Download - Home Ownership Cost
Cost to Own
Guide to the real cost of
owning your home
HOME OWNERSHIP COST
Cost to Own
[email protected] 949.769.1599
The OC Housing News ownership cost calculations for family homes ................................................................. 3 A point-‐in-‐time analysis ........................................................................................................................................................................ 3 Asking Price ................................................................................................................................................................................................ 3 Down Payment .......................................................................................................................................................................................... 3 Mortgage Interest Rate .......................................................................................................................................................................... 4 Number of Years ....................................................................................................................................................................................... 4 Mortgage ...................................................................................................................................................................................................... 4 Income Requirement .............................................................................................................................................................................. 5 Monthly Mortgage Payment ................................................................................................................................................................ 5 Property Tax ............................................................................................................................................................................................... 5 Mello Roos & Special Taxes .................................................................................................................................................................. 5 Homeowners Insurance ........................................................................................................................................................................ 6 HOA Dues ..................................................................................................................................................................................................... 6 FHA Mortgage Insurance ....................................................................................................................................................................... 6 Monthly Cash Outlays ............................................................................................................................................................................. 6 Tax Savings .................................................................................................................................................................................................. 6 Principal Amortization ........................................................................................................................................................................... 7 Opportunity Cost ...................................................................................................................................................................................... 7 Maintenance and Reserves ................................................................................................................................................................... 8 Monthly Ownership Cost ....................................................................................................................................................................... 8 Comparable Rental .................................................................................................................................................................................. 8 Added Cost or (Savings) ........................................................................................................................................................................ 8 Furnishing and Move In ......................................................................................................................................................................... 9 Closing Costs ............................................................................................................................................................................................... 9 Down Payment .......................................................................................................................................................................................... 9 Total Cash Costs ........................................................................................................................................................................................ 9 Emergency Cash Reserves ................................................................................................................................................................. 10 Total Savings Needed ........................................................................................................................................................................... 10
How Much a House Really Costs ..................................................................................................................................... 11 Mortgage Payment ................................................................................................................................................................................ 11 Property Taxes ....................................................................................................................................................................................... 12 Homeowners Insurance ..................................................................................................................................................................... 13 Private Mortgage Insurance .............................................................................................................................................................. 13 Special Taxes and Levies .................................................................................................................................................................... 14 Homeowner Association Dues and Fees ..................................................................................................................................... 14 Maintenance and Replacement Reserves ................................................................................................................................... 15 Tax Savings ............................................................................................................................................................................................... 15 Hidden Savings ....................................................................................................................................................................................... 16 Opportunity Cost ................................................................................................................................................................................... 16 Ownership Cost Math .......................................................................................................................................................................... 17
Cost to Own
[email protected] 949.769.1599 Page 3 of 17
The OC Housing News ownership cost calculations for family homes
Below is a concise description of each line item displayed on the MLS property details, why the item is important,
and how it’s calculated.
A POINT-‐IN-‐TIME ANALYSIS
Today is reality; tomorrow is a fantasy. The ownership cost calculation is a snapshot of the cost of ownership at the
time of first payment. It makes no projections for future changes such as home price appreciation. This analysis
purposely does not project future changes for two reasons: First, the costs at the time of first payment are
concrete and knowable. It requires fewer assumptions and no crystal ball. Second, most people who estimate
future appreciation wildly overestimate. Very small changes in rates of appreciation make very large differences
over 10 or more years. Overestimating appreciation always makes owning a property look very desirable
financially. It’s a mistake many people made who bought at the peak of the housing bubble.
ASKING PRICE
This is the current asking price on the MLS.
DOWN PAYMENT
A conventional loan requires a down payment that is 20% of the purchase price. Down payments will less than 20%
down require private mortgage insurance, a policy paid by the borrower that protects the lender from loss. FHA
down payments are generally 3.5% of the purchase price. The down payment is calculated by multiplying the
asking price by 20% for a conventional loan and 3.5% for an FHA loan.
