Last week, Phoebe and Sophie were perusing through the local news, the Wicked Local, for a school assignment on current events. By chance they came across the Homes for Sale page and started “choosing” their future homes. Being the practical one, I of course asked them how they planned to pay for that stunning 5-bedroom, 3 bathroom $1.4M home with a pool and tennis courts. At which point they giggled and replied, “You’ll buy it for us, right?”
Sure, hell will freeze over before that’ll happen.
However, this brought front and center to me a recent phone call I received from my buddy Joe’s kid, Scotty. He is about 31, recently married, and looking to buy his first home close to Joe, but as Scotty said, “…not too close.” Scotty graduated from Mass. Maritime about ten years ago. While he has a great job as an engineer, he is still laden with student debt and is concerned about qualifying for a mortgage and what that means to him and his wife.
Scotty really got me thinking about while folks my age and older who know what the American Dream of home ownership means, they recognize the world has changed. So this week with our time together, let’s delve into the topic of what does the home ownership look like for our kids and grandkids, and has it changed from when Jill and I bought our first home?
In my opinion, for young folks it comes to down to three key areas. First, do you qualify for it financially, based on your income and amount of debt? Second, is now the right time for a young first-time home buyer to wade into home ownership? And last, the emotional aspect – does the pull of the American Dream of homeownership justify the significant lifestyle changes and lack of flexibility that owning a home brings?
I explained to Scotty that the mortgage process has not changed from when I bought my first house. It still comes down to a person’s debt to income ratio. The debt to income ratio is the debt payments a person pays divided by their monthly gross pre-tax income. Most mortgage providers won’t consider debt to income ratio higher than 43%, and often the preferred number is something no higher to 36%, with the mortgage and mortgage related expenses being no more than 28% of gross income.
With respect to Scotty’s student loan obligations, I explained to him they are considered the same as any other type of normal debt, such as a car loan. Generally, lenders aren’t as concerned with the overall amount of debt you have, but they do care about your credit score and whether it indicates a history of making all your payments on time. In the case of his student loans, sometimes they can be restructured from standard to graduated. The caveat here is that while this will allow you to show a lower current monthly obligation, the overall amount you pay on the loan may be larger in the long term.
The next area of discussion is if now is the right time for them to become a new homeowner. After all, we are in the middle of a time of great economic and political uncertainty that doesn’t show signs of getting more predictable in the near term. While I did advise him to proceed with caution and carefully weigh the pros and cons, I did explain to Scotty that mortgage rates are at historic lows and it may be some time before they approach this level again. On the flip side, it’s currently a seller’s market for single-family homes that is resulting in bidding wars that have some sellers receiving prices substantially above their asking prices. Typically, one measure of value for single family homes is that they shouldn’t be more than 20 times what the current annual rent would be. That means that a $300,000 home, if it were a rental, should be able to sustain a rent of $1250 in the current marketplace.
Now for many of those of my generation, long term ownership has certainly turned out to be beneficial, but not all younger folks have bought in to this version of the American dream. In fact, social changes have pushed home ownership to record low levels for Millennials. With many focusing on their careers first or marrying later in life, home ownership is often delayed. Also, with the K-shaped economic recovery we are experiencing, many young adults are moving back in with their parents at a stunning rate.
Yet home ownership, in my experience, is one of the single greatest things that brings about a personal sense of independence and freedom. Many of the pros and cons are difficult to quantify because they involve things like emotion and pride that can’t be put on a balance sheet. Not only is it an economic achievement, but a place where you dictate how it is decorated or improved upon. But that freedom does come with some potential costs. For example, there is no landlord to make repairs and mow the lawn!
For Scotty, buying his first home – or possibly deciding not to – is both an economic and emotional decision that should be carefully considered. The time may or may not be right today for each individual or family and that can change in a matter of months or a few years.
For Phoebe and Sophie, well, they better keep on focusing on reading, writing, and arithmetic.
So as always – be vigilant and stay alert, because you deserve more!
Have a great week.
Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, Mansfield & Southlake, TX. Jeff can be reached at jeff@cutterfinancialgroup.com.
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