Congratulations to the Class of 2018! As many college graduates prepare to enter the workforce, they often face high—and in some cases sky-high—housing costs. The decision to rent or buy is a question many of you may be asking right now.
What’s happening in housing
The demand for rental properties has risen, and it is reflected in escalating rents. This is especially true in major markets such as New York, San Francisco, Los Angeles and Chicago. Across the U.S., rents are rising faster than the rate of inflation. As of April 2018
- The CPI (all items) rose 2.5% over the prior 12-month period.
- The CPI (all items) less food and energy rose 2.1% over the prior 12-month period.
- The CPI Shelter Index rose 3.4% over the prior 12-month period.
Who is (and isn’t) buying real estate
Not surprisingly, the rate of homeownership in major metropolitan areas has declined from 2005 to 2017, which is likely the result of the Global Financial Crisis and the desire for greater geographic mobility.
Across major metropolitan areas, younger generations have postponed homeownership. After a few years in the workforce—and paying high rents—some may wonder, however, if they would be better off buying a place.
Things to consider before you rent or buy
Buying a home or condo and getting a mortgage are major milestones in your financial life that require careful consideration. The most important factor in your answer to rent or buy is your time horizon. Don’t buy a home or condo unless you expect to live there for several years. A lot of expenses are associated with moving. Not only are closing costs and movers expensive, but outlays for improvements, furniture, and decorating really add up. Moreover, the real estate market is both cyclical and regional. If you are not honest with yourself about your time horizon, you may be forced to sell your place during a market downturn.
There are other general guidelines that you should also consider:
- Do not buy a home or condo that costs more than 2.5 times your annual income. Just as rents have risen, so have home values, especially in metropolitan areas. Moreover, if your income is highly variable, you probably should use a lower multiple.
- Mortgage interest, principal, taxes, real estate taxes, and insurance should not exceed 28 percent of your gross, or pretax, monthly income. This is called the front-end ratio.
- The combination of front-end ratio expenses plus all your other fixed obligations, such as car payments, student loan payments, credit card bills, alimony, and child support, should not exceed 36 percent of your gross, or pretax, monthly pay. This is called the back-end ratio.
Just because you can doesn’t mean you should
You should also keep in mind that mortgage bankers and brokers are paid to help you finance your home. Just because you have been approved for a mortgage for a particular amount doesn’t mean that you need or should have a mortgage of that size.
I hope that this info gives you a good starting point in your decision to rent or buy. If you have other questions, enter them in the comments below!
