How Mortgages work: Buying vs. Renting

Mortgage BasicsHow mortgages work: Buying vs. Renting

"Should we continue renting or go ahead and buy?" That's the question hundreds of thousands of Americans ask themselves every year.

It's not an easy one to answer. Emotions, family and personal reasons all come into play in any home-buying decision.

No one knows what the future holds for you, your family, your job or your finances. But we can help you understand what you're going to encounter when you embark on the sometimes-difficult journey toward the American Dream of owning a home.

Economic differences between Renting and Owning
If you're looking for the best return on your money, historically you're better off investing in the stock market than buying a house. Primary homes generally don't earn the investment return of financial instruments such as mutual funds. While the stock market's long-term average rate of return is in the range of 8 percent to 10 percent, housing has appreciated on average in the low- to mid-single digits for many years. That means you shouldn't buy solely to generate an investment gain.

On the other hand, Uncle Sam helps out by letting taxpayers deduct part of the mortgage interest and real estate taxes they pay each year. Borrowers get the benefit only if they pay enough in one year to exceed the standard deduction. But that usually happens, especially during the first few years of a mortgage when most of each payment goes toward interest rather than principal. 

By the numbers ...
Say someone with gross annual income of $50,000 bought a home using a 7 percent, 30-year mortgage of $150,000 on Jan. 1, 2002. The monthly payment would be $998, excluding taxes and insurance, and this year, that borrower would pay $9,585 in interest. If he didn't have the mortgage, he would take a $4,700 standard tax deduction on his 2002 tax return (assuming he was a single filer). But by itemizing his mortgage interest, he would have $4,885 more to subtract from his income.

Sunny side of homeownership
Owners enjoy other benefits, too. They build equity over time as home values rise and their mortgage balances shrink. They also don't have to worry about their housing costs shooting through the roof because mortgage lenders can't boost borrower rates and payments, unless those borrowers have adjustable-rate mortgages.

Cloudy side of homeownership
When something breaks at an apartment, it's the landlord's problem. When your name's on the deed, it's yours. Someone who throws every penny into a down payment just because homeownership sounds like a good idea is taking a big risk because there's no money left to fix leaky pipes or buy a new air conditioner.

Potential buyers may want to hold off for other reasons. Workers on shaky ground with their employers or those who don't think they'll be able to find jobs nearby if their firms go belly up might want to wait on getting mortgages. The same goes for people who plan on leaving a job soon. The monthly payment isn't the only obstacle for this kind of customer. Closing costs and other home-buying fees, as well as the commission that most owners end up paying to real estate agents when they sell their homes, add up. People who have to sell after living in one place for only a short time can end up in the hole on their investments.

Explore all the options
Some middle-ground approaches to homeownership blend elements of buying and renting. Some of the more popular loan types are seller financing, "lease with an option" and "contract for a deed" plans.

Seller financing
In seller financing, the buyer buys a $150,000 home by taking out an $80,000 bank loan, putting $10,000 down and getting the seller to "carry back" a $20,000 second mortgage. The buyer makes payments on the first loan to the bank and the second loan to the seller. That second mortgage from the seller usually comes with a higher rate, a shorter term and a potential balloon payment. Or, the seller can hold the entire mortgage and the buyer makes payments directly to the seller.

Pro: It reduces the cash needed to get into a home and could reduce closing costs.

Con: There are two monthly mortgages payments and the seller determines the interest rate for the second loan.

Lease with an option
In a lease with an option, the buyer leases a $125,000 home from the seller for 12 months at $1,200 a month, with $200 a month going into a savings account for a down payment and $1,000 going to the owner. Before moving in, the would-be buyer pays maybe 4 percent, or $5,000, of the purchase price upfront that goes toward the down payment. At the end of one year, the buyer gets the home with $7,400 down (his $5,000 upfront plus his savings account) and a regular loan from a bank that pays off the seller.

Pro: It's good for people who don't have a lot of cash, plus you get to "wear" the house before you buy it.

Con: The seller owns the home during the lease period.

Contract for a deed
In a contract for a deed, the buyer arranges a contract with the seller. The buyer makes payments to an escrow agent, who holds the deed to the property. After 180 months or some other term of payments to the escrow agent, the seller tells the escrow agent that payments have been made, and the escrow agent gives the buyer the deed. No financial institution is involved.

Pro: It reduces the closing costs.

Con: A buyer who defaults before fully owning a property can be treated like a tenant and evicted.

updated March 24,2003

 

 

How mortgages work: Buying vs. renting

Mortgage Basics"Should we continue renting or go ahead and buy?" That's the question hundreds of thousands of Americans ask themselves every year.

