Laurence Kotlikoff, What Should First-Time Home Buyers Consider When Choosing a Neighbourhood?

If you have children, the quality of schools is critical. But, in general, the question to economists, of which I’m one, is the expense of buying into the neighborhood compared to cheaper locations, which may also have lower property taxes, but longer commute times and be less safe. My company has a lifetime financial planning tool, at MaxiFi.com, that lets you set up separate profiles and compare what you’ll have to spend, on an ongoing basis, after meeting your housing costs in each neighborhood and, potentially, paying for private schools or tutors if the local school system is below par. You can also enter commuting costs into the profile and, of course, all housing expenses. If the neighborhood’s location impacts where you’ll work and how much you’ll earn, you’ll enter that as well. Whether it’s MaxiFi.com or some other tool, the key is to understand the tradeoffs. If I move into the hottest neighborhood in NY in a cramped efficiency, with high mortgage, condo fees, and tax payments, what will I have to spend on everything else. If I don’t know that free discretionary spending number and what it is at another location, I can’t intelligently choose between the two.

How do you know that you are financially ready to buy your first home?

Easy. You just compare your discretionary spending if you buy the home now or wait X years to buy it. In MaxiFi Planner, you’d set up two profiles, one where you buy the home now and one where you rent at, presumably a low price, for Y years and then buy. You run each and compare your discretionary spending after you’d met the different housing and other off-the-top costs, like taxes.

What do you recommend as the minimum down payment for a first-time home buyer?

This, again, comes down to what discretionary spending will be if you put down a larger downpayment. No rule of thumb will get this right. You need to set up alternative profiles, which consider different sizes of down payments and their different mortgage payments, and see the precise discretionary living standard hit of a larger downpayment. MaxiFi and any other decent spending tool incorporates cash/borrowing constraints. So it will show you that if you put a lot more money down, your living standard may need to be lower for many years. A decent tool will also help you evaluate paying points, which can, as I’ve found, often be a good deal. Here you’d set up two profiles and compare the discretionary spending (both annual and lifetime) from taking a mortgage with and without points.

How can federal, state and local policymakers responsibly and effectively increase home affordability, particularly for first-time home buyers?

What we need is a more progressive tax system. We shouldn’t be trying to make peanut butter more affordable for young people. We should be trying to ensure they are treated fairly by our tax-transfer system and then let them decide whether to buy peanut butter or nutella. Otherwise, someone will argue we need to subsidize first-time BMW buyers. I think we should also levy a federal tax on foreign purchasers of U.S. homes and condos if they don’t spend most of the year in the U.S.

 

Methodology

To determine the most favorable housing markets for first-time home buyers, WalletHub compared a sample of 300 U.S. cities (varying in size) across three key dimensions: 1) Affordability, 2) Real-Estate Market and 3) Quality of Life.

We evaluated those dimensions using 27 relevant metrics, which are listed below with their corresponding weights. Each metric was graded on a 100-point scale, with a score of 100 representing the most favorable conditions for first-time home buyers. Data for metrics marked with an asterisk (*) were available at the state level only.

Finally, we determined each city’s weighted average across all metrics to calculate its overall score and used the resulting scores to rank-order our sample. Our sample considers only the city proper in each case and excludes cities in the surrounding metro area. Each city was categorized according to the following population-size guidelines:

  • Large cities: More than 300,000 people
  • Midsize cities: 150,000 to 300,000 people
  • Small cities: Fewer than 150,000 people

Affordability – Total Points: 33.33

  • Housing Affordability: Triple Weight (~14.28 Points)
    Note: This metric was calculated as follows: Median House Price / Median Annual Household Income.
  • Average Cost of Homeowner’s Insurance*: Full Weight (~4.76 Points)
  • Cost of Living: Full Weight (~4.76 Points)
  • Cost per Square Foot: Full Weight (~4.76 Points)
    Note: This metric measures specifically the median list price per average home square footage.
  • Real-Estate Tax Rate: Full Weight (~4.76 Points)

Real-Estate Market – Total Points: 33.33

  • Rent-to-Price-Ratio: Double Weight (~4.44 Points)
  • Housing-Market Health Index: Full Weight (~2.22 Points)
  • Share of Homes Sold in One Year: Full Weight (~2.22 Points)
  • Median Home-Price Appreciation: Double Weight (~4.44 Points)
  • Foreclosure Rate: Full Weight (~2.22 Points)
  • Share of Mortgage Holders with Negative Equity: Full Weight (~2.22 Points)
    Note: This metric measures the proportion of mortgage holders whose balance on mortgage is higher than the value of homes.
  • Buy vs. Rent Breakeven Horizon: Full Weight (~2.22 Points)
    Note: The “breakeven horizon” is defined by Zillow as the point, in years, at which buying a home becomes less expensive than renting the same home.
  • Share of Listings with Price Cuts: Full Weight (~2.22 Points)
  • Share of Housing Units Built between 2010 and 2017: Full Weight (~2.22 Points)
  • Building-Permit Activity: Full Weight (~2.22 Points)
    Note: This metric measures the number of unit permits pulled per 1,000 residents.
  • Mortgage Lenders per Capita: Full Weight (~2.22 Points)
  • Real Estate Agents per Capita: Full Weight (~2.22 Points)
  • Homeownership Rate for Millennials: Full Weight (~2.22 Points)

Quality of Life – Total Points: 33.33


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Sources: Data used to create this ranking were collected from the U.S. Census Bureau, Bureau of Labor Statistics, Council for Community and Economic Research, U.S. Department of Housing and Urban Development, Zillow, Federal Bureau of Investigation, Insurance Information Institute, AreaVibes, Renwood RealtyTrac and WalletHub research.

Image: Dean Drobot / Shutterstock.com