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To rent or buy? Prepare to do some tricky math

There’s more to buying a house than being able to afford the mortgage. Other expenses can be substantial.

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There’s more to buying a house than being able to afford the mortgage. Other expenses can be substantial.

If you're frustrated at paying rent for your apartment, you may be considering whether now is the right time to buy a home. Making the leap from renter to homeowner isn't as simple as deciding your rent's too high, though. In reality, you need to weigh the pros and cons of homeownership in the context of your finances and your future.

"There's a notion that we have in our heads that we have to buy a house and that it's somehow wrong to rent," says Anna Behnam, a financial adviser and managing partner with Ameriprise in Rockville, Md. "The reality is that it's not true for everyone and there are positive points to renting and to buying."

Behnam says that renting offers the benefit of being able to move whenever you want to take a job in another part of the country or even just in a different location within the same city. "It's also nice not to have to pay for maintenance," says Behnam. "If your air conditioning breaks down, your landlord has to pay $6,000 to replace it, not you."

Homeowners not only need the money to make repairs, but they must make time to maintain their property, says Nancy Wert, an agent with Re/Max Realty Centre in Olney, Md. Even a newer home requires at least some maintenance; an older home may require a bigger budget for repairs.

An important factor in deciding to buy your first home is how long you plan to stay in the area. If you only plant to stay for three years, you should probably rent, says Shelley Green, a real-estate broker in Bethesda, Md. "It's best to stay in your home at least five to seven years to recoup the cost of buying and to build equity."

Buyers who opt for a fixed-rate mortgage have the advantage of knowing their principal and interest payments will remain the same, although property taxes and homeowners' insurance premiums can rise. "Over the long term, a lot of financial planners say buying a home is a great way to build wealth, because you build equity as you pay down your loan and you have the benefit of the tax deduction," says Jen Angotti, a real estate agent with DCRE Residential in Washington.

Even if you're emotionally ready to buy a home and think it's a smart financial move, you need to find out as soon as you can if you're qualified to buy. While a stable job history and a solid income are important, you also need good credit and money saved for a down payment.

The sooner you talk to a lender, the better, says Gail Kullman, a senior loan officer with Prime Lending in Alexandria, Va. The way rents have escalated in some areas means that buying a home sometimes costs less than renting, she says. "But you need to get your finances in order and give yourself time to improve your credit score if you need to, because your score not only allows you to qualify for a loan but it also dictates your interest rate."

Kullman warns that would-be buyers need to estimate a comfortable mortgage payment for themselves rather than relying on the lender's loan qualification process. "If you think you can afford a $1,500 per month mortgage but your rent is $1,100 and you haven't been able to save, you may need to rethink that. Part of your decision to buy should be to take a hard look at your income, to see if it's stable and rising, and to look at your assets to make sure you have enough for a down payment and for reserves in case of an emergency."

Kullman suggests saving the difference between your rent and your estimated mortgage for a year or longer to get used to the larger payment and to generate additional savings for cash reserves and a down payment.

While the Consumer Financial Protection Bureau's new "Qualified Mortgage" rules allow for a debt-to-income ratio of 43 percent, Behnam thinks that's too high because it's based on your gross income. "You should base your budget decisions on your net income rather than your gross income," she says. "A lot of buyers estimate their payment based on the principal and interest they pay, but you also need to include property taxes, homeowners' insurance, homeowner or condo association dues and possibly mortgage insurance and flood insurance."

Behnam recommends keeping a cash reserve equal to two mortgage payments in the bank to cover potential home repairs in addition to your emergency fund of three to six months or more of expenses.

"When you look at your available cash for a down payment, you need to make sure you're not draining your savings to get into a house," says Behnam. "I recommend making a larger down payment of at least 20 percent, though, to avoid paying mortgage insurance, to get a lower interest rate and to make your monthly payments more affordable."

She cautions buyers to think in the long term about the affordability of a home. "You need to look down the road to make sure your income will match your needs for the house but also for other expenses such as college tuition and retirement savings."

Five tips for future home buyers

1. Develop a five-year plan. You need to own a home at least five years to build equity.

2. Determine your budget. Regardless of the loan amount you qualify for, you need to know what you're comfortable paying for your housing.

3. Check your credit. Your credit score is paramount to getting a loan — you may need time to improve it.

4. Consult a lender. Before you look at homes, you must know your price range and your ability to obtain financing.

5. Consult a real estate agent and see what's available in your price range.

To rent or buy? Prepare to do some tricky math 03/05/14 [Last modified: Wednesday, March 5, 2014 4:42pm]
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