As we head into the Spring home buying market, first time home buyers in the Chicago area and throughout Illinois will be making their first tentative steps toward buying a home of their own. It’s conventional wisdom that buying a home makes sense, even now with all the bad news on the housing front. But the question is, does owning a home make sense for you? Some of the reasons you might want to buy are more intangible but emotionally compelling – the pride of having a place of your own, a chance to establish your roots, the joy of having a real home where you can express your own personality and style. These are real reasons for buying your first home. But the some of the best reasons to buy may be financial. In fact, buying a home may be the smartest financial decision you will make in your lifetime.
You know some of the reasons to buy, rates are low and it is a buyer’s market. But the reasons to buy a home go beyond that. If you are a first time home buyer, thinking about buying your first home, you need to know what the advantages of buying are, and how buying a home compares to renting. There are three prime financial benefits of home ownership:
Let’s look at principal reduction. First of all, a quick explanation – with most mortgages each payment is divided into two portions, principal and interest. Interest is the lender’s profit, the amount they charge for the use of their money over the time you hold the mortgage. Principal is the amount of the mortgage you are paying back each month.
Interest is charged on the outstanding loan balance each month. This means that in the beginning years, you are paying mostly interest. But with each payment you make you pay off a little more of the principal, and the loan balance goes down a little more each month. This doesn’t seem like much at first, but it adds up over time.
Let’s say you borrow $200,000 with a fixed rate mortgage at 5.75% interest over 30 years. That means your mortgage payment each month is $1,167. On your first payment, about $958 will go to pay the interest, and just over $208 will go toward the principal, or paying back the loan. That means after one payment, your loan has been reduced by $208 to $199,791. The next month’s payment is based on 5.75% of the new balance, so your interest portion goes down, and the principal payback goes up a little more.
Each month a little more of your payment goes toward reducing your principal, and you pay little less toward interest. If you stay in this house, and this mortgage, for the whole 30 years, you will off the entire mortgage and you will own the home free and clear.
In the early years, you are paying off mostly interest, and chances are you won’t be in that same home 30 years from now (Even if you are, odds are you won’t be in the same loan. Refinancing your mortgage is a way to tap into the equity you’ve built up). Principal reduction is a benefit, but there are other, bigger, advantages to home ownership.
I’ll cover these benefits of owning in my next posts.