Can You Really Afford to NOT Buy That House?

I hear this all the time so I wanted to get to the bottom of it.

I see people buying homes with this line: “Well, at this price, I really can’t afford NOT to buy it!”

Well, if you have been following me for a while you know that I don’t like to just BELIEVE things for the sake of believing them. I like to get to the bottom of it with math. Pure, simple math. I’m a big fan of thought experiments in regard to purchasing a house, so here is my current one:

With today’s low mortgage rates and the tax incentive from Mr Obama – can you afford to NOT buy that house?

So here’s the scenario I’m going to be working with:

A new home buyer.  They want to purchase a $200,000 home. They can get a decent 30 year home loan today at 5% rate with only 5% down. Since they won’t be putting down 20% of the home price, they’ll need to pay PMI. Which, because they’re only paying 5% down will be at a rate of 0.78%/12 of the initial mortgage amount. They’ll be getting their $8,000 tax break from the Obama-man.

Let’s play the numbers for this scenario:

  • Down Payment: $10,000
  • Mortgage amount: $190,000
  • Amount paid to interest over 30 years: $175,662
  • Amount paid to PMI  for first 20 years: $29,760
  • Amount paid to PMI for last 10 years: $3,840
  • Tax break: -$8,000

Total Paid over 30 years: $401,262

Obviously, if you were to refinance at some point in the term of your loan, you would be able to get rid of the PMI payments. And that really is something to consider if you’re in a position where you’ve put enough equity into your home and were previously paying PMI, especially since mortgage rates are so low right now.

Okay, now let’s say that this individual decided to wait two years to save a full 20% down payment. Now they will miss out on their tax break from Mr Obama, and probably the price of the house will go up 0.4%/year (the average increase from 1890–2004) – so now the house costs $201,600. A 20% downpayment will be $40,320. Let’s also say that mortgage rates have gone up and are now at 7% for 30 years. How much will our dear young home buyer pay?

  • Dow payment: $40,320
  • Mortgage amount: $161,280
  • Amount paid to interest at 7% for 30 years: $222,759

Total Paid over 30 years: $424,359

If the interest rate in two years was at 6% instead of 7%, our little experimental buyer would pay $185,091 in interest over 30 years – and end up paying $386,691 for their house.

So to recap:

  • Buying a home now @ 5%: $401,262
  • Buying a home later @ 7%: $424,359
  • Buying a home later @ 6%: $386,691

As you can see, there is no clear cut “win” scenario without knowing the future. Thus, the point here is that the question isn’t “Can You Afford to NOT Buy This House?” but rather: How much are you willing to bet on interest rates?

If interest rates stay the same as they are now, and have been since around January of 2008 (a range of 4%-6%), then you’re better off waiting and saving up a 20% down payment. If however, you think that rates will jump above 6.5% (a historical average in recent decades is between 7-9%), then you’re better off buying now.

I have to admit, when I started writing this article I thought FOR SURE that the math would show that waiting was a better option. After going through the scenarios, I’m not so convinced anymore. In fact, if someone had a full E-fund, no debt, but only 5% downpayment, I’d probably give them the go-ahead now. It isn’t as silly as I thought it was. Thanks Math for proving me wrong! =)

HOWEVER, all of this said, I still feel that you’re FAR better off waiting and paying for a home in cash. While this isn’t an option for most people, you’ll save the most money by not-financing all together and paying 100% down. If you’re still not sure whether you’re ready to buy a house, here is my list of things you should consider before taking the plunge.

What made me happy today: Watching my dog play in the snow!

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7 Responses to Can You Really Afford to NOT Buy That House?

  1. Jessie says:

    wow – really informative!! I wonder if it would be worth it to add in the additional cost of renting while saving for the 20% down on the mortgage – that might sway the numbers enough to make it more definitive.

    • SS4BC says:

      Good point! But there is no way to put that in without knowing EVERYONE’s rent.

      For me that would add in $695×24 months – or $8,340.

      Still making it more advantageous to save for 20% down IF you can get a 6.5% interest rate or less.

  2. Very interesting! Thanks for showing this.

  3. TMcImmy says:

    So, here’s the issue, and I realize this is the exact thinking that drove the housing bubble.

    Let’s say you strongly feel housing in your local market is undervalued. It’s actually not unreasonable thinking in this market of tight credit and high unemployment that those like my brother who have access to credit and job security (he works in health care) can buy property at a discount.

    So assume that $200k property is “actually” worth $220k. Let’s say you know the future, and can see that that house will be worth $220k in two years (assume zero inflation).

    Well, you’re golden. Even if you only paid interest plus a pittance those first two years, you now have an additional 20k in equity. You’ve got the war chest to refinance at a lower rate. Even if you don’t refinance, that 20k has canceled out the difference over time in total interest.

    Obviously the problem here is we’re not psychic. Housing values can drop. No one should buy a home they can’t afford on the assumption it will rise in value in the future. *But* an increase in equity can certainly change the math of home ownership. Heck, even changes in inflation and interest rates can change the math. It’s easy for those of us born in the late 70s and early 80s to take low inflation for granted. But let’s say you have a 6% mortgage. Let’s say inflation rises to 7% a year. Assuming your property value only keeps up with inflation, you are actually *making* money on the loan.

    So that’s where the real trouble comes with figuring out “should we buy or should we wait?” when people have access to 5-10% down payments and jobs that allow them to afford the mortgage they want comfortably. Even if you expected housing prices to go up 2% in the next two years rather than 10%, it certainly changes the “buy or wait” math. Personally I still feel someone with a 10% down payment who doesn’t want to move for 5-7 years and can afford the mortgage should feel comfortable buying now. There’s also an emotional component to home ownership, especially for those with children, but that’s much tougher to quantify.

  4. Can I just rent the rest of my life? I understand that math…

    • SS4BC says:

      As far as I’m concerned, yes. =)

      However, most people appreciate owning their own home when they retire so it is a monthly expense they don’t have to worry about.

  5. Happily found out I have the credit score and long-term stable job on my side. Now, just erradicate a bit more debt and save up a decent downpayment… wha la! I’ll be ready to buy a house. Good post. I love crunching the numbers.

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