It's not an easy one to answer. Emotions, family and personal reasons all come into play in any home-buying decision.

No one knows what the future holds for you, your family, your job or your finances. But we can help you understand what you're going to encounter when you embark on the sometimes-difficult journey toward the American Dream of owning a home.

Economic differences between renting and owning
If you're looking for the best return on your money, historically you're better off investing in the stock market than buying a house. Primary homes generally don't earn the investment return of financial instruments such as mutual funds. While the stock market's long-term average rate of return is in the range of 8 percent to 10 percent, housing has appreciated on average in the low- to mid-single digits for many years. That means you shouldn't buy solely to generate an investment gain.

On the other hand, Uncle Sam helps out by letting taxpayers deduct part of the mortgage interest and real estate taxes they pay each year. Borrowers get the benefit only if they pay enough in one year to exceed the standard deduction. But that usually happens, especially during the first few years of a mortgage when most of each payment goes toward interest rather than principal.

Continued below

By the numbers ...
Say someone with gross annual income of $50,000 bought a home using a 7 percent, 30-year mortgage of $150,000 on Jan. 1, 2002. The monthly payment would be $998, excluding taxes and insurance, and this year, that borrower would pay $9,585 in interest. If he didn't have the mortgage, he would take a $4,700 standard tax deduction on his 2002 tax return (assuming he was a single filer). But by itemizing his mortgage interest, he would have $4,885 more to subtract from his income.

Sunny side of homeownership
Owners enjoy other benefits, too. They build equity over time as home values rise and their mortgage balances shrink. They also don't have to worry about their housing costs shooting through the roof because mortgage lenders can't boost borrower rates and payments, unless those borrowers have adjustable-rate mortgages.

Cloudy side of homeownership
When something breaks at an apartment, it's the landlord's problem. When your name's on the deed, it's yours. Someone who throws every penny into a down payment just because homeownership sounds like a good idea is taking a big risk because there's no money left to fix leaky pipes or buy a new air conditioner.

Potential buyers may want to hold off for other reasons. Workers on shaky ground with their employers or those who don't think they'll be able to find jobs nearby if their firms go belly up might want to wait on getting mortgages. The same goes for people who plan on leaving a job soon. The monthly payment isn't the only obstacle for this kind of customer. Closing costs and other home-buying fees, as well as the commission that most owners end up paying to real estate agents when they sell their homes, add up. People who have to sell after living in one place for only a short time can end up in the hole on their investments.

Explore all the options
Some middle-ground approaches to homeownership blend elements of buying and renting. Some of the more popular loan types are seller financing, "lease with an option" and "contract for a deed" plans.

Seller financing
In seller financing, the buyer buys a $150,000 home by taking out an $80,000 bank loan, putting $10,000 down and getting the seller to "carry back" a $20,000 second mortgage. The buyer makes payments on the first loan to the bank and the second loan to the seller. That second mortgage from the seller usually comes with a higher rate, a shorter term and a potential balloon payment. Or, the seller can hold the entire mortgage and the buyer makes payments directly to the seller.

Pro: It reduces the cash needed to get into a home and could reduce closing costs.

Con: There are two monthly mortgages payments and the seller determines the interest rate for the second loan.

Lease with an option
In a lease with an option, the buyer leases a $125,000 home from the seller for 12 months at $1,200 a month, with $200 a month going into a savings account for a down payment and $1,000 going to the owner. Before moving in, the would-be buyer pays maybe 4 percent, or $5,000, of the purchase price upfront that goes toward the down payment. At the end of one year, the buyer gets the home with $7,400 down (his $5,000 upfront plus his savings account) and a regular loan from a bank that pays off the seller.

Pro: It's good for people who don't have a lot of cash, plus you get to "wear" the house before you buy it.

Con: The seller owns the home during the lease period.

Contract for a deed
In a contract for a deed, the buyer arranges a contract with the seller. The buyer makes payments to an escrow agent, who holds the deed to the property. After 180 months or some other term of payments to the escrow agent, the seller tells the escrow agent that payments have been made, and the escrow agent gives the buyer the deed. No financial institution is involved.

Pro: It reduces the closing costs.

Con: A buyer who defaults before fully owning a property can be treated like a tenant and evicted.

Related Stories:
Rent or buy a home?
Should you stretch to buy that house?

