Buy or Rent?

July 21, 2009

By Tyler Morrison, Research Intern

As I go into my junior year at the University of Maryland College Park I have this persistent thought of the “real world” that lingers in the corners of my mind. With everyone talking about how bad the economy is and one facet in particular – the housing market - I feel like Alice or Dorothy, totally lost. When I graduate what do I do? Should I buy a house and start a family like the American Dream suggests? Or should I continue to rent and save up what little I can after I get my first job and see how the market goes?

There are a few fairly simple strategies that I have found to help you make your decision of what to do when you graduate as far as buying your first home. Ask yourself some questions and the answers will help lead you down the yellow brick road to homeownership. How much of your prospective rent will be going to the homeowner’s down payment toward their rent? How locked in are you if you change your mind? What will it cost you to get out of the deal? How long will it take to accumulate enough of a down payment that you are likely to qualify for a mortgage?

If you expect to move within two years it rarely makes sense to buy. Considering that the average first time home buyer only stays in the home for four years it may not be the best choice for you. That is because when you do sell, there are costs associated with selling - and not just in terms of the sales commissions to the real estate brokers (which are negotiable, by the way!). Most owners rely on home appreciation to pay those other costs and to provide the down payment and closing costs when they buy their next home. So buying a home when you expect to move too soon is a risk, especially in an uncertain market. The second thing to think about when deciding how to pay for your own property out of college is that if you are not an owner, then you are most likely a renter. Renting as a broad generalization is just burning your money with nothing to show for it when all is said and done. You are not able to reduce your income taxes by itemizing deductions such as property taxes and mortgage interest. As a renter, you are limited on what changes you can make to your living quarters. Furthermore, generally the easiest way to accumulate wealth is through home ownership. Three out of four people have more equity in their home than assets in retirement plans, stocks, mutual funds, and savings. Though no one can guarantee your property will appreciate, over time it historically does. If you are still uncertain about which path to choose, the red pill or the blue, there are a number of interactive tools such as this “Is it Better to Buy or Rent- calculator,” which was done by the New York Times in April of 2007.

The current housing market has had a flood of foreclosed homes at sometimes dramatically lower prices and this, combined with the Housing and Economic Recovery Act of 2009’s $8,000 First‐time Homebuyer Tax Credit, has made an almost frantic climate of encouraged home ownership among college graduates and other first-timers. You may be surprised at some of the misconceptions people have about how the Tax Credit works; click here to get the full story.

Buying a home is a very serious event no matter how many times you have done it. You may be signing a contract binding you for the next 30 years. Many FTHBs make a few similar mistakes over and over again. They ask too few questions of their lender and end up missing out on the best deal. They do not act quickly enough and let someone else buy the home. They do not find the right agent for them, one who is willing to help throughout the home buying experience. When they have found their prospective home they do not do enough to make their offer look appealing to the seller. And, they do not think in the longer term about the resale of the home before they buy. To make sure you are making the right moves here are a couple of tips to prevent any mistakes or regrets in your home buying transaction.

Be picky, but don’t be unrealistic. There is no perfect home.
Do your homework before you start looking. Decide specifically what features you want in a home and which are most important to you.
Get your finances in order. Review your credit report and be sure you have enough money to cover your down payment and your closing costs
Don’t wait to get a loan. Talk to a lender and get pre-qualified for a mortgage before you start looking.
Don’t ask too many people for opinions. It will drive you crazy. Select one or two people to turn to if you feel you need a second opinion.
Decide when you could move. When is your lease up? Are you allowed to sublet? How tight is the rental market in your area?
Think long-term. Are you looking for a starter house with the idea of moving up in a few years or do you hope to stay in this home longer? This decision may dictate what type of home you’ll buy as well as type of mortgage terms that suit you best.
Don’t let yourself be house poor. If you max yourself out to buy the biggest home you can afford, you’ll have no money left for maintenance or decoration or to save money for other financial goals.
Don’t be naïve. Insist on a home inspection and if possible get a warranty from the seller to cover defects within one year.
Get help. Consider hiring a Realtor® as a buyer’s representative. Unlike a listing agent, whose first duty is to the seller, a buyer’s representative is working only for you. And often, buyer’s representatives are paid out of the seller’s commission payment.

Between the tax credit and the often low prices of foreclosed homes, college students are reaping the benefits of buying homes, Minn. Realtor® Jesse Godzala said. "It's amazing," Godzala commented. "There are first time home buyers that normally, it would take five to 10 years to get in a home, and in some of these cases, they're getting these homes for 2 percent down or 3 percent down." Prices on many of these houses are so low, that students are buying them and paying their mortgages at a rate of $300 per month, the same price they would be paying for rent. Some foreclosed houses are selling for anywhere from $20,000 to upward of $70,000 - less than their appraised values in some areas. Students are buying these homes in the hopes of selling them for more than what they paid when the market recovers in the near future . Godzala said foreclosures can cost anywhere from $32,000 to $180,000, but most clients are buying those in the $120,000 to $130,000 range.

Godzala also noted that many students have misconceptions about buying homes. He reported that one student looking for a house asked him if first time homebuyers could buy foreclosures because her landlord told her they couldn't. Another student said her landlord told her it takes two to three years to close on a foreclosed home. Both of these ideas are false, Godzala informed us. "Yes, first time homebuyers can absolutely buy foreclosures,". Students are often concerned about financing, but Godzala revealed that there are plenty of lenders who will finance foreclosures. Another question students often ask is if there are any good foreclosures. "I'd say you have to look at five to 10 until you find that one gem,". "A lot of them are really beat up. A lot of them have water damage; they may have cosmetic problems (paint, bad carpet)." So be cautious. "When someone goes into foreclosure there's a history of them not being very nice to their property if they know it's going back to the bank," Godzala said.

To make sure a home is in proper condition, buyers can get house inspections before they buy, which cost about $300 and take about four hours to complete. "I would say anybody these days that buys a foreclosed home without an inspection is looking for trouble because there's little things that I've found where people have sabotaged their house," said home inspector Wayne Sieling. "I've seen headers cut out from beneath steps and I've seen rafters cut in attics, waterlines that have been cut." In short, before you buy, make sure you know what you’re getting into.

This is one in a series of commentaries by the Research staff of the National Association of REALTORS®.