In our society, we always seem to be seeking the bigger and better. And we want it as soon as possible.
We want the brand new iPhone, even though we have one that still works just fine.
The newest advanced TV technology is an apparent necessity (considering the fact that Americans watch an average of 35 hours each week after all).
We need a new car, because the new body style and technology has come out, even though ours is only a couple years old and even still under warranty.
By thinking that we’ll be happier when we finally have this new gadget, higher-paying job or other status symbols we are essentially prioritizing our longing for upgrades over our personal contentment, gratitude and financial security.
Wanting the biggest, best home we can possibly “afford” (as the bank will tell you anyway) is the pinnacle of the American dream.
It’s no wonder that the idea of a “starter home” is so prevalent. We want to buy a home now and then a few promotions later, we think we need something bigger and more stately for our new status. This cycle might repeat several times, after which downsizing is the priority, especially if your retirement reserves are low.
WHAT ARE THE COSTS INVOLVED?
A home is likely the most expensive thing you’ll ever purchase. My husband claims that if he were single, he would live in a single-wide trailer and instead have a huge pole barn/garage with cars that each cost more than the property. But instead, he (so luckily) has all of us (an awesome wife, three kids and a Saint Bernard) and so our home is definitely our most expensive purchase.
It’s not just the home and land that are so expensive, though. When you buy a home, you’re looking at closing costs in the range of 2-5% of the purchase price. Even if you negotiate to have the seller pay some or all of the closing costs, that simply means that you are paying a higher overall purchase price to cover those costs.
Then, when you’re ready to sell your home, you’ll likely pay real estate sales commissions of around 5-6% of the negotiated selling price.
You can easily see how these costs can be significant. These aren’t costs that you’ll want to pay very often.
Of course, then there’s renovations and necessary repair expenses.
Yes, if you compare your mortgage payment with how much you would pay in rent, you may be paying less every month. But this doesn’t factor in the real overall cost of owning a home when you include all of these extra costs for the purchase, renovation, repairs and ultimate sale.
If you are only looking to live in your home for a short period of time (generally 4 years or less), you may actually be paying more than if you were renting. Now, I readily admit that there are other benefits to owning a home other than the cost, but it (literally) pays to be informed about the impact on your finances.
It may be that renting until you can afford to buy your long-term “dream” home is the wisest decision and will actually cost you less.
The best way to look at this is through a couple of examples.
MY OWN STARTER HOME EXPERIENCE
I started following along society’s clearly laid out path from the time I left home for college at 18. With my graduate degree nearly in hand, my first step was to purchase a home. I didn’t know a lot about personal finance at the time, but I did know that everyone should get in the housing market as soon as possible because it just keeps going up…and fast. That was in 2006.
It was all downhill from there… see that downhill trend for my home value?
By 2010, our home was worth less than half of what we paid for it. The Detroit housing market, including the suburbs where we lived, was hit especially hard. Even now, over 10 years after our purchase, our home value still hasn’t gone back up to what we initially paid for the home.
With our second child due, we decided to take advantage of the market crash and purchased our “forever” home in 2010 (it didn’t turn out that way, but that’s another story). Our little starter home was only about 1,100 square feet and in addition to our growing family, we had gathered a lot of random stuff, which we thought we needed more room for. We became reluctant landlords and have been renting out that property ever since, fortunately only having a couple weeks without a tenant in those past 7 years.
Without disclosing all the values, I calculate that our real cost was actually 218% of our monthly mortgage cost for the less than 4 years we actually lived in the home. This is due to a combination of paying very little down, a crashing market and a high-interest rate loan (refinanced somewhat recently). Yikes!
If we were still living in the home and planned to for the long-term as well, it wouldn’t be a major issue. However, even after ten years, we would have to personally pay money just to sell the property (which is why we are waiting until we are at least break even).
You could say that buying a starter home was not a smart move for us. However, we did purchase at the peak of the market, so that does account for a significant portion of our loss.
HOW TO CALCULATE YOUR TRUE SPENDING ON HOUSING
Let’s go through a typical starter home example, one that is less dramatic and that assumes you purchase a home today with expected home prices rising approximately 3.5% per year for the foreseeable future.
- Purchase price: $150,000
- Down payment: 5% or $7,500
- Mortgage terms: $142,500 for a 30-year, 4.25% loan
- Closing costs: 3.5% or $5,250
- Annual property taxes: $1,300
- Annual homeowner’s insurance: $800
At closing, the total paid for the down payment and closing costs would be $12,750.
Then for as long as you own the property, we’ll assume that the monthly payment is $876 for the total mortgage payment, which includes escrowed property taxes and insurance.
Of course, most starter homes need some renovation work so we’ll estimate that at $5,000 (let’s say this property needed new carpet and updated bathrooms).
Ongoing repairs are estimated at $750/year which is about .5% of the property value.