Cost to Own
[email protected] 949.769.1599 Page 4 of 17
MORTGAGE INTEREST RATE
Mortgage Interest rates are set by lenders competing to offer loans to borrowers who are buying or refinancing
real estate. Mortgage Interest Rates are quoted on many websites, such as Bankrate.com. If the loan is over the
conforming limit, a jumbo premium of 0.35% is added to the market rate. The OC Housing News calculations uses
the interest rate prevailing when the listing first came on the market. The interest rate is periodically updated. The
mortgage interest rate shown is not a quote. It is provided for estimating payments and cost of ownership.
NUMBER OF YEARS
The terms of a loan generally require repayment over time. A mortgage with a fixed repayment schedule is called
an amortizing mortgage, and the period of time over which the mortgage amortizes is called its term. The term of
mortgages is generally 30 years, but 15 year terms are also common, and lenders offer other schedules. The OCHN
calculations assume a 30-‐year fixed-‐rate amortizing mortgage because it is a stable balance between low payments
and reasonable repayment period, and it’s the most common form of home financing.
MORTGAGE
The mortgage balance for a conventional mortgage is the asking price minus the down payment. The mortgage is
80% of the purchase price in these calculations, but buyers executing a move-‐up sale may have larger down
payments and smaller mortgage balances.
The FHA mortgage is not as simple to calculate as a conventional mortgage because the FHA charges a 1.75% up
front fee that gets rolled into the mortgage. The amount borrowed is 96.5% of the purchase price (100% – 3.5%)
plus the 1.75% charge, for a total mortgage balance of 98.25% of the purchase price (96.5% + 1.75%). This is why
the FHA mortgage plus the down payment does not equal the asking price.
Cost to Own
[email protected] 949.769.1599 Page 5 of 17
INCOME REQUIREMENT
The income requirement is based on standards set by Fannie Mae, Freddie Mac, and the Federal Housing
Administration (GSEs and FHA). The monthly cash outlays (described later) multiplied by 12 gives a yearly payment
burden. The yearly payment burden must not exceed 31% of a borrowers income under most circumstances (FHA
often makes exceptions). The formula is as follows: Income Requirement = Monthly Cash Outlays X 12 / 0.31
MONTHLY MORTGAGE PAYMENT
The monthly mortgage payment is determined by lenders using a formula outlined below. It’s based on the
mortgage amount, mortgage interest rate, and loan term (number of years) as described above.
The following formula is used to calculate the fixed monthly payment (P) required to fully amortize a loan of L
dollars over a term of n months at a monthly interest rate of c. [If the quoted rate is 6%, for example, c is .06/12 or
.005].
P = L[c(1 + c)n]/[(1 + c)n -‐ 1]
PROPERTY TAX
Proposition 13 sets property taxes in California are set at 1% of purchase price (assumed asking price).
MELLO ROOS & SPECIAL TAXES
Mello Roos are an example of a special tax levy put on the property by the developer in California. The local
Assessor’s office has this information online, but it is not organized in a way permitting easy download, so it must
be estimated. Not every developer creates a Mello Roos district, so some properties developed since 1985 may
have no Mello Roos. For those properties, the cost of ownership calculations will overstate the true cost.
The calculations on the OCHN estimate as follows:
Cost to Own
[email protected] 949.769.1599 Page 6 of 17
If the year of construction is 2002 or later, Mello Roos = Property Cost Basis × 0.04.
If the year of construction is 1994 or later but earlier than 2002, Mello Roos = Property Cost Basis × 0.02.
If the year of construction is 1985 or later but earlier than 1994, Mello Roos = Property Cost Basis × 0.01.
HOMEOWNERS INSURANCE
Homeowners insurance rates vary widely, but the standard estimation is $25 for each $100,000 in home value.
HOA DUES
The HOA dues is taken straight from the MLS. Sometimes agents input this information incorrectly, but for the
most part, the numbers are accurate.
