A house is the largest purchase most of us will make in our lives, so it makes sense that questions about housing come up often in the financial planning work we do with clients. There are plenty of rules of thumb about buying a home, but most of the rules center around affordability and making sure you buy at a certain price. However, there is a good bit less guidance on understanding how a home fits within a long-term financial plan, so I wanted to provide a few thoughts based on our experience. Here they are:
Buying vs. Renting – If you’re wondering whether you should buy or rent, your time-frame comes into play. If you are planning on staying in the house (or the neighborhood) for years, consider purchasing if you can safely afford to do so.
When comparing rental cost vs. cost of home ownership, compare the rent you pay to the interest portion the mortgage payment, plus the cost of property tax and home maintenance. Lastly, deduct the amount you save in taxes through the deductions for property tax and mortgage interest. Even if the cost of ownership is a bit higher now, remember that if your mortgage is fixed, the cost will remain constant while rents rise over time.
Your Primary Residence is a Use Asset – Within the context of financial planning, we view a primary residence as an asset that you use and enjoy as opposed to strictly a financial asset. Based on this, demanding the same rate of return you would expect from your investment portfolio may be unrealistic and unnecessary (especially if you’re okay with the next point below). If, on the other hand, you’re considering purchasing an investment property you should expect the property to meet a minimum level of return and you’ll want to analyze it accordingly.
How Much You Can Afford Over the Long Term – As I mentioned above, there are no shortage of rules to determine whether you can afford a house in the short term, but how do you answer the question surrounding long-term affordability? We focus on whether you’ll still be able to fund your long-term goals at the required level post-home purchase.
So, for example, if you need to save $20,000 for retirement but buying the home means you’ll only be able to save $14,000 each year, it’s doubtful that you can “afford” the house over the long term. If you have your heart set on a house that crimps your savings, you might be tempted to assume you can just sell the house at some point down the line to meet your savings goals, but be careful, as this approach can be a slippery slope.
When it comes to purchasing a home, you should make the decision within the context of your overall financial planning. Beyond assessing affordability, we believe understanding how it impacts your long-term plan and recognizing that it isn’t purely a financial asset are keys to making a good decision.