One of the most significant challenges Americans face today is the soaring cost of housing. As home prices continue to climb, affordability has plummeted. Adjusted for inflation, home prices rose over 60% in the last 25 years while income rose only about 5%. With home price-to-income ratios reaching record highs, purchasing a home has become more challenging.
The Benefits of Homeownership
Despite affordability challenges, owning a home continues to be a valuable financial tool for many Americans. Building equity through homeownership offers a powerful way to improve long-term and economic stability. According to the Pew Research Center, home equity in a primary residence is the most valuable asset for the average U.S. household. Additionally, owning a home with a fixed-rate mortgage allows homeowners to lock in housing costs.
The Costs of Homeownership — Down Payment, Mortgage, and Beyond
While fixed housing costs can make budgeting more predictable, the high costs of homeownership may lead some buyers to stretch their finances too thin. In today’s market, it’s crucial for buyers to carefully plan a home purchase and account for all expenses involved.
Saving for a down payment is often one of the biggest hurdles. A typical goal is to save 20% of the purchase price to avoid the added cost of private mortgage insurance (PMI). Securing a mortgage is another key step. Mortgage underwriters typically prefer a debt-to-income (DTI) ratio of 36% or less, meaning no more than 36% of income should go toward servicing debt, including the mortgage. But the homeownership costs don’t stop there — that’s where they begin.
Property taxes and homeowner’s homeowners’ insurance are key components often factored into mortgage underwriting, but many prospective buyers fail to account for how these costs can rise over time. Property taxes vary significantly by state, with some areas charging less than 1% annually, while others exceed 2%. Meanwhile, average property insurance premiums have surged by 30% since 2020, with homes in high-risk areas seeing steep increases.
Factor in Maintenance Costs
Home maintenance is often overlooked as a key component of homeownership costs. One of the last things a new homeowner wants is to fall short on funds when an expensive repair is needed. A general rule of thumb is to budget between 1% and 4% of the home's value annually for maintenance and repairs. Older homes typically require more maintenance than newer ones.
For some, purchasing a home warranty that covers major appliances and systems failing from normal wear and tear might be worth considering. It can help offset unexpected repair costs, which buyers often overlook.
Accounting for Transaction Costs and Price Appreciation
Despite recent downward pressure on real estate agent commissions, potential homebuyers cannot overlook the transaction costs of selling a home when preparing for a purchase. In some areas, commissions and closing costs can reach 6% of the sales price.
Homebuyers should be cautious when extrapolating recent home price appreciation into the future. A good rule of thumb is to estimate future home price growth at 1% above inflation annually. With this in mind, buyers should be confident that they plan to stay in the property for at least five years before committing. For those considering a new area, renting first can be a wise choice to ensure it’s the right fit long term.
How a CFP® Professional Can Help When Buying a Home
A well-executed home purchase can be one of life’s most significant milestones, offering the potential for both increased life satisfaction and improved financial health. However, the consequences of buying a home without disciplined financial planning can be severe, as issues with budgeting and affordability can quickly undermine peace of mind.
While a skilled real estate agent can be a valuable resource for homebuyers, it’s essential to remember that most agents do not have a fiduciary duty to their clients. This means they are not legally required to prioritize your interests over their own.
Seeking guidance from a professional required to act in your best interest brings a different standard of care to the table. A CERTIFIED FINANCIAL PLANNER® professional can provide expertise to navigate the financial complexities of a home purchase and ensure that it’s consistent with your best interest.
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