Should you buy a home or invest in rental property? Learn the advantages and disadvantages of owning real estate and discover the process for purchasing a home.
Advantages of homeownership
Homeownership comes with several advantages.
Firstly, buying a home, if you can afford to do so, offers stability. You no longer need to worry about rent increases or having control over whether you can stay in your apartment or house.
Secondly, once you have paid off your home, you will no longer have to pay for housing, aside from maintenance, property taxes, and homeowners association fees, if applicable.
Thirdly, property often appreciates over time. If you buy a home and home prices increase in your area, you will build equity. Equity is the wealth in your home which you can access if you take out a home equity loan or sell the house. However, it’s important to note that property prices do not always rise.
Disadvantages of homeownership
Owning property can come with disadvantages.
Firstly, it can take a while to save enough for a down payment, since most mortgage loans require a 10%-20% down payment.
Secondly, homes are usually only a good investment if you stay in them for at least 5 years. If you move and buy another home before then, you may lose money.
Thirdly, home prices may not appreciate as much as other investments like stocks, so you could lose out on gains you could have made if you invested your money into the stock market instead.
Finally, depending on the home prices in the area, the interest rates on mortgages, and the rental prices, it could cost more to buy a home than to rent an equivalent apartment or house.
Owning property also comes with additional costs including property taxes, insurance, and maintenance, which can make owning a home less affordable. However, in some countries like the U.S., there are tax deductions for homeowners that can lower some of the costs of purchasing a home.
Types of property
The main types of property are single family homes and multifamily properties.
Single family homes usually cost the most compared to other types of homes in the same area because they often have more space, larger lot sizes, and usually do not require the owners to pay a Homeowners Association (HOA) fee. They also give you the most flexibility to do what you want on your property.
Multifamily properties include small apartment buildings with 2-4 units, and larger complexes with dozens of units. Multifamily properties are sometimes sold as single units, such as condominiums, apartments, or townhouses.
These types of homes often have monthly HOA dues to pay for exterior maintenance and amenities such as swimming pools. The HOA also sets rules for landscaping the exterior of the unit and may require you to follow certain guidelines for interior renovations.
Homebuying process
To start the homebuying process, you need to determine the parameters of what you are looking for. Make a list of your wants, what you are looking for in an ideal home, and your needs, things you cannot sacrifice. These wants and needs could include locations, type of home, number of bedrooms and bathrooms, square feet, and budget range.
Then, look at real estate listings in the areas where you hope to buy. You may need to adjust what you are looking for based on the prices in that area. Once you have found some listings that interest you, you can start applying for a preapproval for a mortgage and contact local realtors to find one who will be a good fit to help you buy a property.
Home buying budget
The main factor to consider in your budget if you are paying a mortgage are the monthly costs of the loan, which will include principal and interest.
If your interest rate is higher, your monthly payment will be higher. You also must consider how much you need to pay each month in property taxes and homeowner’s insurance.
If you are buying a condominium or townhouse, you will pay a monthly HOA fee as well. In addition, if you are borrowing from a regular lender and you are paying less than 20% as a down payment, you will also need to pay for monthly private mortgage insurance.
Ideally all your housing costs should be no more than a third of your net income, but some lenders will approve you for more if you have few other debts.
Types of home loans
There are many types of home loans, and many countries also have special programs that benefit certain buyers such as ‘VA Loans’ for veterans or first-time homebuyer programs.
Some loans allow you to purchase a home with a lower down payment, such as Federal Housing Administration loans in the U.S which allow first-time homebuyers to put 3.5% down. Most conventional loans require 10-20% as a down payment and offer repayment periods of 10, 15 or 30 years.
Mortgages can have fixed interest rates, meaning the monthly payments are fixed and the interest rate you pay is the same for the whole repayment period, or they can have variable interest rates, where you start with a particular interest rate, and then your interest rate and monthly payments change based on the economy after a certain number of years.
