As the late, great George Carlin once tried to remind us, "That's all your house is -- a place to keep your stuff." Now, his philosophy didn't convince many people, of course, because there are just too many other emotions tied up in the idea of homeownership. It appeals to our territorial instinct to plant roots, to have a little place of our own that we can do with as we please, or to show the world that we're real, responsible adults.
So in our ongoing Motley Fool Answers series covering major life events, this week, co-hosts Alison Southwick and Robert Brokamp tackle the complexities of buying a home, with aid and insight from Ross Anderson of Motley Fool Wealth Management -- a sister company of the Motley Fool. And in this segment, they lead off with one of the biggest questions that people may forget to ask: Should we be buying a home in the first place? It's not a one-size-fits-all answer, and emotions and "stuff" notwithstanding, you'll want to look hard at the real math before you sign on the many, many dotted lines. And not just your mortgage math, either.
To catch full episodes of all The Motley Fool's free podcasts, check out our podcast center. A full transcript follows the video.
This video was recorded on April 9, 2019.
Alison Southwick: The first step, of course, is to decide whether or not you really should buy a house.
Ross Anderson: Which I think a lot of people think of as a given. They just assume "I should be a homeowner."
Southwick: I'm an adult! That's adulting!
Anderson: That's just like checking the boxes. That's the next thing I'm going to do. I'm going to get a job, I'm going to get a home, I'm going to get a dog. Maybe a spouse somewhere in there. We'll interlace this with Sean's episode.
I think the first question is should home owning be in your immediate future or something that you aspire to? And I don't know that the answer to that is definitely yes. I think home ownership gives you a couple of protections. One against the inflation in housing. If you've been a renter, you get that letter. It goes, "Rent's going up."
We just know that inflation is going to pass through so many different items that you're locking in that cost of the home. Your tax bill still may go up as your assessment goes up, but for the most part you're securing that cost of the home that you're going to be in and protecting yourself from that.
People talk a lot about the growth of real estate as an asset. Fun fact: Do you guys know the actual real estate growth rate at a national level for homes?
Robert Brokamp: The stats we've used in the past were stats from David Blanchett of Morningstar saying once you factor in all the costs of ownership -- like taxes and repairs -- it's like inflation or a percentage point above inflation.
Anderson: It's like 3.1%.
Brokamp: So there you go!
Anderson: It's a very unexciting number. If you're in a market like San Francisco or somewhere that home prices have been skyrocketing and have done so for a decade or more, you may think that I'm nuts when I'm say that, but home prices, at least at the national level, are not this big, exciting "go straight up really quickly" sort of asset. But you don't have to put all the money into it, either.
To use really simple math, if you buy a $500,000 home and you put $100,000 down and the home price goes up by 3%; you've made a pretty good return on your $100,000 that you put in because you're borrowing most of that money from the bank. So I think you do get some leverage upside. But in the short term, the things that can go wrong are brutal.
Southwick: Yeah! Yeah!
Anderson: They're brutal and we've got some fun stories, hopefully, that we can share.
Brokamp: Fun, in quotes.
Anderson: Fun as you smile through the pain, but I think every homeowner has gone through some of these things of just stuff going wrong that you don't plan for. And also the frictional cost of moving in and out of a home means that it needs to be a long-term decision. If you're buying a home and you don't think that you're going to stay put in that spot for at least five years, I think you're probably making a mistake. Just the real estate commissions, the mental effort to find and to get into the transaction, and the lost time -- maybe at work -- of spending all the time on this stuff is a lot.
Brokamp: The amount you spend on getting your house ready for sale...
Brokamp: And then there's the inspection and the things you have to fix after the inspection... is a lot of money.
Anderson: Well, selling is another episode which I'm also going to do. I don't want to go too far down that path.
Brokamp: We all know that one.
Southwick: Save it for the next time.
Anderson: Yes, exactly. I think there's a lot of frictional cost when you look at it. And so, if owning a home is your American dream, I think you need to want to be in that place for a while, and you really need to be financially prepared and so we're going to talk a little bit about how to do that.
