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Wednesday, January 14, 2009

The House That Mongo Bought: Rent vs. Buy vs. Build

We continue the Home Ownership series with Part Two.

Take Off Your Shoes….There’s Math Involved.
The decision to stop renting and start owning is a debatable topic covered in full elsewhere on the web. What I will say to this is that prior to buying a home I saw my monthly payments increase while my living space depreciated. In 1999, I was paying half of $375 plus utilities. In 2000, I ventured out on my own and began paying roughly $360 a month plus electric for a one bedroom apartment. By 2003, I had upgraded to a two bedroom townhouse for around $450 plus utilities. As 2003 turned into 2004 I slowly realized that I could keep moving and pay a substantial amount each month for more square footage or I could plateau and remain where I was at for a small incremental increase. I started doing the math and realized that I could make a onetime jump to a 30 year mortgage and be able to own my home, make improvements and not have to worry about someone else being responsible for the state of my place.

People will say, stop throwing money at rent and get equity. What exactly does that mean? It means that after you pay rent for 3 years on an apartment, you have no ownership of that property. If you wanted to get a loan you couldn’t use your apartment for collateral. If you’ve been paying off a house for those same three years, your equity is the difference between the fair market value of your home and the unpaid balance of the mortgage and any debt over the it. Equity increases as your remaining loan amount decreases or the property appreciates from improvements. You could use your equity to get a loan, using your home as collateral. While, this isn’t always a safe or smart venture, depending on your financial savvy you could use it to your advantage.

The other thing I will tell you is that don’t let anyone bully you into buying a home. This is probably the single biggest investment you will make, outside of raising a child. There is a lot of risk, especially because of what happened in 2008.

Be Smart!
We all want to blame Wall Street for what happened to the housing market. Some even want to blame the government. Ultimately, we are responsible for our own actions. Don’t get sucked in by attractive loan packages or promises of unimaginably low rates. Talk to someone you trust about finances like an advisor or even a relative or friend who has been there. While the sub prime mortgage crisis was brought on by fuzzy math and invisible money, the fact remains that a lot of people simply tried to live beyond their means. First time home buyers or even people on their fifth house need to be cognizant of the bottom falling out of everything. “If I lose my job, will I be able to still make my mortgage payments?” “How long can I go without income and still meet all my fiduciary responsibilities?” “What if my lender gets bought or goes bankrupt?” If you think just because you got a low rate you may be able to play the odds today you can buy a million dollar mansion then you are destined for failure. In my opinion, the object is to buy low and sell high. If you want to own a home, begin to figure out what you exactly want in the end before signing your life away now.

Be Patient.
In 2004, I took the plunge and bought my first home. From the previous October, I had looked at about 100 listings online and actually toured about seven in person. We worked with a real estate agent who happened to be a friend of a friend. We asked her to do one thing for us. Tell us her thoughts like we were her kids. Now, not every agent is going to be that honest. In fact the life of a real estate agent is tough. It’s a very proactive career. Some companies don’t pay you a base salary. In fact, some charge you for resources such as desk space, use of MLS (Multiple Listing Service) systems, etc. After that, consider that the real income occurs only after the sale. Let’s say a $150,000 sells and you are the buying agent. Standard commissions are about 7% in most places. There are some that advertise 2% but you get what you pay for there. That 7% commission on a $150,000 comes to $10,500. That is then split between the buying and selling agent. Now, the agent gets $5250. Once they pay off all their fees, the take comes to probably half that. If they sell 20 houses a year for that initial price of $150,000, they’ll make roughly $52,000 before taxes. That’s not bad but not great. You could see why an agent is more interested in selling high and not being completely honest about the house in question.

With our agent being someone we trusted, we started out looking at houses. The third house we looked at became our favorite and the litmus test for all other houses. It was a three bedroom ranch with a finished basement, integrated garage, and big backyard. The view from the back was pretty good. Tall pine trees on three sides blocked out most of the surrounding yards. Two big Maples in the back and two big Oaks in the front provided ample shade. Hardwood floors throughout most of the main level was an added plus. The downstairs had a bricked hearth with a beam mantle above a wood burning insert. A wet bar with a brick wall and counter top that spanned most of the room was all I needed to buy. The downside was that everything was a little dated. The roof was fairly new, but the flooring in the basement was a brown shag carpet and wood paneling on three sides. The back porch, while enclosed, served as a place to keep their dog and the tile flooring was ripped up and scratched overall. The electric was 100amp and the box outside had frayed cabling. More on this, later.

Now, you may ask, “This house seems like a lot of work. How could it have been your favorite?” I never said it was our favorite house. It was however, the favorite in our price range. There was one house, a split level roughly 10 miles away, that was our favorite. My wife toured it with her father while I was at work. It was gorgeous and very spacious. Multi level decks and a very neatly landscaped yard were to die for but the price was about $60,000 above our price range. Granted, we probably could have talked the sellers down $5000 for something, but even still, the taxes alone would have put our mortgage up over $1000 easily. We still talk about that house even though I never saw it. It was probably a good thing, too.

This what you need to consider when buying a home. Do I want to buy a home that is ready to move into and then have a little work to do renovating it? Do I want to sell the house for a profit in less than 10 years? Do I want to buy a cheap house and fix it up? Do I have the skills to do so or the money to pay someone else? Can I live in the house while doing restorations? The answers to these questions can decide your course. I have very little experience in home restoration. At the time I bought my first house, I had only done light plumbing on sinks and toilets, some landscape work, very little electrical work by changing a light fixture, and no structural work whatsoever. For me to be a big fixer upper might take me years to do and more than one try to get it right. I needed a structurally sound roof over my head with aesthetic work to be done on the inside. I don’t intend to sell this house for at least 20 years and by then I should have it where I want it. It will also be where a buyer will want it. I’m learning as I go and fixing a lot of issues that the original owners left behind.

