What was I thinking!? Twenty three and contemplating buying my first house! A first house, a property, a homestead. The idea seemed daunting and overwhelming, but I couldn’t get the idea out of my head. Despite the many things I didn’t know, I did know a few that were compelling enough to take the leap of faith:
* As much as I love Ann Arbor, I was beginning to feel old as new waves of students began to inundate the libraries, bars and restaurants I once called mine; I needed to move.
* I was going to have to live somewhere and pay something.
* If I could be the ‘landlord’ and have others pay me, I could likely break even.
* I would hopefully build equity, or at least maintain it.
* In the event I were to move, I could rent, given I were in an area of high demand.
Armed with that, I was compelled to dig deeper. Fortunately for me, I knew someone in real estate and soon found out a priceless piece of information: as a first-time home-buyer, your are eligible for a FHA loan. Why does that matter? Well because FHA loans stipulate that you only need to make a down payment of 3.5% (as opposed to the conventional 20% down payment). Effectively it’s an incentive to stimulate home buying and allow citizens to purchase homes. Banks love them because the loans are backed by the government and we love them because they allow you to leverage money.
Now as with anything good there is a minor catch, you have to pay what’s called private mortgage insurance, or PMI. But in the grand scheme of things this is only a small percentage of your payment; typically less than 0.1% (that’s right, 0.1%). This is paid due to the small amount of equity investment on behalf of the buyer, 3.5% to be exact. Once a threshold of 20% is reached (a standard down payment for a conventional loan) the PMI or insurance is removed.
So lets add some color to this story with some actual numbers, example:
Down Payment: $3,500
Closing Costs: (Assume seller concession, or rolled into mortgage.)
Mortgage (5%): $96,500
With a 30-yr amortized mortgage, you final payment after taxes and insurance would be approximately $768.
Sounds pretty good, right? Well, it gets better! One of the key benefits to owning property are the tax benefits; the government rewards home-ownership, perhaps one of the many reasons for the crash of 2008/9. However, as long as you’re not buying a $300,000 house on a $50k salary, you should be just fine.
Tax law states that you don’t have to pay taxes on income spent on interest payments; furthermore, depreciation is considered a tax deduction. Now, if you’re new to the mechanics of amortized loans, basically your payments are broken into principle and interest in such as way that 70%-80% of you payment goes toward interest. Over the course of the loan more and more is paid toward principle. Why do this? Well banks want their money sooner than later and the payment remains the same to the customer.
The result of this is that you are able to deduct $4000-$5000 dollars off your income during the initial years of your payments (based on the given example.) Factor in the depreciation deduction of approximately $2900 (based on a specific calculation) and you’ve just reduced your taxable income by nearly $8,000. End result, a monthly savings of approximately $180, bringing your monthly payment down to $588.
Now, if that weren’t enough, you also have to consider the benefit of the money that goes toward the principle payment on your house; equity. As I mentioned before, very little goes toward principle early on, however, it’s not nothing! In the first few years, principle reduction would be around $120 monthly; this can be considered equity in your house, or an investment. This idea here is that you will be able to recoup this once you sell the house (assuming 2008 doesn’t happen again!) With this in mind, our total out of pocket cost is only $470! Welcome to the mind of an investor!
So lets recap:
Monthly payment (after taxes): $588
Pride of owning your own home: Priceless
At 23, I was certainly a minority amongst my peers. I had no one to relate to, no one to validate my decisions, no one to tell me I was right or wrong. It was tough venturing out into the abyss, but looking back, it was well worth it. Generally, it’s the things you work for the hardest for that you value the most and it’s the things you do or learn yourself that you cheerish most. Go beyond your comfort zone!
“Reality is merely an illusion, albeit a very persistent one.”
– Albert Einstein
As an aside, I found real estate such an interesting topic that I decided to get my Real Estate Salesperson license in the State of Michigan. For less than $300 and three weeks of your life (~60 hrs total), I highly recommend it. Even just being a home-owner, I found the information invaluable! Comment if you’re interested in more info.