Financial Timeline

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As storybooks go, the character is introduced, they meet their love interest, a villain thwarts their intentions, true love overcomes, they marry and live happily ever-after.  It’s a very familiar formula.

Similarly, there is a formula that couples follow in real life.  They go to college, get a good job, rent a home, fall in love, get married and buy a starter home.  They start a family, move into a larger home, save for their children’s education, start planning for their retirement and if they live within their means, they invest their surplus funds.

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An alternative to this might be to start investing in rental homes early in their adult life before their standard of living becomes so expensive that they don’t feel like they have the money to purchase rentals.  There are infinite possibilities but let’s say a single person, after getting a good job, buys a small three or four-bedroom home with an owner-occupied, minimum down payment.  They move into the home and possibly, rent out the bedrooms to other singles who need a place to live.

At some point, they decide to buy another home to live in with a minimum down payment and either rent out their bedroom in the first home or rent the whole home to a tenant.  And they repeat the process again with the second home.

This could continue until they acquired several homes.  Let’s say, that in the meantime, they have met their love interest, decide to get married and together, they buy a starter home for them to live in.

This concept advances the investment in rental homes from the latter part of their lives to the early part of their life.  The early investment gives them more time for appreciation and wealth accumulation.  A simple principle of investing is that sooner is better than later.  By delaying gratification to own your “dream home” early, a person may be able to accumulate more net worth in the same period of time.

Buying a property initially as owner-occupied permits a lower down payment of 3.5% compared to a typical down payment for non-owner-occupied properties is 20%.  By using more borrowed funds, leverage can increase the yield on the investment.

It may be too late for some people reading this article to adopt this strategy but if they have kids in college, it may be something for them to consider.

Own vs Rent

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When the standard deduction for married couples filing jointly was increased from $12,700 to $24,000 for 2018, there was some speculation that the bloom was off the rose of homeownership.  The thought was that if the tax benefits from being able to deduct the property taxes and interest was less than the standard deduction, that maybe, the buyer would be better off continuing to rent.

With mortgage rates as low as they have been for the past eight years, payments have been lower and so has the amount interest that was paid.  This and the fact that sales and local taxes, which include property taxes, are limited to $10,000 a year on the Itemized Deduction form have made it harder to reach the increased standard deduction.

The reality of the situation is tax benefits are only one of the components that make a home an excellent investment and it probably contributes the least of the top three benefits.  Principal reduction and appreciation build an owner’s equity in an automatic way that is like a forced savings account.

In today’s market, it is common for the total house payment to be lower than the rent a first-time home buyer is currently paying.  As a homeowner, the buyer would have additional expenses like maintenance and possibly, a HOA.

To illustrate the net effect, let’s look at a purchase price of $275,000 with 3.5% down payment on a 4.75% 30-year FHA loan.  We’ll assume the home appreciates at 3% annually and the buyer is currently paying $2,000 a month rent.

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The total payment is $2,115 including principal, interest, property taxes, property and mortgage insurance. However, when you consider the monthly principal reduction, appreciation, maintenance and HOA, the net cost of housing is $1,181. It costs $819 more a month to rent than to own. In a year’s time, it would cost $9,831 more to rent than to own which is more than the down payment required to buy the home.

In seven-years, the $9,625 down payment would grow to over $58,000 in equity.  The equity build-up far exceeds the tax benefits which some people would have as an additional incentive.  Use this Rent vs. Own to see what the net cost of housing would be using a home in your price range or call me at (830) 708-7199 and I’ll do it for you.