By Nick Stewart
So, renting a home always equals throwing money down the drain, and buying a home is key to building equity … right? Nope. That rule is as outdated as a horse and carriage.
In fact, more people are deciding to keep on renting — indefinitely. Why? People have different financial goals. Some housing markets are ridiculously expensive. And if we learned anything from the crash of 2008, it is that home values are not guaranteed to go up. A mortgage-payment-v-monthly-rent comparison doesn't tell the whole story.
If it's a good fit for you, though, owning a home can have lots of benefits. You get to pick and customise your home to make it your actual happy place. Your housing costs might be more predictable (no landlord to increase the rent). And owning a home often does help you build equity.
No matter what is going on in the housing market, the right time to buy a home, if ever, is when you're financially ready. Ask yourself these four questions to help you decide when that may be:
1. Do you have enough saved?
Buying a home requires a pile of up-front cash. Take out a mortgage before you've got that pile saved up, and you might be putting your financial stability at risk.
There is the down payment — you can get a mortgage for less, but it's wise to put down at least 20 per cent of the home's purchase price. Thanks to KiwiSaver! More than 80 per cent of all first-home buyers now used KiwiSaver in some way to help them buy a property.
There are the closing and moving costs — which run to about 5 per cent of the purchase price. And then there are the things that renters pass off to their landlords, but homeowners can't, like broken water heaters — you'll probably want to save 1 per cent of your home's value a year to cover maintenance costs. And you'll still need three months' worth of take-home pay saved in your emergency fund.
In summary: How much you'll need to save to buy a home
20 per cent of the home's purchase price for the down payment
+ 5 per cent of the home's purchase price for closing and moving costs
+ 1 per cent of the home's value for maintenance costs
+ Three months' take-home pay for emergencies
If you've got that locked and loaded, real estate listings are calling your name. But if you're not there yet, it often pays to be patient while you save up.
2. Can you afford the cost of ownership?
A study says that if you are spending more than 30 per cent of your income on housing, you're "housing-cost burdened". That's a good benchmark to try to stay under. Just remember: Besides mortgage payments, housing costs also include homeowners' insurance, property taxes, and if applicable mortgage insurance.
And if the cost of home ownership in your market does fit into your budget, you'll still want to have enough left over for your other financial goals – like investing, starting a business or retirement planning.
3. How is your overall financial picture?
If your job is new, or you are trying to get your own business off the ground, or your source of income is not certain, it might be safer to keep renting until things solidify.
If something were to happen to your cash flow, a lease is a lot easier to get out of than a mortgage is. Things get even riskier if you put down less than 20 per cent up front: If your home's value were to drop, you might owe more than it's worth, and to sell it, you'd have pay the difference.
Also, check your credit score. A lower credit score generally means a higher interest rate on your mortgage, which means you will build equity — the percentage of the home you own — more slowly.
It goes without saying that your credit score must be in better shape for a home loan approval than it does for a new credit card or mobile phone contract.
However, there's no one-size-fits-all answer for what credit score you need to gain approval. Estimated break points for credit scores vary, but in general, aim to be in the 650-700 range for the best rates.
4. How long do you plan to live there?
If you're going to buy, it's usually only worth it if you plan to stay there at least five years or more.
Couple reasons why:
You'll want to stay long enough that the equity you build can justify the transaction costs, remedial costs you incurred making the house your own, and pay off some of the mortgage, especially if you made a "small" down payment.
Conclusion: Choosing and customising your dream home is one of life's great pleasures. And, yep, buying a home gives you greater control over your housing costs and helps you build your net worth. But renting can give you greater flexibility and let you direct your money to your other financial goals. And, passing your maintenance costs off to your landlord is great too.
Nick Stewart is the CEO and an Authorised Financial Adviser at Stewart Group – a Hawke's Bay-based independent financial advisory firm based in Hastings. Stewart Group works with individuals, families, and businesses in New Zealand who are committed to pursuing financial planning and wellbeing. Our clients understand the value of independent, goal oriented and objective financial advice that is free of conflicts. If that sounds like you, we would love to hear from you.
The information provided, or any opinions expressed in this article, are of a general nature only and should not be construed or relied on as a recommendation to invest in a financial product or class of financial products. You should seek financial advice specific to your circumstances from an Authorised Financial Adviser before making any financial decisions. A disclosure statement can be obtained free of charge by calling 0800 878 961.