Rising home prices and higher interest rates may be a toxic cocktail for those considering a home purchase, but they don’t have to be.
How much the home costs is surprisingly less important than the two most significant considerations: how long you will live in the home and how your income and assets will change.
The shorter your time horizon, the more your original purchase price matters. Your future income or assets (stock options, inheritance, etc.) inform how much you can stretch for the home.
If you make a chart with how long you plan to be in the home on the vertical (y-axis) and whether your assets and income are falling or growing across the horizontal (x-axis) you can create a framework for making the decision.
While there are obviously additional factors such as family size, total spending and other debt, this is a simple way of thinking about it.
If you are in the upper left quadrant, your assets and income are expected to be steady or to fall and you don’t plan on living in the place for very long (less than five years), you should unequivocally rent. You are offloading unexpected costs to the landlord, don’t have to make back the real estate agent’s fees on a sale, and can more easily budget your housing costs.
If your expected income or assets are going to increase by more than inflation and you are not planning on going anywhere, you are in the lower right quadrant and should buy. You can even be comfortable stretching for the purchase.
Your original purchase price matters less when you live in a home for a long time because you won’t have to worry about bringing a check to the closing if your house value falls (unless you have used your home equity like an ATM). You pay down a little of your mortgage every year, your income continues to increase so you can more easily afford that house payment and you can even make investment decisions relating to whether you wish to pay more into your mortgage or make other investments instead.
If mortgage rates continue to rise, then trying to wait for home prices to fall when you are going to be in the home for a long time is not a great strategy. If your house price falls by $50,000 but your mortgage rate climbs by 1% you would essentially have the same mortgage payment. This makes a huge difference for short-term ownership but is not as important for longer-term homeowners.
The other two quadrants are trickier. A short time horizon but growing assets and income tilts you toward renting. Time horizon tends to trump income and asset growth because housing values can be unpredictable. If your assets and income are growing, you can recover more easily from a bad purchase, but it can still be financially painful to take a loss on a home that you never spent much time living in.
A long-time horizon but falling income or assets (think retirement), tilts you toward ownership. You may wish to aggressively work on paying off the mortgage but having control over your housing situation is helpful. We are in a time where mortgage rates are higher than typically prudent spending rates for those living off their assets.
If you are buying a home and are closer to retirement, it will make sense to have a higher down payment and a smaller mortgage (unless you need to sell stocks at today’s lower prices to do so).
This chart is also useful for considering home improvements. You won’t get your money out of most home improvements, but you may enhance your life. The longer you are in the home the more comfortable you can be investing in it. You may not get all your money out of the home, but you get years of enjoyment. That means you can actually enjoy your cocktail.
Related: Why Emotions Often Overtake Personal Financial Analysis