For many during the pandemic, “home” has taken on greater significance, along with expanded expectations of what a home should provide.
Perhaps as a result of this greater focus, the housing market has seen some radical shifts in 2020 and 2021. Rents in historically expensive markets have seen notable drops, while those in traditionally cheaper markets have increased. Meanwhile, inventory of available homes for sale is at near-record lows, leading to a spike in home prices.
All this has once again raised the perennial question of whether it is better to continue renting or to buy that first home. It’s often assumed one can simply compare a calculated monthly mortgage payment to their current monthly rent. Unfortunately, this is far from an apples-to-apples comparison.
Here’s a look at one of the first factors to consider when making such a foundational financial decision: How long you plan on staying put.
Dispersing the cost of closing — then closing again.
As you’re likely already aware, buying a home involves expenses above and beyond a simple downpayment.
While closing costs are typically split between the buyer and seller, buyers are often responsible for the lion’s share. Buyer-covered closing costs include inspection fees, appraisal fees, title fees, document transfer taxes, and more. All in, buyers can expect to pay anywhere from two to five percent of the home’s purchase price in closing costs.
Though the seller pays less in closing costs, the overall financial burden in the home buying/selling process weighs heaviest on the seller. This is because sellers are usually responsible for the five to six percent commission paid to the realtors. Meaning, when their share of the closing costs is taken into account, sellers are typically on the hook for eight to ten percent of the home’s sales price.
Given that the costs on either end of the home buying/selling process can easily run into the tens-of-thousands, it becomes clear why it might not be a great idea to repeat the process every year or two. In fact, the longer you own a home, the more those costs can be dispersed over time.
Interest vs. principal payments.
Assuming a borrower has secured a fixed-rate loan, their monthly mortgage payment will stay the same over the life of that loan. It’s therefore logical to assume that all payments will be comprised of a consistent portion of principal and interest payments. That, however, is not the case.
From month to month, over the life of a home loan, the borrower is paying the interest on their principal balance as it stands at that time. Therefore, in the beginning, when the principle is higher, a larger portion of the mortgage payment goes toward interest, with a smaller portion going toward the principal. As a result, the borrower builds equity much slower during the first couple of years than they do farther down the road.
Because of the lopsided nature of this repayment structure, buying isn’t typically a better choice, financially speaking, than renting until a buyer has remained in their home for at least five years. That is unless the borrower can swing making extra payments on their mortgage.
If you are planning on staying in your home 5 or more years…
Then that’s a major check in favor of buying over renting. Keep an eye on our blog in the coming months for deeper dives into the other factors surrounding this foundational financial decision. And, as always, feel free to reach out to a Directors Mortgage specialist to explore your financing options, or start the mortgage pre-approval process today.