Published December 28, 2016|6 min read
This article originally appeared on Earnest.
You’re ready to buy your own home. What kind should you buy?
Single-family homes, condos/co-ops, or a second home you rent out or visit while continuing to rent a primary residence are among choices today’s first-time buyer faces. Each choice has its pros and cons, depending on how deep you’re digging to finance your purchase, your risk tolerance, your need for flexibility, and your overall financial picture.
Single-family homes are the most-sought housing type in America. They tend to appreciate faster and are generally larger than condos located within the same area, and owners who want to personalize their space have the most creative license in a house. You can influence your home’s value through renovations and improvements, so putting your own stamp on a place can improve its value.
The downside? You may find that single-family homes in neighborhoods where you can afford to rent aren’t so affordable to buy. The term "drive till you qualify," often tossed around in hot housing markets, refers to buyers traveling far from a city’s center to find houses they can afford to purchase. If you’re attached to a specific neighborhood or urban core, you may have to decide what’s more important—space (but in the suburbs) or location (at the expense of space).
When you own a single-family home, you’re responsible for its maintenance and upkeep, which tends to cost 1% to 2% of its purchase price annually. This is important to consider if you’re buying on a strict budget. On the plus side, you get to choose when to tackle and how to finance maintenance projects—and whether to do projects yourself or with hired help.
If you’re stretching to get into a single-family home and looking at fixer-uppers, keep in mind that some financing types (FHA, etc.) require a house to satisfy minimum thresholds for habitability. (The dump can only be so dumpy for some loans.) If what you can afford (or want) among single-family homes is a fixer upper, FHA and other lenders do have fixer-specific financing; ask your lender.
Borrowers may be surprised to learn they can typically borrow more for a single-family home than they can for a condo. In some cases, this is because lenders factor homeowner association dues that condo owners must pay into the total monthly housing obligation/payment. In others, it is because some lenders expect a higher down payment (and thus smaller loan) for a condo than for a similarly priced house because the condo may be in a high-rise. If you’re evaluating both single-family homes and condos, ask your lender about your borrowing power for each type of purchase.
Single family home
Faster price appreciation
More creative license over your own property
More flexibility in improvement-related costs
Condo or apartment
Some property maintenance covered by HOA
Extra amenities in community space
Condominium and co-op buildings are generally among the more safe, secure, and hassle-free ways to own. You get the convenience (no yard!), community (so many neighbors!), and shared amenities (storage, workout room, parking, party room) of an apartment lifestyle, but with the perk of building home equity. And you don’t have to sweat as much home maintenance as house dwellers do. The monthly homeowner dues you’ll pay in these buildings pay staff or contractors to handle common areas outside of your living space—landscaping, elevator maintenance, security, building HVAC, lobby cleanliness, etc.
Some downsides: Condos tend to appreciate slower than single-family housing does—at least in markets where there’s a fairly even mix of single-family housing and condo housing. Some buildings place restrictions on how many units can be rented out at a time, so if you plan to rent out your condo, make sure you understand the rules. Additionally, if a building has deferred maintenance or low cash reserves, you may have to pay "special assessment" fees to fund extraordinary or emergency fixes—on top of your homeowners’ association dues.
Co-op buildings, found mostly in Northeastern cities, work slightly differently from condos. Instead of buying a discrete unit within a building, you are buying a share of the building. Beyond seeing your purchase offer, a co-op building’s board may require an additional layer of vetting before deciding to sell to you. Personal interviews, financial statements, and reference letters are common. Co-op buildings generally have tight restrictions on renting, too. Additionally, when selling a co-op unit you may have to pay what’s known as a "flip tax"--a fee paid to the co-op board at time of sale.
If you live in an expensive city but want to begin building real estate equity, there’s another option: Buy an inexpensive home outside your metro area, in a community where there is rental demand from vacationers or locals and where you enjoy visiting and spending time.
For some urbanites who live in pricey communities like New York City or San Francisco it may make more sense to start with a vacation home and continue renting—provided their rent is affordable enough to leave some funds leftover for ownership elsewhere.
Take Lois and Luke, a New York couple sharing a rent-regulated apartment in Manhattan for $1,500. With two incomes in tech and marketing, they can afford a combined higher monthly housing payment around $4,200—but with such a good deal on rent and such a high price tag on homes for sale in Manhattan, they decided it made more sense to buy outside the city.
Rather than try saving for a 20% down ($145,000) on a $725,000 one-bedroom apartment in Manhattan that would cost $2,625 per month (not including monthly dues) for the mortgage, the duo put 20% ($108,000) down on a $520,000 house set on 5 acres in a Hudson Valley town popular with weekenders, artists, college students, and retirees. Their monthly payment on this property is the same as the Harlem condo.
However, once they finish furnishing it, they can cover most of their monthly expenses (mortgage, insurance, taxes, maintenance) through vacation or long-term rentals.
So while the couple now has a substantial mortgage, they’re beginning homeownership with a nice chunk of equity, will continue to enjoy their $1,500 per month rent in the city, and can expect to pay much less than $2,625 per month—sometimes $0 per month—to own. With just over $4,200 budgeted for housing, and the potential to always pay well below $4,125, they can set aside money for home maintenance, emergency savings, or retirement investing.
Of course, the "second home first" approach has a steep learning curve. Launching homeownership and becoming a landlord or remote owner all at the same time can be stressful. You may need to hire a rental management company, housekeepers, contractors, or landscapers—which can add to your carrying costs—and if you or renters aren’t always on site, you may need security services or see small problems (a leak) snowball into larger ones (a lake). Insurance and mortgage loan interest rates on such homes may be higher than traditionally occupied primary homes, and some communities have rules and restrictions about short-term rentals. Be sure to model costs carefully before proceeding.
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