Little by Little: Saving for a Home

Interactive Brokers’ Director of Education Andrew Wilkinson and Product Specialist, Kayla Melagrano, compare buying vs. renting a home. Searching for a place to live is much more than choosing a location and saving for a down payment.  In this conversation they discuss landlords, leasing, mortgages, trade offs, and more!

Summary – Cents of Security Ep. 10

The following is a summary of a live audio recording and may contain errors in spelling or grammar. Although IBKR has edited for clarity no material changes have been made.

Kayla Melagrano

Welcome back to IBKR Podcasts. I’m Kayla Melagrano and I’m joined today with Andrew Wilkinson and in this episode, we’re going to discuss home ownership and talk about the choice between buying a home and renting one. It’s arguably one of the biggest decisions you’ll make, and it’s a choice you may have to make repeatedly throughout your life. So Andrew, what’s your experience been?

Andrew Wilkinson

So, Kayla, I’ve been in the country for right over 20 years. I first moved down to Florida and I spent the first 17 years renting a home with my family. So you know we’ve had significant needs and I think as I as I kind of top up exactly what I’ve spent on rent over the years, it’s something like $470,000 and I’ll give you a clue, when I bought a house about six years ago, I took out a mortgage for a smaller amount than all of the rent I’ve ever paid. So, there’s ups and downs to it.

Kayla Melagrano

And when you’re purchasing a home, I think a lot of people think in advance that purchasing a home is going to be more expensive than renting, and they’ll just rent to start off so that they don’t have that commitment, but when you look at it in the long run, it ends up being more expensive just renting.

Andrew Wilkinson

Yeah, it depends what you want out of life. I mean, I had the flexibility of moving from place to place, which I didn’t do. I’ve only really lived in three places in this country. When you buy a house, you’re making a commitment to stay in a particular area and you might choose a place because of a certain school system, or because of –generally what people do — it’s where their career is, right. So, you have to live somewhere close to where you’re going to work. If you’re younger, you might go and live on campus somewhere in an apartment or in some situations, you’re going to stay at home with your parents. When you buy a house, generally you’re committing to be there for quite some time. Most people take out a 25 or a 30-year mortgage. Doesn’t mean you have to be in that home for that period of time, you can pay it off over a shorter period. Some people refinance a mortgage and when you decide you want to move from place to place, you can simply sell the home and hopefully go and buy another one, or you can go and rent in the new area.

Kayla Melagrano

Many of our listeners are young adults, so they might currently be living in college or living at home with their parents and wondering when they graduate and get a job, what if it’s halfway across the country? Where will they live? What will they do? And in that situation, if you’re first moving out, you might want to rent. You’re not necessarily familiar with the area, and you’re not sure where you would want to buy a house, or if they would even like the area, if they would like the job. Maybe you want to move back home in a few years. So, I think it really depends on the situation when you’re deciding.

Andrew Wilkinson

Yeah, I think it’s an easy choice to become a renter at the outset, isn’t it? If you don’t know how long you’re going to be in a particular area. You know, you generally know you’re going to be in college for a certain number of years, but thereafter when you take your first job, it’s not something you can do very easily. You’ve got to find a deposit to put down on a home or just go ahead and rent. So, actually saving to put the money down as a deposit on a home is a challenge in itself. Let me ask you, Kayla, you’re in your 20s, you’ve been through college. What’s your housing situation?

Kayla Melagrano

Yeah, so I currently still live at home with my parents. After college, I moved back home. I wasn’t ready to start renting yet and obviously wasn’t in a position to be buying straight out of college. So, I decided to move back home with my parents and that’s allowed me to save up money so that then when I do decide to move out and rent or decide to just buy something somewhere. I’ll have money saved up for a down payment or…

Andrew Wilkinson

Are you sticking to that as a rigid plan, though? You’re not just going out and having a good? Are you able to actually put money to one side with a view to using it as a down payment?

Kayla Melagrano

What I typically try and do is since I’m not paying rent right now, every month when I get my paychecks, I’ll put some of what I would be paying in rent into a savings account so that then I’m saving up something and I’m not just spending all of my money since I live at home, don’t have any expenses.

