Hello Ladies and Gentlemen, Welcome to Part I: Renting vs Buying a Home of my 4 part series Economics made Simple by Malik. With my blogs, I always like to set the tone of the post so there is no misunderstandings about what this post is about. The series will cover the following topics:

1. Part I: Renting vs Buying a home
2. Part II: Why Can’t I Make Ends Meet?
   (How I found the Austrian School of Economics)
3. Part III: Saving Money vs Serfdom
4. Part IV: Casino Capitalism

There is a lot of information in this post so for the sake of time I’ve chopped up the blog into sections. Feel free to jump to any section you want. For you convinence I’ve added “back to top” links that will send you to the Table of Contents. Enjoy!

Table of Contents

1. Malik’s home buying story
2. What you need to buy a home
3. Why are we selling our home?
4. Conclusion
5. Home buying tools and resources to help you buy your house

What this ISN’T, plain and simple:

1. Some get rich quick scheme where after you read this blog series you will become a mega-quadrillionaire in 24 hours. (BTW, no matter what you see on the lackof-Infomericals at 2am, there is no program that will turn you into a millionaire without hard work, thinking rationally, and the proper financial plan.
2. A forum for me (Malik) to spew some ideological financially driven nonsense while making myself feel good
3. A place where you will learn how to build a particle transporter, find out if aliens really exist, or whether there was some hidden plot for the U.S to fake landing on the moon

However, what this IS about:

1. A place where you will get practical advice on day-to-day financial concerns.
2. A place that serves as a spring board into understanding more complicated financial matters, which you will inevitable encounter throughout your life. Consider this series the beginning of the ginger bread path.
3. Remove some of your fears about the word “economics”. Understand that the economic world around you has every bit to do with your own life.

So what is economics anyway? By definition it is the following:
The social science that deals with the production, distribution, and consumption of goods and services and with the theory and management of economies or economic systems.

For the sake of this discussion I would like to call this “Personal” or “Household” Economics. Envision yourself as a small country. Your house is the country, the people in your house are the citizens, and the companies (Supermarket, clothing stores, car companies, dry cleaners, banks, etc) are other countries that you do business with. Your job is what you export/produce, and what you buy (products that you haven’t created yourself) are your imports. The capital (salary) you bring into your home annually is your GDP (Gross Domestic Product). As you can clearly see, you are a microcosm of a large country or continent. Put together all those little personal economies and you have a nationally economy. All the decisions that we do on a day-to-day basis impact the overall performance of the economy.

Malik’s home buying story

So back in 2005 I was living in Brooklyn, Williamsburg to be exact. Now known as hipster/heroine capital of New York. At the time I was paying about $800 a month. Towards the end of 2005 I was ready to move out and a good friend of mine was selling the Coop that I live in now. He said to me, “Well bro, if you got 20K cash I can get you into the Coop. I’ll give it to you at a discount because I’m saving tons by not going through a real estate broker”. From my perspective the deal was perfect. I’ll be a home owner, no more throwing rent money out the window, and I can do whatever I feel like to the apartment (break walls down, add new appliances, redo the bathroom/kitchen, etc). Normally, the Coop organization will ask for about 20% down, but because I was a first time buyer, and my salary was pretty descent, I only had to put down 10% (Later on I realize this was somewhat of a mistake, but not a deal breaker. Should have put 20% down. I’ll explain why later)

