Making the decision to rent or buy
Buying a home is exciting. It’s also one of the most important financial decisions you’ll make. Choosing a mortgage to pay for your new home is just as important as choosing the right home.
Buying a home is one of the largest financial decisions most people make and it’s also a big personal decision. Some people buy because they want more space, the freedom to decorate and renovate, or because they want to live in a particular school district. Many people become homeowners because they want to build equity and have stable housing costs. On the other hand, some people rent for the flexibility of knowing they could move if they needed to, or because they’re not ready to take on the financial and maintenance responsibilities that come with home ownership, or because it is more financially advantageous in their circumstances. Here is one common financial consideration to keep in mind as you decide whether or not owning a home is the right decision for you right now.
Understand when you will—and won’t—build equity
At some point, someone has probably told you that if you rent, you’re “throwing away” money. When people say this, they’re usually talking about the opportunity to build wealth in a home over time by building home equity. If you rent, you won’t build wealth in your home over time.
Home equity is the difference between the market value of your home and the amount of money you owe on it. Essentially, it’s the wealth you hold in your home. The equity in your home grows over time as you pay down the balance of your mortgage. If the market value of your home increases, your equity will also increase. If the market value of your home decreases, your equity will also decrease.
Buying a home is a long-term financial commitment and you will build home equity by paying down your mortgage over time. In the first several years of your mortgage, you build equity slowly. That’s because your monthly mortgage payments primarily go towards interest in those first years of ownership—not towards building equity. That’s why you shouldn’t depend on being able to sell your home to get out of a mortgage, especially in the early years.
If you hold on to your home for many years, the share of your monthly payment that goes towards paying down the principal—and building equity—increases, and the share that goes to paying interest decreases. That means that the longer you’ve had your mortgage, the faster you build equity with your monthly payments. But remember: your home equity also goes up or down as the market value of your home increases or decreases.
If you decide, or need, to move and sell your home within the first few years of owning it, it’s possible that after paying the transaction costs of selling the home, you will not have any more equity than you started with. In fact, you may even have less equity than you started with. Keep in mind that if home prices go down instead of up—as they did from 2007-2012—you could lose some or all of your equity, including the initial down payment, when you sell.
Extracted from an article by Nicole Shea, Consumer Financial Protection Bureau.
Next posting will focus on: Understand how having a mortgage will—or won’t—affect your taxes
For assistance, contact Equity Smart Realty Inc at 888-670-6791.