Anyone who is searching for a house, knows somebody who is, or even reads financial news probably knows that the current state of the real estate market is absolutely bonkers. Home prices in my area are up over 14% since the start of the pandemic. That’s right, a house that sold for $440k before March 2020 would now be expected to sell for over $500k just eight months later. It’s a similar (or even crazier) story across many regions of the US and Canada, and I’d imagine other countries as well.
Record low inventory, record low interest rates, and peoples’ desire for more space while working from home have created a perfect storm to push housing prices to astronomical levels. Anyone who thought homes were overpriced before COVID-19 likely had their head sent spinning by the surge in prices. Potential buyers who were teetering on the edge of affordability are now looking at what seems to be an insurmountable financial cliff.
For a lot of Americans, home ownership is a big deal. And as some watch the dream slip away in real time while others now find themselves just on the new edge of affordability, it generates some very pressing concerns. One specific such emotion is known as FOMO, or Fear of Missing Out. It’s a type of anxiety caused by the knowledge that one is currently not experiencing some event, or may never experience it in the future.
It’s easy to see how those shopping for their first home, or hoping to do so in the future could be experiencing FOMO right now. Here’s just a few paraphrased examples of things that I’ve actually heard over the past few months which perfectly capture that anxiety:
“Buy now while you can afford it, or get priced out forever!“
“Buy while interest rates are low, you can afford so much more house and rates are only going to go up!“
“Renting is throwing money away, you need to buy a house so you can start building equity!“
All of these statements are either exaggerated or completely false. We’ll come back to a couple of those later. For now, let’s consider the sources. These were either direct quotes from real estate agents, the media, or individual home buyers/owners (who are likely just parroting what they heard from the prior two sources).
What many people fail to consider is that real estate agents are salespeople first and foremost. Most everyone seems to have a healthy distrust of car salesmen. I don’t see why this isn’t extended to real estate agents. They’re paid on a commission that’s typically a percentage of the sale, so of course they have a vested interest in trying to pump the housing market. Unless the agent you’re talking to is a highly trusted friend or family member, give their words no more credence than you would provide to a car dealership.
Of course, the major consequence of falling for this particular type of FOMO is making a regrettable decision; to eschew rational decision making and fall victim to making a choice rooted in emotion. You might feel pressured to buy a house that’s not “the one”, or a house in a cheaper area with a much worse commute, or a house that’s way over budget. And you might do so because you’re afraid if you don’t buy now you won’t be able to afford any house at all in the future, or you’re simply fatigued after searching for many months with no results.
As a potential first time home buyer myself, I understand these frustrations on a deeply personal level. We made the decision that we were ready to start seriously considering home ownership in January, just a couple short months before the coronavirus pandemic hit the US. So we made our primary financial goal setting aside enough cash for a 10% down payment. After hitting that goal we started house hunting in earnest in July, hoping we’d have a house to call our own by late fall or even early spring of 2021.
Now fall is on its way out, and based on our experiences over the past five months or so of house hunting, it’s not looking likely that we’ll find “the one” anytime soon. I can count on one hand the number of open houses we’ve gone to where the property ticked off nearly every box on our checklist. They all sold for at least $50k over the list price (the list price itself often being highly inflated when referencing comparable properties that sold before the pandemic).
That’s fine, the rabid overbidders can have those houses — I’m not willing to buy a house if the numbers don’t make sense. Housing is most peoples’ biggest monthly expense, so overspending here can absolutely wreck your chances at financial independence and early retirement. The average American spends nearly a third of their post-tax income on housing, so that’s probably a good measuring stick for what not to do unless you want to end up being financially mediocre. But if you want to FIRE, your entire budget needs to be built from the foundation of your required savings rate to reach early retirement at your desired age.
Figure out your budget for a house
Unless you live in a rural area, chances are that buying a house right now would result in a higher monthly payment than your rent. Buying a house may mean trading off a bit of your savings rate and impacting your FIRE goals, so it’s important to quantify that impact. Be honest and try to calculate the total cost of home ownership. Your mortgage payment is only part of that cost.