Before I get into the crux of renting vs buying a home, I have to give you bit of background information. Presently, my wife and I own a 1 bedroom Coop (An apartment that is treated like a house with a mortgage) in the Bronx. The Coop was purchased in 2005 for $175,000. Today, the value of the Coop is roughly 250K or more. If you include the amount of equity (Amount of the value of the house in 2005 minus the remainder of the loan in 2009) we have in the house, we should walk away with roughly 100K or more. So that is an increase in house value of about 75K over 3 years and 8 months. If I calculate the yield that is roughly 10% a year. Pretty good, even for the NYC national house appreciation averages. Considering I bought a piece of real estate in one of the most inflated real estate markets in history, not to mention during one of the worst financial collapses in history, while walking away with a profit, is not that bad. At the same time, had I not gone through a hook-up, I would have overpaid for a similar 1 bedroom Coop by about 15-20K. For my financial circumstances and situation, it really was the deal of the century. I was able to get into the home ownership world with no red tape, no hassle, and minimum upfront expenses. All I had to pay was the lawyer and closing fees. In addition, I could stem the financial bleeding of rent. That is money out the window that I would never ever see again. Had I rented the $1000 a month 1 bedroom (this is what I was about to rent until my friend came to me) the total in lost savings from rent would have been $52840. Here is the breakdown of what I would have paid with assumed rent increases because the apartment was not rent stabilized:

$12000 $1000 (year 1)
$12840 $1070 (year 2)
$13560 $1130 (year 3)
$14400 $1200 (year 4)
————
$52800

I would have thrown away almost 53K out the window. Not so fast ladies and gentlemen. This is true but we are not done yet. I never calculated the cost of Coop maintenance which is the fee you pay to maintain the building roof, landscaping, certifications, lobby, super who manages the building, etc). That was $470 a month which brings my maintenance costs for 3 years and 8 months to about $20,680 dollars. Now I have to minus that from the potential 100k profit (the amount I should walk away with after I sell my house [including closing fees). Now I'm left with around 80K. yes when i sell the house I'll still walk away with roughly 100K but I'm trying to calculate my TRUE profit margin.

What you need to buy a home

Whew!, lots of numbers. Are you still with me? I hope so. Lets remember that buying a house CAN be an investment. It's no different than any other investment. You have to know how much money you are putting in and get a sense of what your potential return is. Clearly during the last 3 years. Americans have spent a substantial amount of effort turning their houses into big fat credit cards by squeezing equity out of their homes without re-investing that equity back into the house. Bad idea. I'm going to split this section into three areas.

1. Prerequisites for buying a home: 20-30-10 Rule
2. Descent credit
3. Steady income
4. Benefits of buying a home
5. Benefits of renting
6. Patience

Prerequisites for buying a home: 20-30-10 Rule

My 20-30-10 rule is 20% down, the mortgage (no interest) should be no more than 30% of your take home pay, and you should have at least 10% of the value of the house in cash in some bank account. Yes this is after you put the 20% down on the house. So one of the biggest prerequisites for buying a home is to have 20% down. As I sated earlier I put 10% down, because at the time I didn't have the 20% and it was not worth passing up on the opportunity to own a Coop that was marked down 15%. From my perspective I started with a bit of equity from the beginning by getting the Coop at a discount. In addition to that, I had a steady income and enough disposable income to make extra payments each year on my mortgage so I don't get hit with too much interest from the additional 10% that I didn't put down. I also did something that no financial adviser would suggest any of their clients doing which is borrowing from your 401K. You are allowed to borrow from your 401K to buy a home, but if you leave your job before you pay back the full amount, you have two options:

1. Pay back the full amount.
2. Pay taxes on the amount you borrowed come tax time.

Now keep in mind that the 20-30-10 rule is a GENERAL guide. Meaning you can be flexible on the rule, but don't be so flexible that you bend the branch so far that you snap it in two. In my conclusion I'll explain why I broke just about every rule in the book when it comes to buying a home but it's all about your situation. Everyone has different circumstances and what works for me, might not work for you. You have to be smart enough to weigh the pros, cons, and risks of your decisions. There is no book or personal finance guru that will be able to give you the exact answer to you home buying choices. In the end, its up to you to weigh all the pieces to your home buying puzzle and put them together.

Descent credit

What does it mean to have "descent credit" in regards to buying a home? Descent credit means a FICO score that is at least above 700. If you don't know what a FICO score is, then go here and here. This number will impact how much you are able to borrow and how likely (risky) a financial organization sees you in regards to your potential to pay back the organization.

