7 top homebuying myths debunked
Think that you get more for your money in the suburbs, that homeownership is the path to wealth and that a big down payment is always better? Think again.
Myth No. 1: Buying beats renting
Yes, that's what you've been hearing all your life. But then, the chances are that housing values have been climbing for much of your life.
Now, the mortgage meltdown is changing attitudes about buying and renting. In a recent survey, government finance agency Fannie Mae found that 23% of renters are postponing their plans to buy a home.
One big reason to think twice about buying is that home-maintenance chores are endless. Caulk the windows. Regrout the bathroom tiles. Change the furnace filter. Will it ever end? No. Sure, you can hire someone to do all this for you — if you have the money. Otherwise, there goes your weekend: mowing, weeding and checking off items on the honey-do list. That list of stuff hangs over your head like homework.
The only thing worse? Repairs. The roof springs a leak; there goes $20,000. You wanted a new car? Too bad. See that carefree gal at the Saturday matinee? When her toilet broke, she called the landlord — and then she headed out the door.
These days, when people do buy, it's to make a home, not a fortune. People gave the Fannie Mae pollsters mostly nonfinancial reasons such as safety (43%) and school quality (33%) for buying.
Myth No. 2: A home is a great investment
"Real estate is the path to wealth." This belief is so ingrained in our thinking that it's nearly a religion. And maybe once it was so. But today, the return on real-estate investments – and that includes your home – is abysmal. The hard truth: Your money is better off in stocks.
Blogger J.D. Roth did the math. His calculations show that money invested since 1926 in owning a home earned roughly 1% above inflation. Stocks, on the other hand, averaged about 7% over inflation. Not the 15% returns that many investors had been hoping for, but a whole lot better than your average real-estate investment. Nationally, home prices have fallen about 33% since mid-2006, according to the S&P Case-Shiller Home Price Index (.PDF file).
Jack Hough, a financial writer, reached the same conclusion. Stocks have rewarded investors with 7% inflation-adjusted return over long periods, while homes netted their owners about 0%, he says.
"If you have $300,000 and a choice between spending it on a house or shares, you'll pay $6,000 a year in incidentals if you buy the house or about $15,000 a year ($1,250 a month) in rent if you buy the shares. But the shares will return $21,000 a year after inflation, while the house will return zero. My numbers work out even better than these. I pay a smidgen less than $1,250 a month for rent," Hough writes, in "Why rent? To get richer."
But New York Times writer David Leonhardt, a proponent of renting, is rethinking: He now finds buying may be better — in some places. The economics on housing costs vary by market, Leonhardt says in this recent article.
To decide, he calculates a "rent ratio." Divide a home's purchase price by the cost of renting a similar home for a year. At a ratio of around 20 or above, renting looks better. Below 20, buying gets more cost-effective. (Comparing a $300,000 home with a $1,500-a-month rental — $18,000 annually — yields a ratio of 16.6; a strong case for buying.) Many big metros now are down to 16 or lower, but markets with ratios of 25 could be in a bubble. The ratio is only one part of the decision. Other factors matter, too, such as homeowners association fees and commute times and costs.
The new caution on homebuying does seem to be sinking in: 70% of people surveyed recently by Fannie Mae believed that buying a home was "one of the safest investments available." Seven years ago, the same survey found 83% believing that a home purchase was safe. (Just 17% thought stocks were safe.)
Myth No. 3: My home is my piggy bank
When homes were gold mines, borrowing against the equity was common. Prices were rising, interest rates were low and lenders were pushing refinancing; you could imagine that you were borrowing against selling your house in the future for a huge pile to pay it all back.
People used equity lines of credit or mortgage refinances to buy cars and vacations and to put the kids through college. It wasn't unheard of to finance your ongoing monthly expenses with home equity.
In retrospect, it was an awful idea. Today, banks are more conservative about lending, even to those with equity.
But cash-out refis will be back. When home prices rise again and lenders rediscover their courage, remembering the $2,000 and $3,000 fees they earned from each new loan, you could find yourself thinking, "We need a new roof and, look, there's all that equity just sitting there."
When you do, remember that home values can fall, leaving you stuck with a debt bigger than the home is worth. Leaving a cushion of equity gives you protection; you can sell if you need to and still make a little money or at least break even. (Read personal-finance guru Liz Pulliam Weston's "4 reasons not to refinance.")
Myth No. 4: A bigger down payment is always better
Buyers usually are urged to put lots of cash into a home purchase. The reasoning: You'll borrow less, saving tens of thousands of dollars in interest on the loan and lowering your monthly mortgage payments. You won't need to buy mortgage insurance, which is required if you put less than 20% down. Also, if your home value falls and you want to sell, you have a cushion of equity and less chance you'll have to contribute extra cash to pay off your mortgage.
But you don't have to put 20% down. Federal Housing Administration loans, with down payments as low as 3.5%, have grown in popularity.
There are a couple of powerful reasons why a small down payment, coupled with the required mortgage insurance, might be a good idea:
- Borrowers with mortgage insurance may be able to get a lower interest rate than those who put down 20% or even 25%, according to this New York Times article. Lenders apparently feel safer when loans are insured; the insurance covers the lender if you default.
- A low down payment may help you buy now, while prices are at record lows, if you haven't yet saved 20%. If you wait to save a bigger chunk, prices could rise beyond your reach.
There are some other benefits to a smaller down payment:
- Flexibility. Your money is not all tied up in your house, leaving you with little or no cash for home repairs and improvements, an emergency or job loss.
- Diversification. You can diversify your investments, distributing your money more safely among a variety of investment types — stocks, bonds or mutual funds, for example. That way, a real-estate downturn won't wipe you out.
- Choice. You can always make additional payments, adding to your equity and paying off the loan sooner; you can stop paying mortgage insurance once you have 20% equity in the home.