FHA MORTGAGE INSURANCE
Conventional mortgages with 20% down pay no private mortgage insurance. FHA insures mortgages with as little
as 3.5% down, and the cost of this insurance is 1.3% percentage of the loan balance — it’s higher than property
taxes in California.
MONTHLY CASH OUTLAYS
The monthly cash outlays — also known as PITI — is a standard lender calculation of housing costs. It is the sum of
the costs listed above: payment, property tax, Mello Roos, Insurance, HOAs, and mortgage insurance.
TAX SAVINGS
The tax savings is the most complicated of the calculations. Based on the income requirement, the borrowers
income is compared to both Federal and California tax tables to determine the marginal tax rates for both entities.
To determine the maximum potential tax savings, the marginal tax rate (both Federal and State) is multiplied by
Cost to Own
[email protected] 949.769.1599 Page 7 of 17
the sum of mortgage interest, property taxes, and mortgage insurance (those are deductible expenses). However,
to calculate the actual tax savings the marginal tax rate must be multiplied by the standard deduction, and this
number must be subtracted from the maximum potential tax savings. This adjustment is necessary because in
order to claim the deduction, a tax filer must itemize, and this requires surrendering the standard deduction. This
calculation is so complex because it must be repeated for both State and Federal taxes, and both have different tax
rates, different income thresholds, and different standard deductions.
PRINCIPAL AMORTIZATION
Since part of the mortgage payment is principal, and since this is effectively a forced savings account, the amount
of principal amortization must be backed out because it is not a true cost of ownership.
The payment is calculated by the formula detailed above. The interest on the debt is the outstanding loan balance
multiplied by the interest rate and divided by 12. The interest is subtracted from the payment to ascertain
principal amortization. Over time, principal amortization grows and mortgage interest declines. However, since
this is a point-‐in-‐time analysis, only the amortization of the first payment is counted.
OPPORTUNITY COST
Opportunity cost is perhaps the least understood of the adjustments to ownership cost. When a down payment is
applied to a home purchase, that money came from somewhere. If the buyer would have chosen to rent, that
money could have been invested in any number of safe investment alternatives. The loss of this investment
income is the opportunity cost.
The calculation herein takes the mortgage interest rate, divides it by 3, then adds 1% to it. This generally
approximates the yield on medium-‐term CDs, money-‐market accounts, or Treasuries. For example, at 4.5% interest
rates, the opportunity cost would be 2.5% (4.5% / 3 + 1%).
Cost to Own
[email protected] 949.769.1599 Page 8 of 17
MAINTENANCE AND RESERVES
Real property requires routine maintenance. Further, over time, more expensive items such as roofs or exterior
paint need replacement. Budgeting for the irregular expenses of routine maintenance and the slow depletion of
wear and tear requires establishing a monthly allowance for maintenance and replacement reserves.
The formula used here is asking price times three-‐tenths of one percent divided by twelve (0.003/12).
MONTHLY OWNERSHIP COST
The monthly ownership cost is the monthly cash outlays adjusted for tax savings, principal amortization,
opportunity cost, and maintenance reserves.
COMPARABLE RENTAL
Comparable rental rates are determined by an advanced algorithm for selecting comparable properties. When I
was actively flipping properties in Las Vegas, I evaluated both resale and rental comps on over 1,500 properties. I
developed a series of steps to gradually loosen the various parameters until I obtained a sufficient number of
comparable properties to make a reasonable estimate of value. These algorithms are proprietary. As this is an
automated analysis, there is a degree of error in these estimates, and the actual comparable rental rate may be
significantly higher or lower than the rate shown.
ADDED COST OR (SAVINGS)
The savings or loss is the monthly ownership cost minus the cost of a comparable rental. If this number is negative
(in parenthesis), then the property costs less to own that to rent, which is a good sign. If the number is positive, it
costs more to own than to rent.