Qualifying for a loan
In most countries, qualifying for a home loan is a rigorous process, requiring you to have a high credit score, proof of income, and proof of funds for a down payment. If your credit score is not as high, you could still qualify for a loan with a higher interest rate, meaning that monthly payments would be higher for the same home price.
You also must have a low debt-to-income ratio, meaning that your minimum monthly debt payments including the mortgage should not exceed 43% of your income.
Before you make an offer on a house, you usually need to apply to a lender to receive pre-approval for a loan, which means that the lender has seen enough of your finances to be confident that you will receive full approval, but you are still not guaranteed approval.
Making an offer
Once you find a home you wish to buy, you make an official offer. To decide what price you will offer, look at what comparable homes have sold for recently and what the current real estate market trends are in your area.
If many other buyers are interested, you might consider other incentives to convince the seller to take your offer such as waiving contingencies. Contingencies are the circumstances that need to be met for you to buy the home, such as making sure the property passes a home inspection.
If you waive contingencies, you tell the seller that you aren’t worried about those contingencies being met. This might make them look at your offer more favorably, but it will be harder to back out of your purchase if an issue arises.
Casey wishes to purchase a house that is listed for $275,000. She knows she can afford up to $300,000, and homes with a similar square footage in the area are selling for $290,000. Since there is not a lot of competition for the house, she does not waive any contingencies, but she does offer $300,000 with hoping the higher price will clinch the sale.
Home buying budget example
Casey wants to determine what price of home she can afford. Her monthly budget for housing is about a third of her net monthly income.
Importantly, Casey must include not just her mortgage payment but all of her total housing costs in her housing budget, including her property taxes, and homeowner’s insurance. Otherwise she may find that even though she can afford her mortgage, she won’t have enough for the other costs of owning a home.
She calculates how much her total monthly housing payment will be for different home prices. If she puts a 20% down payment on a less expensive house, she can easily afford her total monthly housing costs.
If she uses the same amount of down payment on a more expensive home and only puts 10% down, her mortgage payment will take up almost all of her housing budget, leaving little room for other housing costs. Therefore, she should look for a house that she can put between 10-20% down to make sure she can afford her monthly housing costs.
Rental property
Rental property is real estate that you buy to rent to a tenant. There are many different types of rental properties, including a second home that you rent out as a vacation rental or a multifamily home with several units.
Rental property is often subject to different laws and tax codes than a home you occupy. Also, renting to tenants does not necessarily guarantee you will profit. You must be able to rent your unit or units for enough to cover the mortgage, insurance, property taxes, and maintenance costs.
You also must manage the property or hire a property manager or management company. Contrary to popular expectation, being a homeowner is not a requirement for buying rental property since you could purchase a home in a cheaper area and rent it out at a profit while paying rent in a more expensive area.
Passive investing in real estate
To benefit from real estate as an investment without paying the upfront costs of a down payment or a mortgage, you can invest in Real Estate Investment Trusts (REITs), a type of investment that allows you to own a share of a commercial real estate company.
REITs pay dividends to the people who own their shares, meaning that you will receive regular income from investing in them. REITs are typically companies that buy real estate on a large scale, so they can be less risky than buying one particular property.
However, they are impacted by supply and demand, so if home prices or rents decrease in the economy overall, REITs value may decrease.
Flipping homes
Imagine there’s a house that’s in a great location, but the owner has neglected to take care of it: it has overgrown gardens and smashed windows. It is for sale at a discounted price because it is not a fit state for anyone to occupy.
This type of property could be a great investment if you are interested in flipping homes.
Flipping homes means buying properties that need repairs and renovations, improving the properties on your own or using contractors, and then selling them at a higher price than you bought them.
To make a profit from flipping a home, you need to sell it for a price higher than the price you paid for it plus the amount of money you invested into it to improve it.
Flipping properties can be risky because you may not be able to sell the house for a profit depending on trends in the housing market.
