Four questions to ask yourself before you jump on the home buying bandwagon

Should I buy a house?


Four questions to ask yourself before you jump on the home buying bandwagon.
April 4, 2005: 8:54 AM EDT
By Sarah Max, CNN/Money senior writer

Salem, Ore. (CNN/Money) –A month ago my friend caught me off guard when she asked the seemingly simple question: "Should I buy a house?"

After seeing all of our friends – even the single and unsettled – jump on the buying bandwagon, this free-spirited friend was starting to think that she too should commit to a mortgage.

"Am I going to kick myself a year from now for not doing it?" she asked.

"Do you even know where in the world you'll be a year from now?" I came back, thinking of recent conversations about out-of-state job opportunities and international fellowships.

Still, I wasn't about to take responsibility for this kind of decision.

So I did what any good friend would do: I asked a few leading questions and waited for her to come to her senses.

Why do you want to buy a house?
It used to be that buyers wanted to find a place to live, with the additional benefit of making some money over the long run. Increasingly, buyers say they want to find a place to invest, with the additional benefit of having somewhere to live in the short term.

Yet, even cheerleaders of the housing market warn that double-digit price gains aren't realistic. David Lereah, chief economist of the National Association of Realtors and author of the new book "Are You Missing the Real Estate Boom?" says he expects healthy price appreciation through the next decade. But his idea of healthy is 4 percent to 6 percent a year.

Even in strong markets, you may not break even if you sell too soon.

Let's say my friend buys a $200,000 house and sells it a year later for 10 percent more than she paid, which a pretty nice return by historical standards. After she pays a real estate agent, accounts for her closing costs and pays capital gains taxes, she'll walk away with less than $4,000 -- which is what I'm guessing she would spend sprucing up the house.

If the house appreciates only 5 percent, she'll lose money on the deal.

True, my friend could hold the house and rent it out. Of course, if she's not sure she's ready for the responsibilities of owning a house, she's definitely not ready to be a landlord.

At least she won't throw away money renting, right? Actually, most of her mortgage payment will go toward interest during her first year, and what little she puts toward principal will be eaten up by property taxes, insurance and other costs of owning.

A reasonable timeframe is three to five years, said Linda Marcelli, managing director of Merrill Lynch in Tampa Bay, Fla. "If you do happen to buy a house at the top of a market, you need to have flexibility to wait for prices to come back," she said.

Can you afford it?
Given that you can buy a house with no down payment, roll your closing costs into your mortgage and opt for an interest-only loan, this question might sound outdated.

But buying a house still takes money even if you manage to keep your mortgage payments low and save on closing costs. Between the time you pay for a home inspection and make your hundredth trip to Home Depot -- and I'm speaking from experience -- you could spend thousands of dollars in incidental expenses.

"We always advise people to have a cash reserve of four to six months of expenses in the bank," said Marcelli. "But if you're buying a house you should have even more."

What is the cost of renting?
Nationally, the gap between the cost of renting and the cost of owning is now the widest it's been in a decade, according to Gleb Nechayev, senior economist for Torto Wheaton Research. In most markets, he said, the price of owning has gone up while the cost of renting has remained flat or declined.

If you're weighing the pros and cons of buying, you might find it useful to take the pulse of the local rental market for a couple of reasons.

First of all, you might learn that you can actually save more money renting over the course of a year or two than you would on an appreciating home. My friend thinks she could rent a small two-bedroom house for about $700 a month in her market.

Her mortgage, property taxes and insurance on a similar house would likely ring in at close to $1,300 a month. At that rate her house would need to appreciate more than 10 percent in a year (assuming she sells with an agent) for her to walk away with more than she saved renting.

Second, the relationship between rent prices and the cost of owning is one way to gauge the health of a real estate market.

"There is an underlying relationship between home price and rents in close analogy to the stock market's [price-to-earnings ratio]," said Nechayev. If the cost of owning is significantly higher than renting similar property, the housing market may be overvalued relative to its economic fundamentals.

Are you ready to commit?
You should weigh the pros and cons of owning, take a close look at what you can afford and research your local market. But, at the end of the day the answer to the question "Should I buy a house" isn't going to show up on a spreadsheet or be revealed by a survey of friends and family.

"Emotionally, I'm not ready to commit," my friend told me a few weeks after she first came to me with her dilemma. "I feel like I should listen to that."

"A house is a huge commitment," I added, thinking how instead of touring Europe this summer I'll be landscaping my overgrown yard and pulling up tile in an out-of-date bathroom. "You'll know when the time is right."

As the saying goes: You want to own the house. You don't want the house to own you.