Assuming you keep this property for 5 years and then sell it, you’ll see that the total cost over that time period is $38,748. Calculated monthly, the cost would end up only being $646.
In a growing housing market with low mortgage rates, a starter home can actually save money over renting! However, there are certain factors that will determine whether this ends up being true. Some of these include:
- Rising interest rates if you have a variable interest rate mortgage, or if interest rise (likely) if your home purchase is in the future
- Risk of an overall, local or neighborhood market decline
- Extensive and necessary repairs
For example, if the interest rate goes up to 7.65% (what we paid when we first mortgaged this property), the monthly cost would go up to $1,116. If the housing market is stagnant, resulting in 0% growth over the 5 years, the monthly cost would be $1,087. If there was major damage found to the structure of the home (let’s say $20,000 total renovation/repairs), the monthly cost would be $833.
The moral of the story: if you’re thinking of buying a starter home, run a variety of scenarios specific to your situation to see what the possible outcomes could be. Then make an informed decision.
Here’s a spreadsheet template to get you started:
The real question now is this: is buying a starter home worth it? The answer is always, always: it depends. Because that’s where we get the “personal” in personal finance.
I would like to hope that for someone buying their starter home today, property values will go up enough that it will be worth it for them and save them money in the long-run. However, this isn’t my own personal experience.
If you’re looking at buying a home with the full knowledge that it will likely be temporary, take the following steps:
- Research the housing market forecasts in your local area
- Calculate the estimated costs involved for that time frame, including closing costs, the down payment, monthly payments, renovations, repairs and associated selling costs
- Run a variety of other scenarios, such as the interest rate increasing if you don’t have a fixed rate loan, different market growth rates and increased repair expenses.
We’re finally in our “forever” home and I definitely wish I had known more about how to calculate true housing costs back 10 years ago! Best of luck!
I bought a “starter” home in 2004. 13 years later I’m still there and honestly if it wasn’t getting really tight in there, we’d probably stay. We’d love to get a yard though for our son so he can stretch out his legs. The postage stamp of a yard that we live on is a bit tough 🙂
I’m glad it worked out. My sister made this exact same comment to me (it was even 13 years!). Everything changes when you have kids (#2 will be another big change for you!).
You’re so right about the pressure to buy! Buying definitely saves of you find a reasonable house for the long haul, but that’s not the norm.
We have to question everything in personal finances I think. So many times there are things like that generalized for an entire population. Buying a home isn’t a good choice for everyone.
Bought a starter home way back in 1992, moved in ’96 due to a job change. I’ve never run the numbers but I believe we came out ahead as we built a new kitchen in a +300 square foot addition very inexpensively due to cheap labor from my dad and my mad DIY skills.
I bought a re-starter home (after a divorce) in 2011 at the bottom of the market and did very well on it in 2014 when I relocated again due to a new marriage. A few updates and good market timing really helped.
I’ve been fortunate with housing transactions and I’m very grateful for that.
I definitely didn’t hit that kind of luck with that starter home purchase, but was fortunate enough to make money on the home I purchased in 2010. It’s never a given.
This kind of reminds me of the HGTV show Property Brothers, especially the repairs part. They buy a fixer-upper, and end up making it an awesome home. But along the way, there’s always some kind of unexpected repair that wasn’t originally budgeted. That’s what would scare me the most – the unknown costs associated with repairing because for example they would go to repair the sub floor and then found a termite problem and have to call a specialist. So the homeowners total cost ends up right at the peak of their budget.
That sounds a lot like our recent home renovation project. Homes can be so expensive!
We bought a starter home when we first got married and it turned out to be a good deal but it was mostly luck. Our second home turned out to be a stinker as we were selling right into the housing collapse. In retrospect the home was a stupid investment but I was like you and didn’t know how to calculate possible costs back then. I was just following the herd.
The conventional wisdom of getting in the house game asap is just too simplistic and we need to show people both sides of the story of renting vs buying.
I think there’s been a lot of luck involved in the real estate market in past recent years. It’s something I love to track, and I hope I’ll hit some of that luck in the future.
I bought an apartment a few years ago simply because I needed the security. Back in my uni days, I had an important file stolen from my room (I was living on campus, and the RA’s could access your room at any time).
That’s a bad situation. Unfortunately, we’ve had to deal with a break-in before and it’s hard to feel safe in your own space. I probably would have done the same thing.
It’s true the housing market “typically” goes up. But it isn’t always the case. It is nice seeing people admit to and share their stories of it not working out for them when buying a home. Everyone’s situation is different and there are reasons behind every decision. No two stories are the same so it makes it interesting. Even though you are just taking about purchasing a starter home, you still give some good points on the age old argument of rent vs buy. Thanks for sharing.
We would have been so much better off renting! Of course, you live and learn and we’ve done better in the real estate market since, fortunately.
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