Southwick: Let's talk about that. How do you make sure that you are financially ready to buy a house?
Anderson: I think most people think of the housing purchase in the component of a monthly expense. They think about their rent and they look at what they can afford relative to that.
First of all, if you're going up -- if you assume that your mortgage payment is going to be more than your rent -- start making that payment right now. And I don't mean paying extra in actual rent but start treating your housing payment as if it's more than it is and committing those extra dollars to savings.
I really think that's the simplest way to figure out what you can afford. Now I heard that I was mentioned on this show as the anti-budgeter.
Brokamp: It's true. On Financial Health Day.
Anderson: And I believe that. I really am. I embrace that. I'm not a budgeter where I want to figure out where every line item goes, but I do want to figure out if what's left after I commit to those expenses is enough for me to live my life comfortably. So if you think that you're going to go up by $500 in your payment, start putting that $500 in savings. Don't touch it. You can still spend the rest and see if that's a comfortable space for you.
And I think that does a couple of things. No. 1 is it starts preparing you for a down payment, because now you're accumulating cash. That's all good. And we're kind of stress testing. Does our budget support this higher level of payment, even though we haven't committed to it yet? I think that's one of the first things, is to start to stress test your budget a little bit to see what you can afford. Because if you go to the mortgage guy, they're going to tell you that you can afford...
Southwick: An insane amount of house.
Anderson: An exceptional amount of house. They're going to look at what the most you could borrow is that we think you're likely to probably not default, maybe, but if you do we're going to take your house from you.
Brokamp: But at that point they've sold you the mortgage anyhow, so it doesn't matter to them.
Anderson: Exactly. They've made their money. That's not a knock against mortgage guys. I don't think that's an evil industry. They're allowing a lot of great things to happen. But don't look at the number that they show you and go, "Oh, I can afford it!"
Southwick: It's ridiculous. We got approved for double what we should probably be living in. It's insane!
Anderson: It's a lot of money!
Southwick: Especially our first house. We were like, "What? You think we can afford this?" Ron was like, "There's no way we can afford this." I'm like, "I know! Did these people really vet us? We just gave them everything and this is what they came back with?"
Anderson: Did you guys read these numbers?
Southwick: Did you read this? Are you assuming that our only expense is going to be a house, because it's not really what it's going to be?
Anderson: I think that's the wrong way to determine the budget but start figuring out what you spend by actually doing it, and I think it's got two effects. You stress test your own budget and you start to save a little bit more aggressively.
The other thing is really that your emergency fund needs to be in a bigger spot. So three to six months is the typical guidance. If you're on the three side, I think you need to be closer to six when you become a homeowner because there's going to be big stuff. Even in a condo, which is what I just came from, I replaced every appliance and most of them not out of choice. Hot water heater, HVAC system. You name it. Dishwashers. It all breaks over time, even if you've got decent stuff in there and it's going to happen when you don't expect it.
So don't get caught out of position and end up in a spot where you're kind of pedaling backward with credit card debt and everything else. I think you've got to have your savings level higher to go into a home and be able to take the bumps and bruises along the way.
Southwick: When you're a renter you just don't think about it. You're like, "Oh, my toilet broke!"
Southwick: Call! It's a call! Oh, that was annoying but now it's fixed. I don't know how much it costs to fix a toilet. I wouldn't even begin to know.
Anderson: Sure. Yeah.
Southwick: It could be $1 million. It's not $1 million. I actually do know about how much it is to fix a toilet. But I didn't when I was in my twenties and when I was renting. You don't even think about all those costs and boy, they add up!
Brokamp: A couple of rules of thumb that people will use is you should assume that you'll spend 1%-2% of the value of the house on annual maintenance. So if you have a $500,000 house, then $5,000 to $10,000 a year. Or there's also a square footage rule of thumb. So $1 for every square foot or $2 will give you the price of your place. That gives you a rough idea of how much you should plan.
The thing is it doesn't happen each and every year. Sometimes you'll go a couple of years without anything and then "poof!" You need to replace the roof for $30,000.