Cost to Own
[email protected] 949.769.1599 Page 9 of 17
FURNISHING AND MOVE IN
Furnishing and move in costs vary considerably depending on the tastes of the buyer. There are generally fixed
costs for movers and other service providers, and variable costs for furnishings. In general, people will furnish a
house in proportion to its cost. The following formula is a low-‐cost estimate; most people when moving in to a
family home will spend much more.
The formula used here to estimate is 1% of the asking price plus $3,500.
CLOSING COSTS
The buyer and seller often split certain costs at closing, and some costs are entirely the responsibility of the buyer.
What’s paid by the buyer and what is a split cost varies by local custom. For financed purchases, the buyer must
pay closing costs including loan origination fees and other lender costs.
The formula used here to estimate is 1% of the asking price plus $3,500.
DOWN PAYMENT
The down payment is calculated above. It’s repeated here because it’s part of the calculation of total cash costs.
TOTAL CASH COSTS
The total cash costs is the amount of money a buyer must have available to complete the sale including furnishing
and move in, closing costs, and the down payment. People often forget about closing costs and furnishing cost and
go into debt shortly after the sale to cover these costs.
Cost to Own
[email protected] 949.769.1599 Page 10 of 17
EMERGENCY CASH RESERVES
Though not an actual cost of acquiring the property, financial advisors always recommend having sufficient cash
reserves to cover expenses in case of an emergency. Further, lenders often require liquid cash reserves in addition
to the down payment as a condition to funding. Most borrowers do not reserve much if anything when buying a
home. Almost none have an additional six-‐month’s income like most financial advisors recommend.
The calculation herein only estimates three month’s of income based on the income requirement generated
above.
TOTAL SAVINGS NEEDED
The total amount of savings necessary to have a stress-‐free purchase is the total cash costs plus sufficient
emergency reserves.
Cost to Own
[email protected] 949.769.1599 Page 11 of 17
How Much a House Really Costs
If you are leaning toward owning, it’s important to know how much the property will really cost to own. Most
people make emotional decisions about ownership without a careful examination of the costs. Any analysis is
usually slanted toward justifying a decision they already made. Therefore, the costs tend to be underestimated or
missed entirely, and the benefits are often exaggerated. Getting this right can make the difference between a
happy period of ownership and a soul-‐draining loss of income or even the house itself.
A useful way to look at the total cost of housing is to evaluate the monthly cost of ownership. An ownership cost is
any expenditure required for the possession of property. A working definition is important because there are many
hidden or forgotten costs people overlook. These costs are borne by owners and not by renters. There are 7 costs
to owning a house. Although some of these costs are not paid on a monthly basis, they can be evaluated on a
monthly basis with simple math. These costs are:
• Mortgage Payment • Property Taxes • Homeowners Insurance • Private Mortgage Insurance • Special Taxes and Levies • Homeowners Association Dues or Fees • Maintenance and Replacement Reserves
MORTGAGE PAYMENT
The mortgage payment is the first and most obvious payment because it is the largest. It is also an area where
people take risks to reduce the cost of housing. It was the manipulation of mortgage payments that was the focus
of the lending industry “innovation” that inflated the housing bubble. The relationship between payment and loan
amount is the most important determinant of housing prices. This relationship changes with loan terms such as the
interest rate, but it is also strongly influenced by the type of amortization, if any. Amortizing loans, loans that
require principal repayment in each monthly payment, finance the smallest amount. Interest-‐only loan terms
finance a larger amount than amortizing loans because none of the payment is going toward principal. Negatively
Cost to Own
[email protected] 949.769.1599 Page 12 of 17
amortizing loans finance the largest amount because the monthly payment does not cover the actual interest
expense. Interest-‐only and negatively amortizing loans proved so unstable during the housing bubble, they were
withdrawn from the mortgage market.
