fixes it for no money. Maybe they are slow and maybe they are selective, but they are always free. If your heater or air conditioner goes out you can be on the hook for thousands of dollars. A water heater installed can be around $700. A roof can cost $5k-$10k depending on the size and shape.

If you buy a condo then the condo complex will charge you a fee for keeping up the common area’s for you. In housing areas that provide community areas (pool, park, etc) or that provide yard maintenance (lawn mowing, etc) for you will charge you a home owner’s associate (HOA) fee. These fees can range from $50 to $500 so it is good to understand whether your house has these fees and what kind of amenities you will receive in return.

The last true cost is the desire to fix, upgrade, or remodel some aspect of your house. If you were renting you would never dream of painting a room, getting new sinks, installing a built in fireplace on the patio, etc. Somehow when you buy you start getting those desires. If you have a life partner then the two of you will dream together of even costlier modifications. Obviously this is fine, but you should be aware that this dreaming happens and budget appropriately.

Picking a good investment

When buying a house it is good to spend a little bit of time planning your move out. Houses are expensive to sell and can take a lot of time to sell if you aren’t lucky. Here are a few tips.

You should usually budget 8%-10% of your house sale towards closing costs. There are a few costs that are based on percentages of the sale (real estate commissions) and other costs that are fixed prices (title insurance) which is why there is a range. A real estate agent can help you get estimated closing costs. That means that if you bought your house for $500k and you sell it for $550k you haven’t made any money. You will get back your downpayment and the principal part of your payments and break even. This usually translates to having to live in a house 3–5 years to break even but this depends on the real estate market in your area.

If your house looks like all of the other houses then chances are it will be easy to sell. A lot of houses look similar because those are the style houses that builders know they could sell. If you buy a unique house then you are going to need to find a unique buyer to sell to. This is one of the tensions you need to resolve. If you are going to buy a unique house then you should be prepared to sell the house under market value if you need to sell the house quickly.

In the technology industry it is common to move jobs every 2–3 years. If you are going to relocate to different states often then you may be better served to stay as a renter.

Leverage

Real estate investing is based on the principle of leverage. When you buy a stock you usually pay cash for the entire cost of the stock (we’ll ignore buying on margin). In that case you can’t lose more money then you already paid. If the stock goes to $0 you have a worthless piece of paper (more literally a worthless electronic record) but nobody can come and collect more money from you. When you use leverage you pay a portion of the investment and someone else pays the other portion. In the case of real estate your lender is paying most of the money.

With leverage if the price goes down you can lose more money then you put into your house. This happened in the housing crash of 2018 and is called being upside down. It will happen again. In real estate you only lose money when you sell so the value of the house doesn’t matter while you are living in it, only when you sell.

Rent Control

One of the really great advantages to owning a house is rent control. For 30 years (or the life of the loan) your “rent” is locked it. It will modestly go up every year because your property tax will go up, but generally that will be less than $10 a month. At the end of your loan your “rent” takes a dramatic drop. You will then only pay property tax for the rest of the time you own your house. This future of cheap housing can make all of the extra costs above worth it in the long term.

Conclusion

Buying a house can be really exciting, but it is good to go into it with eyes wide open. Home ownership works really well for people who stay in one place for a long time and have stable housing needs. While buying initially looks cheaper than renting, the hidden costs may end up making it quite a bit more expensive than it looks at first, but depending on your situation it can be worth it.