-- Updated: March 24, 2003

BACK: Intro
  top of page

How mortgages work: Buying vs. renting

Mortgage Basics"Should we continue renting or go ahead and buy?" That's the question hundreds of thousands of Americans ask themselves every year.

It's not an easy one to answer. Emotions, family and personal reasons all come into play in any home-buying decision.

No one knows what the future holds for you, your family, your job or your finances. But we can help you understand what you're going to encounter when you embark on the sometimes-difficult journey toward the American Dream of owning a home.

Economic differences between renting and owning
If you're looking for the best return on your money, historically you're better off investing in the stock market than buying a house. Primary homes generally don't earn the investment return of financial instruments such as mutual funds. While the stock market's long-term average rate of return is in the range of 8 percent to 10 percent, housing has appreciated on average in the low- to mid-single digits for many years. That means you shouldn't buy solely to generate an investment gain.

On the other hand, Uncle Sam helps out by letting taxpayers deduct part of the mortgage interest and real estate taxes they pay each year. Borrowers get the benefit only if they pay enough in one year to exceed the standard deduction. But that usually happens, especially during the first few years of a mortgage when most of each payment goes toward interest rather than principal.

Continued below

By the numbers ...
Say someone with gross annual income of $50,000 bought a home using a 7 percent, 30-year mortgage of $150,000 on Jan. 1, 2002. The monthly payment would be $998, excluding taxes and insurance, and this year, that borrower would pay $9,585 in interest. If he didn't have the mortgage, he would take a $4,700 standard tax deduction on his 2002 tax return (assuming he was a single filer). But by itemizing his mortgage interest, he would have $4,885 more to subtract from his income.

Sunny side of homeownership
Owners enjoy other benefits, too. They build equity over time as home values rise and their mortgage balances shrink. They also don't have to worry about their housing costs shooting through the roof because mortgage lenders can't boost borrower rates and payments, unless those borrowers have adjustable-rate mortgages.

Cloudy side of homeownership
When something breaks at an apartment, it's the landlord's problem. When your name's on the deed, it's yours. Someone who throws every penny into a down payment just because homeownership sounds like a good idea is taking a big risk because there's no money left to fix leaky pipes or buy a new air conditioner.

Potential buyers may want to hold off for other reasons. Workers on shaky ground with their employers or those who don't think they'll be able to find jobs nearby if their firms go belly up might want to wait on getting mortgages. The same goes for people who plan on leaving a job soon. The monthly payment isn't the only obstacle for this kind of customer. Closing costs and other home-buying fees, as well as the commission that most owners end up paying to real estate agents when they sell their homes, add up. People who have to sell after living in one place for only a short time can end up in the hole on their investments.

Explore all the options
Some middle-ground approaches to homeownership blend elements of buying and renting. Some of the more popular loan types are seller financing, "lease with an option" and "contract for a deed" plans.

Seller financing
In seller financing, the buyer buys a $150,000 home by taking out an $80,000 bank loan, putting $10,000 down and getting the seller to "carry back" a $20,000 second mortgage. The buyer makes payments on the first loan to the bank and the second loan to the seller. That second mortgage from the seller usually comes with a higher rate, a shorter term and a potential balloon payment. Or, the seller can hold the entire mortgage and the buyer makes payments directly to the seller.

Pro: It reduces the cash needed to get into a home and could reduce closing costs.

Con: There are two monthly mortgages payments and the seller determines the interest rate for the second loan.

Lease with an option
In a lease with an option, the buyer leases a $125,000 home from the seller for 12 months at $1,200 a month, with $200 a month going into a savings account for a down payment and $1,000 going to the owner. Before moving in, the would-be buyer pays maybe 4 percent, or $5,000, of the purchase price upfront that goes toward the down payment. At the end of one year, the buyer gets the home with $7,400 down (his $5,000 upfront plus his savings account) and a regular loan from a bank that pays off the seller.

Pro: It's good for people who don't have a lot of cash, plus you get to "wear" the house before you buy it.

Con: The seller owns the home during the lease period.

Contract for a deed
In a contract for a deed, the buyer arranges a contract with the seller. The buyer makes payments to an escrow agent, who holds the deed to the property. After 180 months or some other term of payments to the escrow agent, the seller tells the escrow agent that payments have been made, and the escrow agent gives the buyer the deed. No financial institution is involved.

Pro: It reduces the closing costs.

Con: A buyer who defaults before fully owning a property can be treated like a tenant and evicted.

Related Stories:
Rent or buy a home?
Should you stretch to buy that house?

-- Updated: March 24, 2003

BACK: Intro
  top of page