By far the best way to determine affordability of a financed home purchase is to compare the cost of ownership to
the cost of a rental. Most markets trade near rental parity levels because financially whichever is lower is generally
the better deal. As rents become
less than the cost of ownership,
many chose to rent, and when
the cost of ownership falls below
the cost of a rental, people chose
to buy.
PROPERTY TAXES
Property taxes have long been a
source of local government tax revenues. Real property cannot be moved out of a government's jurisdiction, and
values can be estimated by an appraisal, so it is a convenient item to tax. In most states, local governments add up
the cost of running the government and divide by the total property value in the jurisdiction to establish a millage
tax rate. California is forced to do things differently by Proposition 13, which effectively limits the appraised value
and total tax revenue from real property. Local governments are forced to find revenue from other sources.
Proposition 13 limits the tax rate to 1% of purchase price with a small inflation multiplier allowing yearly increases.
In California, the first half of regular secured property tax bills are due November 1st, and delinquent after
December 10th; the second half are due February 1st, and delinquent after April 10th each year. If the delinquent
date falls on a Saturday, Sunday, or government holiday, then the due date is the following business day. Often the
lender will compel the borrower to include extra money in the monthly payment to cover property taxes,
homeowners insurance, and private mortgage insurance, and these bills will be paid by the lender when they come
Cost to Own
[email protected] 949.769.1599 Page 13 of 17
due. If these payments are not escrowed by the lender, then the borrower will need to make these payments. The
total yearly property tax bill can be divided by 12 to obtain the monthly cost.
HOMEOWNERS INSURANCE
Homeowners insurance is almost always required by a lender to insure the collateral for the loan. Even if there is
no lender involved, it is always a good idea to carry homeowners insurance. The risk of loss from damage to the
house can be a financial catastrophe without the proper insurance. A standard policy insures the home itself and
the things you keep in it. Homeowners insurance is a package policy. This means that it covers both damage to
your property and your liability or legal responsibility for any injuries and property damage you or members of
your family cause to other people. This includes damage caused by household pets. Damage caused by most
disasters is covered but there are exceptions. The most significant are damage caused by floods, earthquakes and
poor maintenance. You must buy two separate policies for flood and earthquake coverage. Maintenance-‐related
problems are the homeowners' responsibility.
PRIVATE MORTGAGE INSURANCE
Mortgages against real property take priority on a first recorded, first paid basis. This is known as their lien
position. This becomes very important in instances of foreclosure. The first mortgage holder gets paid in full before
the second mortgage holder gets paid and so on through the chain of mortgages on a property. In a foreclosure
situation, subordinate loans are often completely wiped out, and if the loss is great enough, the first mortgage may
be imperiled. Because of this fact, if the purchase money mortgage (1st lien position) exceeds 80% of the value of
the home, the lender will require the borrower to purchase an insurance policy to protect the lender in event of
loss. This policy is of no use or benefit to the borrower as it insures the lender against loss. It is simply an added
cost of ownership. Many of the purchase transactions during the bubble rally had an 80% purchase money
mortgage and a “piggy back” loan of up to 20% to cover the remaining cost. These loan pairs are often referred to
Cost to Own
[email protected] 949.769.1599 Page 14 of 17
as 80/20 loans, and they were used primarily to avoid private mortgage insurance. There were very common
during the bubble.
In the aftermath of the housing crash, many mortgage insurers went out of business due to excessive losses.
Further, the insurance funds maintained by the FHA became dangerously imperiled. As a result, private mortgage
insurance costs rose significantly. Since private mortgage insurance is simply an add-‐on cost of paying the
mortgage, it can be looked on as an additional interest charge. An FHA loan may have a 3.5% interest rate, but
when the FHA insurance premiums are added, the effective interest rate rises to 5% or more. Avoiding the cost of
private mortgage insurance is a strong financial reward to those who can put 20% down.