Andrew Wilkinson

That’s really important because when you’re renting, you have an outgoing. When you’re paying a mortgage, you have an outgoing. In my situation, they would typically — you know, side by side I was paying as much in rent as I might have been paying on the mortgage. Actually, now I’m paying about 30% more on a monthly mortgage payment, but that includes taxes and insurance as well. To actually save while you’re paying rent is not easy. So, you might think if I’m renting, I can also save to be able to afford a down payment and then I’ll have a mortgage, but it isn’t easy it’s always a challenge. When it comes to a mortgage, when it comes to buying a home, typically a bank or a lender is going to want 20% down as a minimum. Now on a $200,000 home, that’s 40,000. That’s quite a chunk of change for anybody to put together. Sometimes younger people or even people in their 30s and 40s might have the luxury of going to the Bank of Mom and Dad to help with the loan. When it comes to the actual mortgage payment, you can use a mortgage calculator online to figure out what your all-in payment would be for the property. You put in the price of the property, and you put in what the local taxes are, that’s generally shown on a realtor’s website and you can figure out whether that fits your budget or not.

On the rental side when you’re going to rent an apartment, you agree with the landlord what the monthly rents going to be, and thereafter, that’s all you’re paying. So technically, for about I don’t know, 17 years, I wasn’t actually paying any taxes and I wasn’t paying any insurance on the property, that’s the landlord’s responsibility. If a window breaks, if the toilet blocks or whatever, in a rental that’s for my landlord to sort out. Some people have better experience than others with landlords. You know, if you got a hole in the roof after a hurricane or something down in Florida, you really hope that you’ve got a good landlord. If you don’t, you know, then you’ve got a problem.

As a homeowner, you’ve either got insurance which will patch up some of that work, maybe all of it. I had a roof blow off after I’ve been in the house for a couple of months and the insurance did take care of that, but other people aren’t necessary … they don’t have the same type of insurance policy. With a mortgage payment as I say, you’ve got three different components. You’ve got the actual mortgage amount based upon the capital and then interest that you agree with the bank to pay and then you’ve got to take out an insurance in the event that you default, and it protects the bank. And sometimes, if you don’t have that 20% down payment, the lender might insist on what you call a PMI or a purchase mortgage insurance, which means that you have to pay an incremental amount on top. That’s if you don’t have that 20%. And then there’s the taxes, and the taxes are a function of what the local town charges for you, they set that at town rate. If you want to move to a town that’s got a good school system, you can guarantee you’re going to be paying higher taxes. If you don’t have a school system, you can rely on having lower taxes.

Kayla Melagrano

And I think that’s good to note that the additional costs that come along with both buying a house and renting, because some people might just think, oh, whatever my mortgage payments is all I’m going to be spending on this and is that cheaper than what rent would be? But it’s not just that, it’s the taxes, the insurance and any repairs costs as well.

Andrew Wilkinson

But even if you’re renting Kayla one of the drawbacks is that you’re typically tied in for a particular period. Any landlord wants you to sign a contract, and a contract is typically for a year. If you want to get a good deal on rent or lock into a particular rate over time, it might ask that you sign a 2-3 or even a 5-year contract, which could work out for you but then you are tied to the particular area. So, if you decide to change careers, change jobs, go to a different city, you can do that as a renter, and you can literally just pack up and go. OK. But if you’re having a now sell a house because you want to go and live in a different city altogether to take that better job, you might find you’re in a bit of bother trying to sell your house, time that with moving into a different place. Some companies are very good at helping accommodate that.

Kayla Melagrano

The other thing is that when you are buying a house, you can also always think about down the line in the future, are you going to want to have multiple properties that you can rent out? That’s also always an option. Where you can own different properties, be renting them out and those rental payments that the renters are paying to you can go towards paying off the mortgage and depending on how much you’re charging and rent, you can start to make passive income from those properties as well.

Andrew Wilkinson

That’s a really good point, Kayla. A lot of people do this for a living, right? If I bought somewhere in every town and city that I had lived in and I became the landlord, I could probably retire tomorrow. People make a living out of this. As you say, making rental income from a place that you own often exceeds what you’re going to have to pay out in terms of a mortgage. Then over time, you’d have paid off as much of the capital as you possibly can, and ultimately you own the whole property. And then you’re sitting with something that you hope will have appreciated in time. Property real estate is one of people’s biggest assets in life. Getting onto the property ladder at an early stage in life is always recommended, but using rental properties to generate income is also a very good strategy.

Kayla Melagrano

And the housing market is also always changing. I know a lot of people that sold their houses a couple of years ago and made a ton of money off of it because they were able to sell the house for a lot more than what they paid when they bought it.

Andrew Wilkinson

Yeah. Typically, housing prices go up. There have been times when we’ve had, you know, retrenchment in the housing markets, particularly when you were a lot younger during the 2007-2008 crash. That was all about over lending within the mortgage sector, and everything came crashing down, so people got stuck with what you call negative equity. It is a rare occurrence, but it can happen. And right now, the real estate market remains robust, particularly for newly built homes. The existing homes market is kind of a little stagnant, but prices don’t seem to be falling even though the Federal Reserve is tightening interest rates.