You’ve got to consider:
- Mortgage payment (principal and interest).
- Property taxes.
- Home insurance.
- Private Mortgage Insurance (PMI) if you don’t have 20% down.
- Maintenance (budget 1% of home cost per year).
- The opportunity cost of not investing your down payment in the stock market (estimate 5% of your down payment per year in lost returns).
- Higher utilities costs if you’re moving into a larger space.
- What you’re going to spend to furnish your house.
A lot of people only seem to consider the first four. If you’re not honest with the total cost of ownership, all of those hidden costs will sneak up on you and you’ll be spending a lot more on your house than you thought.
Next figure out the trade off: what additional percentage of your budget would you be willing to spend for the benefits that come with owning a home? Feel free to use a mortgage amortization calculator to understand what portion of your payment goes towards equity, since that’s technically “savings” assuming your home at least holds it’s value against inflation.
For me, I determined that spending a maximum of $1,600 per month beyond the cost of our rent would decrease my savings rate by about 5% of my income. That’s where it felt like a fair trade off for me, but you’ll have to make your own personal decision here.
Working backwards to determine the price of a house which supports what I considered to be an acceptable budget for total cost of ownership put the home price at 2.5x our annual gross household income. Around 2x our gross income is when the house started to flip towards actually being financially advantageous to own. Interestingly, this lines up with many different sources I’ve seen over the years which claim that buying a house at 2x to 2.5x your annual gross income ensures that you’ll be able to comfortably afford it. So that’s cool, I just independently proved that old rule of thumb is pretty solid after all!
Then, stick to your budget!
On the other hand, banks will allow you to buy a house up to 4x your annual income fairly easily, and sometimes even beyond that! Apparently we’d qualify for a monthly PITI (Principal, Interest, Taxes, Insurance) payment of nearly $5,000. I can’t overstate how devastating such a payment would be to my financial goals like early retirement, even though we could certainly afford it from a cash flow perspective. That would mean nearly half of our take home pay just going to housing! Buying anywhere close to the maximum the banks will lend you is a one-way ticket to being house poor.
It’s easy to give in to the frustrations of today’s housing market and increase your budget beyond the 2.5x income rule (or whatever you’ve decided is a fair budget). List prices are much higher than at the start of this year. People are overbidding by 10% or more beyond the already inflated list price in many areas. It’s a cutthroat market for buyers out there, and for those buyers like myself trying to stick to a budget and avoid getting sucked into the wanton frenzy, it may feel hopeless that they will ever secure a home.
Possibly the worst part is that if we had started looking a year prior, we would have been able to buy a pretty nice house for 2x our income, or an absolutely gorgeous house for 2.5x our income. Ever since the pandemic, it’s more like 2.5x our income gets us a dumpy fixer upper that needs tens of thousands in renovations, and the perfect turnkey houses have been pushed to selling for over 3x our income.
During our home search, I’d be lying if I said I hadn’t considered “if you can’t beat ’em, join em” at least a few times. We certainly have the means to participate in bidding wars and probably come out on top. But I quickly snap out of it when I calculate the impact that raising my housing budget would have on my FIRE goal. Am I really willing to spend 3-5 more years of my life working just to own a house in the Boston area?
Certainly not. It seems far more efficient to just rent until I’m financially independent, and then move to one of the many areas of the United States (or even internationally) where I can buy a house for less than my $2,000 monthly rent.
In defense of renting
And speaking of renting, I’ve heard people claim that renting is “flushing money down the toilet” or some similar statement over and over. It’s this kind of ridiculous hyperbole that makes everyone think they need to own a house to get ahead financially, when that’s simply not true. I rent, and look at me. I’m 27 years old, I don’t even have a six figure income, and my net worth is over $180,000 USD. At the rate I’m going, I will retire by age 40.
Renting is exchanging money for shelter. Yes, it’s true that at the end of a 30 year mortgage you own a house, and after 30 years of renting you own nothing. But guess what — property taxes never go away, nor do home maintenance costs. In fact, both of these expenses tend to go up over time. So it’s not like you get to live for free once your mortgage is gone. Assuming that I owned an average house in my area free and clear, I’d still be paying $1,000 to $1,500 per month in taxes, maintenance, and home insurance. That’s 50–75% of my monthly rent.