SPECIAL TAXES AND LEVIES
Several areas have special taxing districts that increase the tax burden beyond the normal property tax bill. Many
states have provisions which allow supplemental property tax situations. The State of California has Mello Roos
fees. A Mello-‐Roos District is an area where a special tax is imposed on those real property owners within a
Community Facilities District. This district is established to obtain public financing through the sale of bonds for the
purpose of financing certain public improvements and services. These services may include streets, water, sewage
and drainage, electricity, infrastructure, schools, parks and police protection to newly developing areas. The taxes
paid are used to make the payments of principal and interest on the bonds.
HOMEOWNER ASSOCIATION DUES AND FEES
Many modern planned communities have homeowners associations formed to maintain privately owned facilities
held for the exclusive use of community residents. These HOAs bill the owners monthly to provide these services.
They have foreclosure powers if the bills are not paid. It is given the authority to enforce the covenants, conditions,
and restrictions (CC&Rs) and to manage the common amenities of the development. It allows the developer to
legally exit responsibility of the community typically by transferring ownership of the association to the
Cost to Own
[email protected] 949.769.1599 Page 15 of 17
homeowners after selling off a predetermined number of lots. Most homeowners' associations are non-‐profit
corporations, and are subject to state statutes that govern non-‐profit corporations and homeowners' associations.
MAINTENANCE AND REPLACEMENT RESERVES
An often-‐overlooked cost of ownership is the cost of routine maintenance and the funding of reserves for major
repairs. For example, a composite shingle roof must be replaced every 20-‐25 years. It may take $100 a month set
aside for 20 years to fund this replacement cost. Also, condominium associations often levy special assessments to
undertake required work for which the reserves are insufficient. In the real world, most people do not set aside
money for these items, which is a mistake. Most will attempt to obtain a Home Equity Line of Credit (HELOC) to
fund the repairs when they are necessary. Of course this assumes a property has appreciated and such financing
will be made available.
TAX SAVINGS
There are two other variables people often consider when evaluating the cost of ownership that is not included in
the prior list: income tax savings and lost down payment interest. When a borrower takes out a home loan, the
interest is tax deductible up to a certain amount. For borrowers in the highest marginal tax bracket, the savings
can be significant, and this can make a dramatic difference in the true cost of ownership. However, this benefit
diminishes over time as the loan is paid off and the interest decreases. Plus, contrary to popular belief, it is never
good financial planning to spend $100 to save $25 in taxes. Also, these benefits are almost universally
overestimated by people considering a home purchase. A renter considering home ownership will need to
remember they will be giving up the standard deduction when they itemize to obtain the Home Mortgage Interest
Deduction (HMID). A "married filing jointly" taxpayer will forgo a $10,700 deduction in 2007. This reduces the net
impact of the HMID. Anecdotally, even those in the highest tax brackets usually do not get more than a 25% tax
savings.
Cost to Own
[email protected] 949.769.1599 Page 16 of 17
HIDDEN SAVINGS
This is the forgotten benefit of a conventionally amortizing loan: forced savings. Most people are not good at
saving. The government recognized this years ago when they started taking money out of peoples salaries to pay
income taxes because they knew people would not do it on their own. People who become homeowners during
their lifetimes often have the equity in their home as their only source of retirement savings other than social
security. To accurately calculate the cost of ownership, this hidden savings amount needs to be deducted from the
total cost of ownership because this money will generally come back to the borrower at the time of sale. Since
taxpayers in the United States get a capital gains exemption up to $250,000, this savings amount does not need to
be adjusted for taxes.
OPPORTUNITY COST
Unless 100% financing is utilized, a cash down payment will generally be withdrawn from an interest bearing
account to purchase a house. The monthly interest that would have accrued if the down payment money was still
in the bank is a cost of ownership. This is perhaps the most overlooked ownership cost. For instance, if you are
putting 20% down on a $500,000 property, you will be taking $100,000 from a bank account where it would have
earned a return. If someone chooses to rent rather than buy, they would earn this interest income. Of course, this
earned income is also taxed, so 75% of this number is the net opportunity cost of a down payment.