Kayla Melagrano

Yeah, that’s another thing. When you’re looking to buy a house, you should also keep an eye on the interest rates, because when there’s a higher interest rate, then your payments are going to go up. So, if that’s one of your concerns, you might want to wait until times when the interest rates are a little bit lower so that your monthly payments aren’t as high.

Andrew Wilkinson

 And again, what I would say is to look out for a mortgage calculator on realtor websites, or banks websites. You know, all these people want to lend you money and as long as you know the underlying cost of the property, they’ll allow you to pick from one. You know, you’ll have a selection of interest rates to choose from, typically the 30-year mortgage rate or you can get 5/10/15 year ARMS or other financial products. But you’ll be able to, you know as I said earlier, as long as you can put in the taxes and the insurance, the applicable values in there. You’re going to be able to see whether it’s within your budget range. Don’t be afraid of high interest rates, it really comes down to what’s within your budget and as long as you plan for an increase in interest then on the downside, if interest rates do fall overtime, you might even benefit.

Kayla Melagrano

Yeah, you can always refinance, so.

Andrew Wilkinson  

Yeah, refinancing is also another huge point here. A lot of people use equity in their house. So if you what — what do I mean by equity in your house? If you pay half $1,000,000 for a house you lock into the value of the home when you buy it, and you get a mortgage on that value. So you know, typically you’d put 20% down, so you’d have what, $400,000 mortgage and $100,000 equity in the home. If the value of the house goes up to $750,000 overtime, well, you locked in at half a million. The equity, your equity has now grown from $400,000 — your equity has grown from $100,000 what you put down on the property to $350,000 which is the 750 minus the $400,000. So that is yours, should you sell the property. But what a lot of banks do is to kind of make you play clever with that that you can actually release some of that equity and take it out as a loan, an additional loan. So, your monthly payment goes up, but you have access to that cash, and you can use it for whatever you want, particularly home improvements. Maybe put a swimming pool in the yard or put a new roof on the house or pay for college expenses or something. So, this is why getting onto the housing ladder is kind of critical because there’s so much you can do, assuming that home prices continue to increase over time. And even if they don’t, you’ve got a roof over your head and you’re not going to get asked to move out as long as you maintain the payments.

Kayla Melagrano

And when you’re renting, I’ve seen in the past that typically rent payments just keep going up. If you’re renting an apartment, the price isn’t really going to go down, pretty much going to stay the same or just keep going up.

Andrew Wilkinson

Well, the problem with that also Kayla, is that when the price of the property goes up, even if you’re renting, your landlord every year has the right to reset your rental payment and so if the value of his underlying asset is going up, you know, arguably he might want to put the rent up every year and there’s not a whole lot you can do about that. So, it’s just an ongoing kind of fact.

Kayla Melagrano

If the place that you’re in then, price goes up, you can’t afford it anymore. Maybe you have to look for a new apartment or house. And if you were spending a certain amount on one place and now you have to look for something less expensive, it might not be the size that you’re looking for or as new and updated as you’re looking for.

Andrew Wilkinson

Now, when people are looking for a new home, they’re, you know, they’re very picky, right? Because you want the perfect place. It’s the biggest expense you’re ever going to make, arguably. When you’re looking for a rental, you think maybe you’re going to be in there for two or three years and you assume that the supply of rentals is abundant and there’s plenty of them around. You don’t like this one, because you don’t like the color of the wall or you didn’t like that because there’s five steps up to the front doorway or something or you didn’t like the 1st floor or whatever. You know, that’s that, you move on to the next one, but what you’ve got to be careful of is the supply of homes — sorry, the supply of rental apartments or homes that fit your needs. When housing markets get tight and we saw this during the pandemic, things can go very, very wrong. You know, if you can’t find somewhere to live … yeah, that’s problematic. Of course, if you own a home, you’ve got a roof over your head but if you are renting and you’re between rentals, you can’t find anywhere, you might be forced into the next city, hopefully not the next state, but things can go wrong on that front.

Kayla Melagrano

Yeah, or forced back to moving in with your parents.

Andrew Wilkinson

So how is that? How’s living at home with the parents? Is there a tradeoff here not having to pay rent?

Kayla Melagrano

I mean, I think it’s worth it being able to save money, but I don’t know.

Andrew Wilkinson

The real trick is that you actually put the money to one side, and you don’t just buy a bigger car or spend more money parting at weekends.

Kayla Melagrano

Yeah, as much as I would want to do that, I’m trying to think a little smarter.

Andrew Wilkinson

Kayla, thank you very much for joining me on this podcast. It’s been a great experience. Thank you very much for hosting.

Kayla Melagrano

Yeah, of course. It was great, thank you.