When I bought my first home in Miami, I was fresh out of graduate school, and it was a true necessity. I was commuting 100 miles to work watching at least three accidents on the highway daily—it was life or death in my world.
Buying at that time was not the wisest choice since interest rates were at 8% and my savings account was a fraction of what it is today, but the bank I found gave me a first-time buying special and only asked for 5% down of the purchase price.
The mortgage represented 37% of my income and the monthly expenses were almost the same as renting an apartment, so I chose ownership and enjoyed my 10-mile commute. Since then, I have had my ups and downs buying several properties and as a Certified Financial Planner, I can suggest you take the following steps to make a wise decision—especially in these times when the real estate market is so unpredictable and interest rates are on the upswing—and don’t look back.
Take the temperature of your need on a scale of 1 to 10
In my case it was a 10, due to my 2- to 3-hour commute and my boss’s sarcastic comments about my oversleeping when I was one minute late—it was just unhealthy. And having an apartment that was on Miami Beach was just priceless.
Maybe you are not in a dire situation like me, but assessing the why and identifying what this purchase means to you beyond numbers will help. For example, I have friends that bought a house knowing it was expensive and small because of the school system, and for them, their kid’s education was more important than for each kid to have their own room.
Another friend wanted to be close to their parents and paid market value to be walking distance to take care of them. Unless you are just buying it for investment and flipping it, the purchase of a home is driven by your emotions and some things that money can’t measure.
This is where you will spend holidays, celebrate birthdays, stay home sick and watch movies on rainy days. The question in this step is not whether financially it’s a good deal or not, it’s “is it in the right location for me and my family to be happy?” Close to the things you need; work, school, a hospital, parks, shops, friends, family, etc.
Assess the timing and opportunity cost of waiting
Historically, the average house in the U.S. costs around five times the annual household income. In 2021, $79,900 was the average household income and $428,700 was the average home, respectively, according to the Federal Reserve Bank.[1]
During recessions, household incomes decrease by 8% to 16 %. But it may still make sense to buy. Historically, recessions have caused an average price decrease of 7.5% in home prices. And during the last recession in 2007 to 2009, interest rates on mortgages saw a 20% drop.[2]
Based on those numbers, if you purchased a home at the pre-recession price of $500,000 with a 20% down payment and a 30-year fixed rate mortgage at 5%, you would pay $141,000 more over the term of the mortgage than if you waited until the recession brings down prices and rates.
Of course, you may not see decreases in prices and interest rates at exactly the same time, but the idea is to look at both before you make any decisions.
But also keep in mind that making the decision to buy a house is beyond just the price and interest rates. There are other factors to be taken into consideration: the location, the interest rate projections, the mortgage term, real estate taxes, maintenance costs, insurance premiums, whether you are buying in a rising economy or during a recession, your credit scores and whether buying is the best use of your money right now. You want to make sure you have a complete financial picture for your particular situation and outlook before signing the contract.
Consider the role a house will play in your overall financial plan
It is recommended that your payment, property tax and insurance costs stay below 35% of your income and that you evaluate the cost of renting, too.
For example, I have a client who has three children, two teenage twins in junior high school and one in middle school. She needs a big house now but in two years when the twins go to college, she will downsize to a small two bedroom apartment.
In her case buying in a high market does not make sense; she will rent (since 1980 rent has been up only 8% on a yearly basis) for a couple more years and then buy a smaller place and save her money in other asset producing investments.[3]
For other people it is important to have a piece of real estate as an investment and rental income and travel around the world—it depends on your goals and your debt tolerance. I worked with another client who exhausted her home equity line of credit, retirement account loans and investment lines of credit to buy rental properties. Her tolerance for debt was high but as long as she had a responsible debt to equity ratio of 2x assets to debt it was aligned to her goals and her risk tolerance. With volatile times coming, an ounce of prevention (and caution) is worth more than a pound of cure. Plan based on your own risk tolerance and expectations you have for your life—if you are in your growing years, perhaps you can afford to take a chance but if you are close to retirement and will have a fixed income, act with caution.
