Homeownership has always been a pillar of the American Dream but after the last recession's dramatic home price drops people became reluctant to reexamine the possibility of achieving this traditional American ideal. Is homeownership even still a part of our national ethos? Most would agree it still is, and we want to assure everyone that they can still achieve homeownership with a little planning and diligence.
Of course in Santa Cruz it may take more than a little planning to achieve the American Dream. As you well know, everyone wants to be here and for good reason but that means housing costs are high and available homes are hard to come by. Whether you are a renter or a homeowner you are well aware of the monthly costs associated with your living situation. It doesn’t matter if you want to live near the beaches on the Westside or have easy highway access in Scotts Valley or the San Lorenzo Valley. You may want a rural life, so you choose to live in Corralitos, Day Valley, Davenport or Bonny Doon. Or you may gravitate towards the East Side or the water’s edge in Capitola. All of these beautiful areas come with a high price tag but that doesn’t mean your favorite place, the one you yearn to call home, is out of reach.
As REALTORS we talk to people for a living. We talk to homeowners who want to sell, and we talk to renters who want to buy. It is from renters that we get the most questions because they’re still trying to achieve the dream of homeownership. As local Santa Cruz REALTORS, we meet them on the waves, at First Friday, hiking in the redwoods, on the beach and in the bars and restaurants (maybe we’ve met you!). We meet renters everywhere. Almost all ask the same questions so let’s take a look at what a typical renter in the Santa Cruz area is up against, what he or she should be thinking about, and what to expect when it comes to buying in the Santa Cruz area.
Should You Buy or Continue to Rent?
So, the big question is do you continue renting because of the initial high costs associated with being a homeowner or do you buy a house because it’s a waste of money to pay someone else rent every month? Is it really cheaper in the long run to own a house? And even if you want to buy a house, how can you possibly achieve homeownership if you’re throwing all your money away on rent every month?
Lets start at the beginning. For most of us, we leave home and start off by renting. We get comfortable and often continue to rent until some life changing event happens such as marriage, our first high paying job, or a feeling of stability. Traditionally, most people don’t think of buying right after leaving home or just after graduating college. We tend to wait until the time is right. But when is the right time to buy? For many it comes down to three factors:
- Are you ready to put down roots and stay somewhere long enough to make buying worthwhile?
- Have you budgeted to buy a home? Do you have the down payment, good credit, a stable job?
- Does it make financial sense to buy at this time in terms of the market?
There are pros and cons for both continuing to rent and buying that first home. You’ve already been told by your peers, parents, friends, and loved ones that buying a home is likely the biggest financial decision you will make as an adult. Which option makes sense to you can depend on several questions only you can answer.
The Conversation Between You and Your REALTOR
As REALTORS we come across clients who ask us to help them through the process of analyzing the rent versus buy scenario all the time. Here is a typical conversation we have with a renter, we’ll call her Sara, who is weighing the decision to buy versus continuing to rent. It goes something like this:
- Sara: Is this the right time to buy?
- REALTOR: It depends on what your personal and financial goals are. Have you thought about this?
- Sara: Yes, I want some stability in my housing and I think it’s the right time to buy.
- REALTOR: What makes you think that?
- Sara: Well, I hear interest rates are low and I don’t want to miss out on getting a home before the interest rates rise again. They will go up, right?
- REALTOR: Yes they will. Eventually. But we are still seeing historically low rates so you have some time. Have you thought about the financial costs and benefits of buying?
- Sara: Sort of. I have a stable job, great credit, and I have saved some money for a down payment. What else do I need to think about?
- REALTOR: All of those things are great. Sounds like you are planning ahead which is smart. Let me ask you, do you rent right now?
- Sara: Yes, I have a two bedroom townhouse I rent for $2400 a month.
- REALTOR: Great, so what are you looking for in a home?
- Sara: I want a three bedroom, two bath single-family house. I want the dream! Great schools, nice yard, clean home and good neighborhood. You can help me, right?
At this point in the conversation it sounds like Sara has given some serious thought to buying. So we need to take the conversation to the next step. We discuss with Sara the pros and cons of buying a house. We see she is emotionally ready to buy, but is she financially ready? We need to analyze her current financial situation and balance that with her future financial obligations before she commits to buying. We know she is paying $2400/month for her current rent, so at this point it’s time to bring in our team members to help answer Sara’s most important question: How much can I afford?
