Real Estate Matters
Think 'Dream Location' More Than 'Dream House'
Q: My primary residence is under contract and I am trying to make a wise decision around my next home purchase. I am trying to decide if I should purchase a "dream home" that I could see myself living in for many years, or a much less expensive home that I could pay for with cash, live in a few years and then turn into my first rental property.
The interest rate for a loan for the dream house is less than 5 percent, and I would put 20 percent down. I can afford the nicer home, but I wonder which scenario is better for me in the long term financially. I know ultimately this is a personal lifestyle choice, but I am interested in your opinion from an investment standpoint.
A: I think it's tough to look at investing in real estate unless you simply look at the dollars and cents.
Certainly, if you can put down 20 percent and the house is affordable with a super-low 30-year, fixed-rate loan, and you plan to stay there for seven to 10 years, then you should buy the house you want to live in for that amount of time.
In terms of affordability, we won't see these low prices again for a long time. And you will get the benefit of living in the home of your dreams for years to come. There's a value to you to living in that home, but that may not make it the best decision strictly on the basis of investment potential.
Over time, you'll do better by purchasing your "dream house" -- or, rather, your "dream location" -- with maybe a nice enough house that you can get at a particularly great price and fix up over time. The smartest thing you can do is to buy the best location you can afford.
If you're looking purely for investment, then you have to look at a neighborhood where you can buy a property and finance what you can without paying through the nose in fees and interest expenses and then generate a fair amount of income from it once you decide to move on. Again, location is important, but you should also consider how easy it would be to rent the property, who could afford it and how you would find your renters.
Finally, you need to evaluate whether you could earn enough money from the rental of the property to justify the monthly expenses. If real estate values were to remain flat for some time, would that investment pay off over time with rental income that increases over the years? Or would you need to rely on appreciation to make the investment work out?
If you can't answer those questions to your satisfaction, you're better off buying a home that you'll love and enjoy.
I read your recent article about the IRS rules regarding the $8,000 first-time home buyer tax credit. I understand that the deal cannot be between close kin. However, if our son (age 22) buys a home for $100,000, and we as parents provide $100,000 cash for the deal, is our son still eligible for the $8,000? Actually, the cash we provide would be temporary. He would then get a mortgage on the property on which we would co-sign. The house would always be titled in his name only. The reason I am considering this is to close a deal quickly, if needed. This would be like a bridge loan, so I am hoping we could avoid gift tax issues too.
I believe that your son could buy the property alone or your son could buy the property with you and still qualify for the $8,000 tax credit. The IRS rules state that, while you might have owned a home during the last three years, your son can't have owned a home during that time period and his modified adjusted gross income must be less than $75,000. Above that amount, the tax credit starts to phase out.
Be sure to talk with a tax expert to make sure your son isn't disqualified for another, undisclosed reason. You might also think about simply giving your son a low-cost loan (with signed paperwork) to make it clear that you're the lender. That way you would benefit from receiving interest payments from your son, which would be higher than what you might be earning at the bank, and your son would get the mortgage interest tax deduction on those same payments.