Wednesday, 4 June 2014

Buying a House Now vs Saving: Six Steps to find your Answer

It is disheartening during a booming property market to see already unattainable prices move further out of reach. After all, every dollar more you have to borrow will add more to interest and repayments. For example, $5000 at 5% over 30 years will attract $4662 in interest.

Although other asset classes like stocks/shares beat property, buying a residential home generally beats renting and investing the surplus over the long term. You can model this with the most comprehensive rent vs buy calculator I've found.

I used to get caught up by statements like, "I can only save $X per year, but prices are increasing by $aX per year!". Then I realised that there were too many variables for that sentence to mean anything. Why can you only save $X? Prices of what? There is no way to calculate a definite Buy vs Save answer because X and aX can fluctuate so much.

So let's take a fresh step-by-step approach.

  1. Do you need to buy a house? If 'No', then examine why you want one. Borrowing to avoid price rises is unwise. You could take advantage of rising asset prices in the stock market without borrowing instead. An ethicist friend once remarked that while being independent in finding shelter is naturally 'good', it doesn't have to be through home ownership. Furthermore, real estate speculation can be exploitative, wasteful, and greedy. Jesus drove the money lenders out of the temple for usury; collecting interest on money. You know, what we do when we deposit money with banks. Just sayin'. If 'Yes', move to the next step.
  2. Do I know what property I need? A studio apartment will generally be more affordable than a McMansion in the same area. If 'Yes', move to the next step.
  3. Am I saving efficiently? This is a major variable. It is far easier to save a dollar than to earn a dollar, not the least because you are taxed on what you earn and not what you save, but also because you have complete control of your spending habits. It is easier to deny yourself a pack of cigarettes than to get a raise but both will increase your savings by hundreds of dollars a month. It may be even possible to save on big ticket items like rent and transport by living with parents or giving up cars.
  4. Do I have a 20% deposit? If 'no', then go back to Step 0. Yes? Go to the next step.
  5. Can I afford the loan? Many first homebuyers have a hard time at this step because they currently occupy lesser accommodation - quite prudently - while they save for their ideal property. The rent cannot be compared to mortgage repayments because the properties are different. Generally speaking, if you can afford the rent on an equivalent property, you can afford the loan. A more traditional way of calculating loan affordability is the 28/36 rule. If 'No', then go back to step 0.
  6. If you've 'passed' all the steps beforehand, then go ahead and buy, knowing that you will be better off financially for living in your own home over the long term. About 5 to 7 years in the long run, according to the default scenarios in most rent vs buy calculators. Can't wait that long? Go back to step 0. Maybe buying isn't for you.
As you can see, home ownership is far more than timing the market to take advantage of price movements. Buying (what?) vs saving (how much?) may be a valid question, but it is nowhere among the first.

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