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The way we speak about and educate the consumer about real estate in the U.S. needs to change.
I enjoy reading universal buyer’s guides: reasons in favor of buying a home, rent versus buy comparisons, finance articles on why buying a home is a good investment, finance articles about why buying a home is a bad investment, why you should (or shouldn’t) buy real estate. Actually, I don’t enjoy reading them, but rather I enjoy knowing what advice people are being given and the narratives they are told about the market.
While these guides make compelling arguments, there are often important pieces of information missing, and they always seem to be one-size-fits-all answers. Not to mention the information is being given to a national audience, without regard for individual regions or demographics.
Most prospective buyers are told that a major reason to buy a home is to build equity by paying the mortgage, followed by the popular maxim, “You’re throwing your money away by renting.” These pieces of advice are probably true if you are buying your “forever home.” Often, this advice is given to us by our parents (I’ve definitely heard this from a family member before). But it’s outdated information that may not necessarily be relevant to the lifestyles and shifts that have occurred in this country over the last 20 years.
The concept of paying off a mortgage over 30 years is outdated in many circumstances, and only applicable to a certain portion of buyers. Following the Great Depression, the idea of the 30-year mortgage was put forward to the American public when it was broadly adopted by the FHA. During this time, there was a suburban sprawl — people were leaving the cities, buying homes and staying in them for a long time, just like on Leave it to Beaver.
The economy looks a lot different today than it did back then, yet the information out there is still decades old. Today, many populations across America are shifting back toward urban areas and working in freelance jobs or on bonus schedules, or changing jobs and moving for their work more often, and many buyers with high-paying jobs near the city are not able to buy their forever homes in the early stages of their careers.
Trends in the housing and job markets usually involve a series of moves and stepping stones as income and savings increase, or buyers move to the suburbs if they cannot find the space they want for their family. In many people’s situations, the idea of buying a home in a city and building equity by paying off their mortgage is a fallacy, yet it is constantly spoken about as the goal we should all be striving for.
Based on our team’s observation and experience, in Manhattan the time horizon of ownership is, on average, roughly five years. In this case, there is no equity being built with mortgage payments for a 30-year fixed mortgage. The first five years’ worth of payments on a 30-year fixed mortgage are mostly made to interest (and at a higher rate than a five- to 10-year interest-only mortgage). A better strategy for homeownership in cities where there will be a few stepping stones is an interest-only mortgage. An interest-only mortgage will have a much lower monthly payment. The payments on an interest-only mortgage are simply interest payments based on the loan amount and not on an amortization schedule. Interest-only mortgages are fixed for a number of years, usually five to 10, and then they turn into 20- to 25-year amortized mortgages after the interest only period.
Take a $1 million purchase with a down payment of 20%, for example. In this case, an $800,000 loan at a 4.125% interest rate for a 30-year fixed mortgage would mean payments of $3,877 per month. A 10-year interest-only payment, on the other hand, would only be $2,500 at 3.75%.
The delta between the monthly payment of a 30-year fixed mortgage and an interest-only mortgage can be saved for your next down payment on another property, or it can simply be invested. This strategy places the homeowner in a much more liquid position. The drawback of an interest-only mortgage is if rates are higher after the introductory interest-only period expires, then you will be subject to current interest rates and the loan will start to amortize in a shorter duration, around 20 years. So if you are planning on going down this route, make sure that you are only planning on holding the property for a finite amount of time, or refinance.
There are many good reasons to buy a home in a city if you plan on owning it for five years — but paying down your mortgage is not one of them. Some of the reasons people purchase are for financial diversification so their assets are not just in stocks and cash, a sense of permanence, appreciation, the ability to be unaffected by rising rental payments, moving on your own schedule (as opposed to a landlord’s) and simply living in a space that is yours to enjoy.
More than anything, the “why” in “why this conversation needs to change” is because misguided information is keeping some people of out the housing market. Millennials, for example, are finding themselves behind on the homebuying process because the information they are being fed is not relevant to them at the stage they are at in their lives. In general, millennials are not making decisions over a 20- to 30-year horizon, but rather 3 to 10 years. Misguided information on the 30-year fixed mortgage dialogue presents a real opportunity cost for the money they could save and invest if they choose an interest-only mortgage.
I live and work in New York City, where I am a homeowner, and these are the types of conversations I constantly strive to educate buyers about in an urban market, so that all may be equipped with the right information to access the real estate market appropriately.