Sunday, August 29, 2010

Useful "rules of thumb" for home buying

I don't own a home yet, but every time I think of buying one I do some research and find some useful information.  I've read each of these in different places at different times and this is my attempt to consolidate all of them.

What are the costs to be aware of?
  • Mortgage payments covering principal and interest.
  • Property taxes.
  • Home owner's Insurance.
  • HOA dues. Usually for condos, but nowadays many gated communities and new neighborhoods have these.
  • Other taxes, such as Mello Roos bonds in newer neighborhoods.
  • Estimated on-going maintenance costs.
Another thing to watch out for with condominiums are "special assessments" which are one-time levies to pay for significant repairs or renovations to the complex.

Aside from the very first expense above, one would have all of the other expenses even if one owned the home outright.

Typically, only the portion of the mortgage payment towards interest and the property taxes are tax-deductible.

How much home can one afford?

One rule I've heard is that one should buy a home that is no more than 2.5-3 times one's gross annual income. I've seen this ratio recommended to be as low as 1.5 and as high as 3.5.  Incidentally, this is what the price-to-income ratio looks in countries around the world.  As of 2014, this ratio is reported as being 2.4 for the US and it is one of the lowest.

Another is that the PITI (principal, interest, taxes, insurance) should be no more than 30% of gross pay, assuming no other significant debt.

Is the home a good value?

There's the cash-flow analysis where all of the expenses listed earlier in this post must be less than what the property would rent for.

Additionally, patrick.net has the following suggestion:
  • Annual rent / purchase price = 3% means do not buy.
  • Annual rent / purchase price = 6% means borderline.
  • Annual rent / purchase price = 9% means OK to buy.
Indeed, I've often heard that the general rule of thumb is that this ratio should be 10%.

Based on the above analysis, some low end condominiums work out to be "OK to buy", but if we were to subtract the HOA dues from the rent, then the ratio falls to where it's no longer favorable to buy. Condominiums are kind of tricky in that way.

Patrick.net provided an awesome "Should you buy that house?" calculator which allowed you to plug in a price for a given and address and used market rents off of craigslist to answer the question for you.  The calculator is no longer active.  However, one can get rent estimates for any given property/ area from Zillow, but those numbers may not be as accurate.

Rent vs Buy Calculator

This is straying from the main topic of the post (which is supposed to be about "rules of thumb"), but I got a note from a friend who suggested adding it. Rent vs Buy calculators, such as this one offered by the NY Times attempt to tell you whether you'd be better off renting or buying depending on things like:
  • Current rent,
  • Current home value,
  • Length of time that one plans to live there,
  • Prevailing mortgage rate (no provisions for a variable mortgage rate),
  • Projected annual increase/decrease in rent, and
  • Projected annual increase/decrease in the home's value.
Since the last 2 of these variables are almost impossible to predict accurately (especially given the current economic climate), it becomes really hard to get any concrete guidance from the calculator. But I guess it is still fun to play with the numbers.

Researching a purchase

These are some of the things one should get answers for when buying a home.
  • Research the school district.
  • Check with the local police station about crime in that area.
  • How old is the home?
  • How old are the plumbing and electrical systems?
  • What type of roof?
  • Have there been any losses or significant damage?
  • Is the home in a flood zone?
  • Check the Walk Score if you like to walk to stuff.
Of course, anything that's broken will probably be caught during the inspection, so this phase is mostly about catching things that may be about to break or that are not covered by a normal home inspection.

For new homes that are not yet built, check the following:
  • If considering a single story home, will it be surrounded by any 2-story homes?
  • Locations of public utilities such as transformer boxes, fire hydrants, mailboxes, etc.  Will any of those be on your property?
Looking for a home

Here are some websites that allow you to search and view the MLS listings that match a user's criteria.
Other useful stuff
Update 8/20/2013

Came across this video titled Don't buy a house without checking these 5 things.
The checklist includes: mold, pests, outdated fixtures and wiring, cosmetic headaches like painted over wallpaper and poorly done DIY flooring, and drainage problems.

Update 4/8/2016 

I did end up buying a house in May 2015.
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