15

We are a family of 3. Couple with one kid (2nd grade). We have been in states for 13 years. All these years we have been renting. So far I preferred to rent. But the rents are going up. Currently, for a decent 2 bed apartment, its costing up $1500+. Currently, we are renting a condo for $1300. So we are thinking of putting that amount towards mortgage and buy a house. Its in Illinois Chicago Suburbs. As a first time home buyer, so many questions...

First up some background:-

  • We both combined make close to 200K year. (My wife started working a year ago)
  • No Credit Card debts ever.
  • Bought a 2nd car last year for $18K (with 6K down payment and 12K loan for 2.5% interest. Paid about 6K.)
  • 80K in bank for downpayment, if buying a house makes sense.
  • Credit score (Equifax 766, Transunion 739, don't know the other one). Pulled in the reports. There were two late payments back in 2014 and another one in 2013. Credit history is a little over 9 years.
  • My wife does not have a credit card of her own. So not much credit history.
  • Monthly expenses about 2800, includes rent, school, car payment, groceries, etc.
  • Considering up to $300K home, if buying a home makes sense.

Questions:-

  1. With rent $1500+, would paying that amount + a few more hundreds towards mortgage makes sense? Or still good with renting? I am planning to stay longer in one place. But I understand with renting, I can move freely. But each year, rent goes up by $100 to $150.

  2. Buying a townhome vs single family home. Any pros and cons? I am actually looking for townhome the decent one I can buy for $250K. Single family home costs a little over $300K. Not that comfortable with that amount, unless there is a clear advantage over townhome. Everyone seems to suggest single family home. I am not looking for house as an investment, but as a saving from paying rent.

  3. Mortgage: Should I go for 5/1 ARM or 30 year fixed or? The average rate for 30 year fixed is around 3.6. With my score (as mentioned above), can I get lower than 3 on 30 year fixed? possible?

  4. Should I put more towards downpayment or pay extra every month? Or invest those amount instead of paying towards mortgage?

  5. I don't see much tax benefit here. 12.6K standard deductions would outweigh taxes + interest on $200K loan. Do I still benefit from buying a home vs renting?

17

Wow, you are in an excellent situation. If it was me here is what I would do:

  • 0) I would only buy if I plan to stay in that location for about 5 years. If you are planning to move, then renting is not a waste of money. Also what are your future plans for your family? Are you planning on more children? Buy with that in mind.
  • 1) At your salary, you could reasonably go a lot higher than 1500/month. Twice that would not be out of the question, but I'd stick around the 2100 mark.
  • 2) I kind of hate condos/town homes for living or investment. The first is more of a personal choice. I would much rather have a single family detached home. However, that choice is yours. Keep in mind most condos/town homes have a signficant monthly fee which cuts into your monthly costs.
  • 3) Stay away from any kind of ARM, interest rates are likely to go up not down. I'd rather have a 10 or 15 year fixed rate mortgage.
  • 4) I'd put about 60K down and keep 20K for an emergency fund. Just sitting in a boring savings account, not earning anything, for emergencies only.
  • 5) Huge question here, but yes you do benefit in many ways from buying instead of renting. For one, your "rent" mostly never increases. Property taxes and insurance might, but not the mortgage payment. Secondly the majority of your rent is for a limited time.

If you did a 15 year when you first got to the states, you'd be just about done paying off your home.

  • 2
    Note that much of the condo fee goes (or at least, should go) to expenses that you otherwise would have paid (eg. maintenance of the exterior of the building). – Mark May 27 '16 at 21:11
8

I often use the cliche "don't let the tax tail wag the investing dog." In this case it's the house dog. If the tax consideration is enough to sway your decision either way, you need to sit down and re-evaluate the purchase. A bit more detail -

Say your state tax is 4% (pls add a state to your question if I'm way off, or no state tax.). That's $8000 or so that starts your schedule A. The property tax will be added and put you over the standard deduction. On the $240K loan, the first year interest is $8640. That will save you just about $2400 or $200/mo in taxes. You make $200K. Do you see why this tiny bit should really have no influence on this purchase?

By coincidence, I just sold a townhouse (condo) today. It was purchased in 1987 for $119K, and sold for $180. 29 years, 50% gain. just under 1.4% average yearly gain. With inflation only, it should have sold for $250K. Do I wish I had purchased a house instead? It was nice to have someone do the work, but I still had to write the checks. Others would tell you that one anecdote doesn't reflect a market, and especially in real estate, it's all local.

