Saving for your First Home
We discussed this a little earlier, but let’s dig in some more. For most people, a home is the single biggest investment you will make in your entire life. That sounds a little scary, but with a little common sense approach, it can also be the most valuable investment you ever make. While home prices do tend to go up in the long run, they also tend to fluctuate up and down significantly. Be patient and time your home price right - when prices are down. It’s easy to panic when you see home prices rising rapidly, but remember what physicist Isaac Newton said – what goes up must come down. Surges in home prices are often triggered by drops in interest rates. This often happens when the economy is in or headed for a recession. The US Federal Reserve bank lowers interest rates to stimulate borrowing by companies that will in turn invest in new plants and equipment and hire workers. The problem for home buyers is that sellers figure that if you pay less to borrow mortgage money (lower interest rates), you can afford to pay more for the home. So, they raise the price of homes. A prospective buyer can still afford to pay the same monthly amount, but that payment is going to pay off the now higher priced home (since the lower interest rates reduce the amount of interest payable each month). Normally, it’s a good thing to pay less interest, but in this case you are also having to pay more for the home itself.
Let’s take an example. Let’s say a home cost $100,000 and you will pay $20,000 cash down payment and need to borrow $80,000 at 7% interest rate (via a home mortgage). Suddenly interest rates go down to 4% due to an impending recession and the home price jumps 50% to $150,000. You’ll pay $30,000 cash and borrow $120,000. It would have been better to pay the higher 7% interest rate on only $80,000 than it would be to now have to pay off $120,000 in debt. So, it’s best to try to time your home purchase when home prices are relatively depressed due to a recession or other reasons. Also, even if you have a higher interest rate, you can typically refinance to a lower rate (when interest rates go down) or even pay off your mortgage earlier and avoid the interest altogether.
Some other suggestions regarding home purchases are:
Don’t get emotionally attached to a prospective new home because you like some feature about it or are just excited to be buying your first home. Always be ready to walk away form the opportunity if it does not make financial sense.
First 3 rules of home purchase are Location, Location, Location. A home in a desirable location near school, park, easy commute, quiet street, easy access to food shopping, etc.) will tend to retain and increase value much more than another home.