Sure, in this hypothetical scenario I’d also have nearly half a million in home equity. But equity is dead money. You can’t touch it or invest it in anything else without paying a bank interest on a HELOC, which almost always makes no financial sense. The best way to access it is to sell your house, upon which you lose 6% in commission to your agent. Obviously you still need shelter, so now you get to either rent alongside the people you’ve been making fun of for 30 years, or buy another house to live in. Basically the only scenario in which you sell your house and end up with a huge pile of cash is one in which your house was mostly or fully paid off, and you exchange it for one in a cheaper locale.
At the end of the day, every single portion of your mortgage payment that doesn’t go towards principle is a waste of money in the same manner that renting is a waste. If you buy a house with a PITI payment equal to 150% or more of your rent, chances are good that you’re coming out behind compared to if you stayed renting and just invested the difference in stocks.
Actually, that’s a big reason that I believe home ownership is so overrated by the average American — most people don’t have the self-discipline to “invest the difference.” Anything in their bank account beyond their monthly bills each month will get spent. Home ownership is essentially a type of forced savings plan, whereby after 30 years of paying their bills and not particularly caring about saving or investing, people will end up with an asset worth a few hundred thousand dollars. The alternative outcome here is they rent for 30 years and spend everything else on consumer goods, ending up with nothing for retirement besides Social Security and maybe a tiny 401k balance. I think that’s part of the reason older people in particular claim that you “need” to buy a house, because they couldn’t possibly have conceived of making retirement work out if they hadn’t done so.
Don’t get me wrong, I’m not saying home ownership is a bad choice. It’s just probably not the financial slam dunk that American culture makes it out to be. There’s definitely ways to come out ahead financially by buying a house, as long as you’re buying well below your means. Likewise, there’s ways to come out ahead by renting instead if it means avoiding buying a house that would stretch your budget.
Maybe you’re like me, where you feel like you can’t find a house that makes financial sense among the current real estate market insanity. And that’s perfectly fine if you can rent for significantly cheaper than the total cost of home ownership, all while continuing to shovel your free cash flow into savings and investments. Keep your eye on the prize of your overall financial picture and building your financial independence nest egg.
There’s no shame in renting, and you can certainly still get rich by doing so.
What’s the best course of action moving forward for potential first time buyers?
What will happen in the future is unknowable. Will the FOMO peddlers be right, that if you don’t buy now and get on the property ladder, you will be priced out of the housing market forever? Potentially, but probably not. On the other hand, the people calling for a 2008-style housing crash are probably similarly off-base. The truth is almost certainly somewhere in between those two extremes. Exaggeration and pretending to have all the answers drives news headlines.
While I’d love to see prices come down a bit, I recognize that’s just my bias coming into play as a potential first time home buyer myself. Just as the statistics show that almost nobody can consistently predict the direction of the stock market beyond random chance, so too must we apply that logic to the real estate market.
Buy if the numbers make sense to you, and only if you fully understand the trade off that you’re making with your other financial goals in order to own a home. Otherwise, be content to rent. The market could change, your financial situation could change, or maybe you plan to FIRE and move elsewhere so you simply don’t need a forever home in your current location.
As for myself, I’m going to take a break from house hunting until at least after the holidays. I’ve filtered the MLS notifications that I get for new homes so they go straight to another e-mail folder that I can check whenever I remember to, and I don’t have to see the inbox notifications multiple times per day. It’s a nice separation from that false sense of urgency. After all, browsing Redfin and Zillow in this current market is just a constant alternating sense of disappointment and wry amusement — “they want $600k for that?!”
Heading to packed open houses every weekend has been getting a bit hectic, so I need some time to recharge and reflect. I know what’s important to me, and that’s having the financials make sense for a home that’s up to my personal standards for quality and potential. I am not willing to compromise when it comes to my largest monthly expense.
Rent or own, I’ll achieve financial independence either way. And you can too, if you’re smart, methodical, and intentional with your personal finances.