When people first start thinking about buying a house, they often mistakenly compare the cost of a loan for a house to the cost of rent. Then they think they are being ripped off on their current rent and that they should go buy a house ASAP instead of “throwing money away on rent.”
The true payment
The real payment for a house is the mortgage + property tax + insurance + money set aside for repairs.
Use an Amortization Calculator and plug in the amount of money you need to borrow and the interest rate you think you would qualify for (check www.bankrate.com for an idea of current rates). That’s your mortgage payment.
Look up the property tax for the house you would like to buy. You can find this on some popular housing sites, but the best source is the county’s tax website.
Take that property tax, divide by 12, add it to your mortgage payment.
Also be aware that the tax will likely go up in the first year after you bought the house, especially if the county finds out what you paid for the house.
If you are responsible, you already have renter’s insurance. Home owner’s insurance is much more expensive. This can vary widely depending on your policy, but they tend to scale based on the replacement cost of the house.
Look up what it costs to insure the house you are looking at. Add that to the mortgage and property tax.
Total payment to the bank
If you escrow your taxes and insurance, then all of the above will be rolled together into one payment to your bank.
But wait, there’s more
Stuff breaks in your house. Hail storms happen. Tree limbs fall through your window. Toilets overflow and ruin your floors. Pipes develop a leak over time. Some of these are covered by insurance, but you will still be paying $1,000 or 1% of your house value out of pocket. Those are two common deductibles for insurance.
Leaking pipes, painting your house because it is worn, trimming your trees, replacing broken appliances, AC dying of age, foundation issues, etc. are typically not covered by insurance. You’ll have to pay for them out of pocket and they can range from $100s to $1000s of dollars. These are all issues your landlord takes care of today (or should, at least).
One rule of thumb is to save 1% of the value of your house per year into a rainy day fund for repairs and upkeep. At some point, you don’t really need to keep adding to that rainy day fund. Personally, I skip this, but that is because I have a HELOC I can tap or I can withdraw funds from the stock market at 2%. I would rather invest everything in the market for the best long run outcome. But if you are just starting out, keep a savings account and set money aside for repairs and maintenance.
Home owner’s association dues
The house you are looking at may have a home owner’s association that you must pay. Some HOAs are optional. Some are cheap. Some are very expensive.
In the case of condos and townhomes especially, HOA dues can be significant. Think about who has to pay to replace a shared roof, repair a shared pool, pay the electric bill for communal lights, replace broken gym equipment, paint the exterior of buildings, etc. While an HOA in a neighborhood may feel like a scam if there are no amenities, the HOA of a condo or townhome really is necessary and can easily be $100s per month.
Does your rent currently provide amenities that you value, such as a pool and gym? Will you be paying for a membership to access these kinds of amenities? If so, add that to your math.
If you are renting an apartment, your utilities are probably cheaper than they would be in a house. When shopping for a house, ask for recent utility bills to see how they compare. If they are higher, add it to your math.
Add it all up
Add up your mortgage + property tax + homeowner’s insurance + rainy day fund contribution + HOA dues + amenities + utilities. That’s your true payment to compare to your rent.
I think homeownership is very important. It is a key component of building wealth over time but home ownership also adds risk to your financial equation. Be sure to do an accurate comparison. Don’t think that if you pay $1500 per month in rent that you can buy a house that has a $1500 per month loan payment. Even if your mortgage + tax + insurance is $1500, keep in mind you won’t have a landlord to call when something breaks. If you want to go to a gym or pool, that will probably cost money. Your utilities will probably go up.
Just use this math to set a responsible budget for your home purchase. Keep in mind that you also want to be able to save to invest, so keeping your housing expense low is important. Even though home ownership technically is an investment, unless you are renting it out to someone, it does not pay you a dividend that you can live on like a stock market investment. You may choose to sell your house and downsize when ready to retire. If that is your goal, then you can count it as part of your investment portfolio. But don’t trick yourself into stretching to buy a home by calling it an investment.
What would it rent for?
Especially if this is your starter house, you should see what it would rent for and if the price you are paying would make for a cash flow positive investment. In other words, find out what it could rent for and subtract your all in expenses from above. Maybe you will live here for 5-10 years and then move into another house. If you can rent out this house profitable, that could be a great deal for you. That’s what we did, twice.