Brian Wynne, CPA

The last three years have surely been some of the scariest times to be a homeowner.  The well-documented sharp increase in home sale prices between the early 2000s and 2007 has been followed by a continuing 3 year correction, bringing house prices right back down to near the levels they were at when the run-up started.  I would surmise that for most homeowners, the safest course is to stay in your home and wait this correction out.

The government has been acting in a limited fashion to try to buck this trend and spur some buying activity in the real estate market.  Lawmakers initiated a tax credit for homebuyers that recently expired, but have also exerted their influence to keep mortgage rates as low as possible.  Right now, the average rate in the DC area for a 30-year fixed rate mortgage is a little over 4.5%.

To Buy or Not to Buy – That is the Question

If you are not a current homeowner, it may look like an attractive market to enter into, even without the credit.  Home prices are low, mortgage rates are low, and there is a lot of inventory out there to choose from.  However, loans are hard to get right now, with down payment requirements usually exceeding 10% of the purchase price.  Lenders learned their lesson and are leery of taking chances.  Further, if you are looking at a home as an investment (and why can’t it be both?), what will the near-term future hold?  Is it a good time to buy or does renting make more sense?  What about the tax benefits of owning a home?

You can always run the numbers, especially if you have an idea of where you want to live.  There is a terrific calculator the New York Times set up a while back that can factor in a lot of variables and give you a timeline on when it is better to buy versus rent.

Without getting too far into the exact numbers, though, here are a few big picture things to consider:

1) Most buyers know that mortgage interest and property taxes are tax deductible.  However, you should consider the benefit of these deductions relative to the standard deduction that everyone gets anyway.  If you are married, and you purchase a house expecting to see a tax benefit from $15,000 of mortgage interest AND $2,500 of taxes each year, consider that not in addition to the standard deduction of $11,400 you may have enjoyed last year, but in lieu of it.  The added tax benefit may not be as large as you think.

2) Financed real estate can be a good investment because you are leveraging a small amount of initial investment (say 10% of a $300,000 home, or $30,000) to get appreciation on the full $300,000.  If appreciation is 4% per year in a normal real estate market (historical appreciation is generally between 3% and 5% per year), and you hold your house 4 years, your $300,000 house would be worth a little over $350,000.  But, that is $50,000 return over 4 years on an investment of $30,000 (albeit with some annual costs on interest), almost 28% return per year.

3) But, as a lot of homeowners are now painfully aware, appreciation in the value of a house is not always easy or cheap to realize.  The cost of selling a home usually includes a commission to a realtor, usually 5% or 6%.  That commission is paid on the total sales price, so in our earlier example, if your $350,000 house sells in that fourth year, you may pay a realtor as much as $21,000 (6%) just to sell.  That $50,000 of appreciation suddenly got a lot lighter.  Couple that with the uncertainty of being able to sell when you need to, and the decision point may change.

There are many more factors that go into the decision on whether to buy a home in this market or continue to rent.  Some are financial and there are many calculators available like the New York Times one that will help you sort those out.  Some are not financial, though, like the pride of owning a home or being able to modify the home as you see fit.  However, everybody now realizes that the market can go down, and owning a home is not always a risk-free proposition.  Even in this buyer’s market, renting may not be such a bad idea, if you can find a comparable rental rate.  You can let someone else bear the risk of ownership, and save the money that would otherwise go into a down payment for a time when the market may be stronger.