Our worksheet will help you determine which housing option is best for you, renting or buying.
While home ownership provides security, it almost certainly doesn't give you the returns provided by equities. With history as a guide, you can reasonably expect roughly 8% annual gains on your stock portfolio over the long term. House prices, on the other hand, tend to follow the rate of inflation.
That said, home ownership has a signficant tax advantage. Married couples can earn up to $500,000 tax-free when selling a home at a gain. Singles get $250,000. For a breakdown of how to qualify for this generous break, click here.
Buying a house isn't strictly a financial decision. This may sound simplistic, but first and foremost you should find a neighborhood and a house that you just like.
Moreover, you should check on the sales price trends of homes in that neighborhood. If it looks like the area is declining in value, then avoid commitment: You're probably better off renting.
Finally, don't forget that even with the tax-breaks of home ownership, you will still be incurring out-of-pocket costs that you wouldn't encounter as a renter from the cost of ripping down wallpaper to repairing a leaky roof. So, before you buy, estimate how much those costs will be. After all, you don't want to live hand-to-mouth even if it is in your own home.
The Rent/Buy Matrix of Satisfaction
|Renting||Flexiblity (relocate easily)||No equity|
|Can invest money elsewhere (stock market)||Annual rent increase could outpace inflation|
|No upkeep fees (drippy faucets, broken dishwashers, etc.)|
|Buying||Tax-break: deduct mortgage interest and property taxes||Property tax and upkeep|
|Potential tax-free capital gain||Mortgage costs|
|Emotional satisfaction||Less flexibility should you want to move; in very bad housing markets, you could lose principa|
If you do decide to buy, it's in your best interest to put down at least 20% of the purchase price, to avoid private mortgage insurance (PMI).
Tapping Your IRA
Congress has a soft spot for first-time home buyers. IRA owners can withdraw up to $10,000 as a lifetime credit penalty-free (but not tax-free) for the purchase of a first home. This means you and your spouse together can withdraw up to $20,000 (as long as each of you pulls $10,000 from your individual accounts). It also means that your relatives can raid their own IRAs penalty-free to make a gift to you for a first-time home purchase.
Believe it or not, you can actually use the first-time home-buyer exemption more than once. You simply must not have owned a home during the previous two years. But don't get too excited: No matter what, each person is limited to $10,000 over a lifetime.
Draining Your 401(k)
Even though it is an option, withdrawing money from your 401(k) to fund a home purchase is a rotten idea. Assuming you're not at least 59 1/2 years old, you'll owe taxes plus a 10% penalty. You will also cripple your retirement savings, since most plans won't allow you to contribute to your plan for at least a year following a withdrawal. This means you're going to lose out on your company match as well as future tax-deferred contributions, not to mention the earnings on the money you've withdrawn.
Borrowing from a 401(k) isn't much better. If you leave the company for any reason, you run the risk that your loan will be called immediately. While out of your account, those dollars will also miss out on any market gains, and that tax-deferred growth.