Steady Income

Make sure you have a steady income. Don't do things like "hope for the best" or "hope for a raise" that is supposed to give you the financial wherewithal to buy a home. Buying a home is a huge responsibility. This is not a game. A home is not one big credit card or some asset that you can use to hypothetically create unrealistic lines of income. You should make enough that you can pay for the mortgage, utilities, other monthly expenses, and you better make sure you can SAVE at least 5% of your take home income. I'm really leaning on 5% as the "I don't have a choice in the matter", but you should be shooting for 10-15% of your take home pay.

Benefits of Buying a home

This is pretty easy. First off, you are not throwing money out the window like rent and every payment you make towards your mortgage is just building more equity into your house. Second, owning real estate is one of the fastest ways to increase your net worth and build up your credit rating. (of course that is assuming you pay your mortgage on time, make extra payments a year, and didn't pay too much for the house, and it is likely that the house will appreciate in value). Unlike renting, you can use the equity in your house to re-invest in other money increasing investments. Notice how I said "money increasing" investments. Not clothes, sending your kids to private school, buying a car, or a flat screen or some depreciating asset that will erode what you just borrowed which is the equity in your house.

Benefits of Renting

Most times if somebody is renting, it's not by choice, unless you are Peter Schiff. Peter Schiff mentions some good points. He basically saying that he can utilize the mortgage and associated costs of a house better, by investing that money. There is something to say for all the overhead the comes with buying a home, not to mention the ridiculous maintenance fees that come with buying a Condo or a Coop. In New York, the real estate market is way more stable than the rest of the country, not to mention it's one of the hottest real estate markets in the world, but it's the exception. Renting has many perks. One plus is piece of mind. All the maintenance of the building, including the room you are renting is taken care of by the owner. The only unfortunate part of renting is the money you pay is money lost, but it depends? When you think about how many people are going under in their own homes, it makes you wonder whether those individuals should have rented in the first place. Renting is also a good option, if not the only option to use when you don't have enough money to buy a home. I don't think it's wise to rent indefinitely but it serves as a good pit stop before you can sum up the courage to buy a home, if that is your plan.

Patience

Before you cut that check to buy your first home make sure you have spent the necessary time researching all your buying and renting options, that you understand what a mortgage is and your financial obligations towards that potential house. Too many people get bit by the "He or she has a house, why not I?" or "It's the American dream" bug and do very little research resulting in financial ruin and sometimes bankruptcy. I've said this over and over in this post, do the proper research so you know what you are doing. Walking into a contract that's hundreds of thousands of dollars is not a small thing. Weigh all your buying and renting options before you take the plunge.

Why are we selling our home?

This past April we had a son (Saud) which means we need more space. For the past 2 months we have been looking to buy a 2-3 bedroom house, but there are a whole host of circumstances that played into why I bought the first Coop in 2005.

One other very important reason that started the whole decision of looking for a new apartment (prior to Saud being born) was getting out of an interest bearing mortgage. In Islam, interest (usury) is prohibited. Whether you are taking it or paying for it. So the plan is to so sell the house, releasing us from the interest and use an Islamic bank. Now you are probably asking, "Um, how does the Islamic bank make money if there is no interest?". Well in Islam you cannot make money off of money. [Don't worry, I'll be short because I know you want to finish this blog post] Very similar to an interest bearing mortgage a non-Islamic and Islamic bank actually start off the same way. They both cut a check for what you are borrowing from the bank, but the difference with an Islamic bank is they buy the house then add their profit on top of the house which you pay for 15 to 30 years. Here is a simple scenario:

1. House is 200K
2. I put 20% down, 40K
3. Islamic bank buys the house for the remainder, 160K
4. Bank calculates what I should pay based on future appreciation values, the current housing market, etc.
5. They say, “Hey we will sell this house back to your for 280K.”
6. They chop up the 280K over 30 years and that would be my monthly mortgage. It doesn’t matter how much interest rate fluctuate because there is no interest, just fixed payments of the agreed upon amount.

