10/21/2010

Buying a Home is An Opportunity to Leverage

Often when prospective buyer(s) think about making the change from being a renter to a homeowner, they add up all their monthly costs as a renter and then compare it to their monthly costs as a homeowner. If the amount as a homeowner is more, then they get discouraged and assume that buying is not a good deal for them. But instead of focusing on only their current role as a renter, they should go further and realize their role, and their opportunity, as an homebuyer/investor for their future:

Some people define leverage as using other people's money but another way to describe it is when a small down payment controls a large asset by placing a high loan-to-value mortgage on it. There are not many investments that allow leverage but homes certainly do and especially with FHA or VA loans.

Let's assume a couple or single buyer has the down payment and good credit that would allow them to buy a home. We'll compare some alternatives to see where their best outcome may be.

If a person put $6125 in a certificate of deposit (CD) that earned 2% annually, it would be worth $6,762 in five years and the profit would be taxed as ordinary income. If a person could take a little more risk and pick the right stock, the $6,125 might grow to $7,817 and the profit would be taxed at  the more favorable long-term capital gains rates if they held the stock for more than one year.

On the other hand, if the $6,125 were used as a down payment for a $175,000 home (possible with an FHA purchase) that went up in value only 1% per year, the equity would grow to $30,575 in the same five year period of time based on appreciation and amortization. In most cases, the gains on principal residences are excluded from income tax subject to limits. (Single person usually has an IRS $250,000 capital gains exemption and married couple usually has an IRS $500,000 capital gains exemption.)

The difference is dramatic and is one more reason that buyers should be taking advantage of the great selection of homes, the lower prices and incredibly low interest rates to fix their cost of housing for years to come. There may never be a better time to buy a home than now.

For more information on this, a rent vs. buy analysis may be obtained. Or please contact me through http://www.juliahuntsman.com/

Inspired by Pat Zaby

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