Why Not Build?
There is not a thing wrong with building your dream home. But, can you afford it? Today’s construction costs are well into the mid six figures and that doesn’t get a lot of bang for your buck, depending on where you live. Not to mention, you need to do the interior and landscaping as well. If you are an accomplished carpenter, electrician, and plumber you can cut costs by doing a lot of work yourself. If you’re not, you are at the mercy of the men with the calculators. It can get expensive and the more people you deal with, the harder it is to keep track. A lot of contractors are working on multiple projects and can’t devote all their time to finishing your place on time and under budget. I would never suggest this as a first time homeowner venture. Just like people say with car ownership, buy someone’s mistake. You can find lists of homes for sale due to foreclosures, back taxes, or sheriff’s sales. If you’re dead set on having your dream home from day one, do the research.

Now, I would eventually like to build a home. I have a lot of ideas in my head for how I want my dream home to look. I will probably never be able to afford it unless Ed McMahon or the Powerball people show up at my door. But, I am willing to work at making my current home the best I can possibly make it. It may take me the length of my mortgage but once that’s been paid in full, I can start planning for the future. Small moves. That’s why I have been trying to pay down personal debt in order to pay off a house early. The quicker I get the principal down the more I’ll save in interest. That’s what the 13th payment is all about. If you make a plan and are disciplined enough to follow it, you can make anything happen, economy be damned.

Anyone who is in a hurry to buy a home is crazy. Yes, it’s smarter to pay mortgage than rent. Yes, it’s better to have equity. No, it’s not mandatory to own a home as soon as you graduate college. Look, I admit, we got caught up in the whirlwind romance of home buying back when the housing market was booming. Low interest rates and incentives to buy courted us like we were royalty. I never thought I would buy a home when we started looking. I figured it would be a lesson. Something to use in the near future. I was getting married and the timing just worked out. That house we kept coming back to became more and more attractive against all the others. I also relied on the opinions my family as well as our agent. That is a big plus. Look to the people who you trust for help. Especially parents or friends who have been down this road before. Advice is free. Mistakes are costly.

Final Thoughts on Buying.
Look at your lifestyle. Are you someone who likes to entertain or are you someone who just likes to curl up on the couch at night with a glass of wine and the remote? The biggest problem I had with both my townhouse and my current house was spacing. Furniture was not an option. I already accumulated living, dining, and bedroom suits from various sources. Every Christmas in my townhouse was an exercise in ridiculousness. There was one window in the living room and the tree would go in front of it. This meant my love seat had to go somewhere else. For two Christmases I had to live with a love seat in the dining room up against the sliding glass door to my patio. Being winter, we didn’t use it. But it did cut down on space for having people over for dinner. The dining room wasn’t big to start. The same occurs in my current home. Every year, I have to put the love seat in a spare bedroom to make room for a Christmas Tree. I have take the feet off just to be able to fit down the hallway and I have to take the door off the spare room to fit through the door way. This is an annoyance but I wouldn’t let my furniture dictate the house I was buying. That’s the tail wagging the dog. Now, of course, being a man, there is some thought put into whether or not the television is visible from every possible seating arrangement. We used to joke about the first house I lived in when I rented with a friend. The owners took a closet in the dining room and converted it into a powder room with a folding door. You could sit on the toilet with the door open and see the television in the living room. Of course, it wasn’t always ideal if you left the front door open and someone popped in unannounced.

Spend the money on home inspection. Because of the type of loan we had and the home owner’s insurance, there was a lot of work to be done before we could submit an offer. I mentioned that the cabling on the electrical box was frayed. In order for us to secure the loan and insurance, the head had to be replaced and the covering for the cable had to be upgraded to code. Since I had an electric dryer and the house was only 100 amp. I offered to front the difference in order to upgrade to at least 150. It was either pay for it then or more later. The house had the screw in fuses and a breaker box was a better choice. The owners also had to pay for a radon mitigation. Unfortunately, we had no say in the installation of the pipes and fan. It will be hard to renovate the second full bathroom in the basement with this huge pipe coming out of the floor and going into the exterior wall.

Plan for the worst.
My wife has been bugging me for a pool since we bought the house. One, I can’t afford it. Two, I CAN’T afford it. Three, I can’t AFFORD it. I’ve already told her that at least three things have to occur before that pool can even become a thought in my head. One, the furnace will have to be replaced. The thing has got to be like 30-40 years old. Hell, it might even be original to the house which was built when Kennedy was still alive. The air conditioner will have to be replaced. I think it might be 20 years old, but I’m not sure. Lastly, the hot water tank will have to be replaced. The thing was ten years old when we bought the house and within the first year, it went. I’ll never forget it. I was snoozing on the couch one night when my wife began screaming for me. I ran into the bathroom where the furnace and hot water tank were kept to find a geyser. Water was just spewing out of the top of the tank and onto the floor. Now, the sales folks in the big box store wanted me to buy a huge tank. One even tried to turn me onto an electric hot water tank. I thought he was nuts. I have a budget plan for my gas bill. The cost to my electric by adding in a hot water tank would have been crazy. So, we went with a middle of the road size for a tank and I installed it myself. This was my first real plumbing experience. We got lucky. Had we already gone to bed before finding the mess, our basement would have been flooded by the morning, ruining everything thing we owned. We got lucky. I always tell my wife if she wanted a pool so badly, she should have left the tank go. We would have had an indoor pool for free.

Useful Links:
Rent vs. Buy Calculator from
Build vs. Buy from HGTV
Making the Decision to Custom Build or Buy Your House from
Building Costs Calculator based on area and features. Foreclosures

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