I'll also add another cliche - bankers will sell you just enough rope to hang yourself. Your $200K should qualify you to borrow nearly $800K in a mortgage. (Actually, a bit more) In my opinion, $240K isn't just reasonable, it's very prudent. You'll set yourselves up to live on one income (assuming they are somewhat similar) and bank the rest. I'd put just 20% down, stay liquid, and save the maximum in your 401(k) and IRAs. I'd also get the 30 year, and further down the road, pay more to cut it short if you wish. If you are really debt averse, the 15 will have a slightly lower rate, but will still have a payment about 50% higher than the 30. With your income, no issue to do this, if you wish.

  • I'm not sure I agree with $200 being a tiny amount. If you took that and put it into a bank account, you'd end up with $12K in just 5 years. If you put into prepaying the loan (3.6%) it's worth another $1200. Or, if you invest it into something that earns an annualized 7%, you have more than $14K. It's not life changing but it could help with putting the kid through college or help pad the nest. – JimmyJames May 31 '16 at 18:41
  • My point, perhaps not well articulated, is that OP is able to make the purchase, in fact a purchase twice as large. You are 100% right to watch the dollars, as $200/mo over a lifetime is huge. But, for the OP. +/- $200 should not impact his buy decision. If there were no tax deduction, he should still buy the house. On the flip side, my first mortgage was 13.5%. On $240K, $32K in interest, and $8000/yr back in tax. Nearly $700/mo. For someone with a closer set of ratios, that might make the difference to be able to afford it. – JoeTaxpayer May 31 '16 at 21:36
  • 1
    I misunderstood your answer. I agree, this isn't the primary concern. That's why I think it's important to think about the deduction as a discount a.k.a subsidy on the mortgage. It's tempting to think of it as an independent windfall especially if you get a refund at tax time. If you instead add more withholdings, it's more aligned with what it really is. – JimmyJames Jun 1 '16 at 16:48
  • Much appreciated! Improving my writing style for clarity is an ongoing process. Always glad to have a chance to expand or refine a thought. Especially when it leads to agreement. – JoeTaxpayer Jun 1 '16 at 17:22
6

I see that you have considered the value of the tax deductions Presumably you are in a area with fairly low property taxes. Another thing to consider is that when you sell, as long as you use any capital gains to purchase another primary residence, those gains are not taxed.

Based on your income, you can buy a lot more house than that, so your range seems pretty prudent. I'm not sure it makes sense to put down more than the 20% required to avoid PMI at current interest rates. I would hold onto the extra cash for a rainy day fund and/or improvements. If you put it into the down payment, you need to sell to get it back. The paltry 3% or so you 'make' on it by lowering your mortgage doesn't seem like it's worth losing access to the funds over.

You seem concerned about being trapped in the house if you want to move. That's a legitimate concern. The best way to minimize risk of that is to buy in a highly desirable area. You might be tempted to buy in a new development or a less desirable location so you can get more house, but these types of homes tend to be subject to more (downward) price volatility in a soft market.

I popped the following into a basic mortgage calculator: 240K, 3.6% interest and I get a payment of $1,091 a month. Assuming taxes of 1%, that's another 250 a month. This is less than what you are paying now, right? In addition to paying less, you will be building equity in the home. Assuming that inflation will pick up, a lot of the value of a 30-year mortgage is that as time goes on, the payment becomes insignificant. Your taxes will likely increase but more slowly than rents. If you sell and have equity in the home, you can transfer that to the next home and which means a lower payment based on your priorities.

  • +1 for comment about buying in a less desirable location. – Pete B. May 27 '16 at 18:15
  • The property tax in the area I am looking for is, 2.7. Chicago Suburb :-) – Kint Kant May 27 '16 at 19:32
  • @KintKant OK, I'm confused then because the numbers come to something over your standard deduction which seems to contradict your point #5. – JimmyJames May 27 '16 at 19:57
  • @JimmyJames Yes, its a little over 12.6K. May be 2K more. But thats not much of a benefit from the tax standpoint. Am I right? 2K (25% tax bracket). So you would get back $500. Not sure I got this part right. – Kint Kant May 27 '16 at 20:08
  • 1
    @KintKant Your top bracket is 28% so it's a little more (I calculated around 600) but sure, it's not a huge amount but it's like earning another $800 (ignoring FICA) after all your bills are covered. The best way to look at this is to think of it as reducing your monthly payment. For example, if put down only 20% instead of putting down 80 on a 280K loan, your interest goes up $108 a month. At that rate, it takes 18 years to recoup that extra down payment. But when you consider the tax break, you are getting a tax break of $98 per payment versus $70 per payment (above your std. ded.) – JimmyJames May 31 '16 at 18:27

You must log in to answer this question.

Not the answer you're looking for? Browse other questions tagged .