Determining How Much You Can Afford
Asking how much you can afford is a great question with a complicated answer that usually begins with “it depends" (like all things in real estate). To help justify such a vague answer for a renter like Sara, here is some local perspective:
In October 2017 the median single-family home price in Santa Cruz County was $867,000 and the medium townhome/condo price was $511,250. That doesn’t mean this is what Sara has to spend. This only shows how the general market is at a particular moment. So Sara needs to examine her budget closely. How much (what size) of a home and what type of home can she afford? With the typical first-time homebuyer budget, a home on the beach is probably out of the question, but maybe a condo or townhome near the beach is within reach. This is where your REALTOR and mortgage advisor can be a huge help.
Get Help from a REALTOR and Mortgage Advisor
Working together with your REALTOR and mortgage advisor will help a buyer like Sara (or you!) put together a home affordability analysis. A mortgage advisor can get you pre-approved so that you and your REALTOR will know exactly what your budget and purchasing power is and in most cases, where you can afford to live - and when.
When a renter becomes a homeowner they have the opportunity to choose their monthly 'rent' for the term of the loan. That control and stability is priceless. Who knows where rents will be in 5, 10 or 30 years!
How Interest Rates, Access to Capital, and Tax Breaks Affect Your Purchasing Power
During the financing pre-approval process the next most common question is, “What are the interest rates and how do they affect my purchasing power?” In today’s economy it is important to understand that gaining access to capital in the form of loans, is more important than interest rates. This, combined with a tight housing market, is making it very hard to get into a home. But when you do have access to the capital and can qualify for loans, our current, historically low interest rates are what can increase your purchasing power significantly.
One other important area most renters forget to consider is that owning a home comes with property taxes but also tax breaks (yay!) in the form of mortgage interest deductions. These tax breaks can be significant. So it is important to also add a professional tax advisor to the team who can walk you through all the pros and cons of the tax benefits and liabilities that come with homeownership as well.
From Renter to Homeowner: Making the Numbers Work
So going back to our renter, Sara -- what do her prospects for homeownership look like? Let’s assume that she makes a good living and her mortgage advisor and REALTOR have concluded she can afford a home up to a maximum $550,000 purchase price. What can she buy for $550,000 and where? Remember, she wants that great neighborhood, good schools, and a three bedroom, two bathroom dream home.
When Sara was renting she paid $2400 per month -- the equivalent of a mortgage payment on a $524,000 home at the current interest rates of 3.92%. So, her purchasing power of $550,000 equates to a monthly mortgage payment of $2600 before taxes and insurance. This is pretty close to her current monthly budget while renting which means Sara may not have to change her financial lifestyle too drastically. Surprised?
So running the numbers in a realistic scenario would look something like this below. (We are using a 3.92% mortgage rate on a maximum $550,000 purchase versus her current rent of $2400 month.)
Sara’s current rental situation: She pays $2400/month + renters insurance of $100/month for a total of $2500/month for housing.
She wants to buy a $550,000 house at a 3.92% interest rate with 30 year mortgage.
- Purchase price of home: $550,000
- Down Payment at 20%: $110,000
- Insurance: $67/month
- Property Taxes accrued: $550/month
- Principal and Interest: $2,080/month
Total monthly estimated mortgage payment would equal $2,697 or $197 more a month than her current cost for rent.
Of course the scary number here is that big $110,000 down payment. Keep in mind there may also be some nominal closing costs as well. In Sara’s case, she had already saved up for the down payment, probably through years of pinching pennies and putting a little bit away at a time. But what if you haven’t scrimped and saved since your very first job and don’t have over $100,000 lying around? Not to worry, there are lending programs out there that only require as little as $3% down, decreasing that $110,000 to $16,500! Woohoo!
It’s important to note that with a low down payment comes a higher monthly payment (in this case $3,575 a month vs $2,697). If you can make the numbers work, then you may be able to get into that house for a much cheaper cash outlay. You can always negotiate with the seller and lower your purchasing price to make it more affordable as well. That is where a great REALTOR can come in handy.
Purchasing a home may feel overwhelming and a lot more complicated than renting but that’s why there are so many professionals ready to help you through the process. Renters should never be discouraged from starting a discussion with their favorite REALTOR about buying. It is never too soon to plan. The dream of homeownership is possible. If you build the right team around you and plan accordingly, you can achieve your dream. So maybe the beach is not where you end up, but you can still call the Santa Cruz area home while living in a great neighborhood, with good schools in a beautiful house that is all yours...well, all yours and the bank's until you pay off that mortgage!