Here is another scenario, know as Ijara with diminishing Musharaka:

1. House is 200K
2. I put 20% down, 40K
3. Islamic bank buys the remainding share of the house, 160K
4. Islamic bank now owns 80% and I own 20%
5. The Islamic bank chops up my 160K over 30 years.
6. As I pay down the mortgage I increase my share of ownership.
7. Let’s say 10 years go by, and I’ve paid 60K in payments which means there is 100K of value that I own and 100K from the bank.
8. So the shares have changed, it’s now 50% and 50%. Let say the value of the house is now 350K
9. If I sold today, me and bank would split the profit by 50%. The total profit is 150K. Each of us would get 75K out of the deal
10. As you can see the house is treated as a true partnership. As I buy more shares I get more profit.

Conclusion

As you can see in 2005 I pretty much broke every rule in the book, but rules are made to be broken ONLY if you know the amount of risk you expose yourself to when you break the rule. In 2005, from my perspective, all I needed was about 6 months more to cover the remainder of what I borrowed from my 401K. As I stated earlier, I made a descent amount of money so I could afford the risk. I knew I wasn’t going to be jobless in 6 months, so I was at least okay in regards to my 401K loan obligations. It was not worth passing up on home ownership because I did not have the 20% I would have liked to put down, not to mention the house was being sold at a 15%-20% discount, fully furnished too. The owner sold me everything, so I did not have to deal with the burden of buying new furniture, tvs, appliances, etc. All I had to do was literally move in. All I had was a room of stuff from my Brooklyn apartment. A bed, some bedroom furniture, my weight set, and some clothes.

In regards to my 30-20-10 rule I broke 2 out of 3 rules in 2005. I broke the 20% down rule and I broke the mortgage should be no more than 30% of your take home pay. I think it was somewhere around 35%-40% at the time. I put 10% instead of 20% down. So how is that I broke my own rules but yet remained on solid financial ground? Remember what I said earlier. These rules are flexible, as are many rules in life. I didn’t bend my financial branch so far that it snapped. I needed a bit more wiggle room and I used it to my advantage. An example of snapping the branch is someone who puts 5% down and the mortgage is 60%-70% of their take home pay with less than 5% saving of your take home pay. Not only would this person have snapped the branch in half but they put the branches in the fire never to be seen again.

If there is anything that you should get out of this post is this. There is no clear cut straight answer to most problems, especially home buying. You have to weigh your personal situation, preferences, willingness to compromise, financial intelligence, practicality, and common sense to know whether you can or should buy a home. As you can see there were a multitude of things that I had to take into an account. A lot of it had to do with my financial situation, but one nice benefit is the neighborhood I live in is nice and very quiet. Young aspiring families, multi-cultural with access to the city in less than 40 minutes. You can’t beat that. Good luck on you home buying /renting travels and if you have any questions hit me up on Facebook. Just search for Malik Oxford or go here

Tools and Resources

• Home affordability calculator:
  http://homeloans.bankofamerica.com/en/home-loan-experience.html
• Buying vs Renting calculator
  http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html
• Home appreciation calculator
  http://www.moneytoys.com/home-sellers-profit-calculator.php
• Time to tackle the real evil: too much debt
  http://www.ft.com/cms/s/0/4e02aeba-6fd8-11de-b835-00144feabdc0.html
• Jackson’s Money Woes Can Teach Us About the Dangers of Entitlement
  http://www.washingtonpost.com/wp-dyn/content/article/2009/07/01/AR2009070103640.html?nav=rss_opinion/columns
• Less pay, same mortgage payment
  http://money.cnn.com/2009/08/06/pf/pay_cut.moneymag/index.htm?section=money_pf
• Bakes hereself out of financial ruin
  http://www.huffingtonpost.com/2009/07/28/woman-bakes-herself-out-o_n_246417.html

Other posts in this series

1. Renting vs Buying a Home (This post) (August 10, 2009)
2. Why Can’t I Make Ends Meet? (Redux) (September 28, 2009)
3. Saving Money vs Serfdom (October 6, 2009)
4. Casino Capitalism (February 28, 2010)

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