Vertical portrait of a mixed cheerful family posing at camera
December 2020

You Can’t Afford Not to Own a Home in Santa Cruz

By Sebastian “Seb” Frey

Vertical portrait of a mixed cheerful family posing at cameraIn the column I wrote last month for Growing up in Santa Cruz, I shared a lot of information that would-be Santa Cruz homebuyers need to know right now. Yes, the market is hot, and prices are up…but what else is new? I’ve been a Realtor in Santa Cruz since 2003, and while I can say that this market is more difficult for buyers than any market I have known – it’s not that much harder. People – people who are not so different than you – are buying homes every day in Santa Cruz, and if you’re planning on staying here, I recommend that you make buying a home a top priority.

I know what you’re saying – real estate in Santa Cruz is so unaffordable! And that is very true. It has been true, for a very long time. Without researching the very latest statistics updated for Q4 2020, I can tell you that Santa Cruz has the lowest affordability of just about any county in California. I’ve read a number of articles over the past few years showing that Santa Cruz actually has the lowest affordability in the country, and one of the lowest in the entire world. Yikes!

But just how unaffordable is Santa Cruz County?

Last I checked, it had been determined that only 12 percent of Santa Cruz households could afford the median-priced home, assuming a 20 percent down payment. With the median price recently up over $1 million, that means a $200K+ down payment. Do 12 percent of households even have $200K to put down on a home? I’m not so sure.

But how do “they” determine that someone can afford a home?
It’s a function of your debt-to-income (DTI) ratio. A home is considered “affordable” if the monthly cost (loan principal repayment + interest + property tax + insurance, or PITI), plus your existing debt service costs (student loans, car payment, credit cards, etc.) is less than 36 percent of your gross monthly income.
As an example: if your household income is $100,000 per year, that means you’re making $8,500 per month (pre-tax). 36 percent of $8,500 is $3,060 – so if you had no debt, your maximum all-in monthly mortgage payment would be $3,060. However, most people carry some amount of debt. If your debt service costs are $500/month, that means your maximum mortgage payment would be $2,560 per month. So now the question is, how much home would be “affordable” for you?
To answer that, I broke out my trusty mortgage calculator. With a $480,000 purchase price and 20 percent down, you’d have a loan amount of $384,000. Assuming a 2.5 percent mortgage interest rate, you’d have a payment of $2,043 per month which includes $1,517 for principal + interest, $460 for property tax, and $67 for insurance. These are rough numbers, of course, but they give you an idea of how mortgage qualification works.

Obviously, $480,000 does not buy a lot of home in this town. It is important to understand a few more things, however.

Most lenders do not have a maximum DTI of 36 percent. In fact, it’s more common that a maximum DTI for a conventional loan is in the neighborhood of 43 percent. Depending on your credit score and the type of loan you’re applying for, your max DTI could be 50 percent, or higher.

And, as I mentioned in last month’s column, most Santa Cruz homebuyers don’t put 20 percent down. It’s very common for first time homebuyers to put down 3.5 percent to 10 percent on their homes. And yes, most sellers will be happy to help you pay your closing costs, with a sufficiently high offer.

Let me guess: your eyes are watering. For a lot of you, these are going to be staggering, and seemingly insurmountable, numbers. You may be thinking there’s no way you will ever be able to afford to buy a home in Santa Cruz.

And now we come to the tough love part of this column.
If you plan to stay in Santa Cruz for the long term, the truth is: you can’t afford not to buy a home in Santa Cruz. That’s because renting a home in perpetuity in Santa Cruz is a ticket to poverty. There may be a certain romanticism that goes along with being broke at age 30, but at age 60, it’s practically a crisis.

According to a U.S. Federal Reserve study completed in 2016, homeowners in the USA enjoy a net worth that is 45 times greater than renters. You read that right! The net worth of renters in the study was $5,200 – but the net worth of homeowners was $231,400.

Of course, buying a home isn’t going to add $226K to your net worth overnight. But here’s how to understand the impact of homeownership vs. renting over time. When you buy, you are locking in your monthly housing cost, which will rise over time but at a rate far lower than the rate of inflation. When you rent, over the long term, you can expect that your rental costs will rise right along with inflation. Let’s examine what that looks like, after just 10 years.

Year 1
Mortgage Payment (PITI):
$3,000 ($559K loan @ 2.5%, $700K purchase price)
Rent Payment: $3,000

Year 10
Mortgage Payment (PITI):
$3,250 ($418K loan balance, $896K Fair Market Value)
Rent Payment: $3,840
Equity Accumulation:
$337,000 ($141,000 mortgage pay-down + $196,000 appreciation)
Saved Rent vs. Mortgage Payment: $51,500 (estimated)
Total Advantage Owning vs. Renting: $388,500

I’ll give you the standard caveat emptor, which is that these numbers are approximate and the assumptions going into them will change over time. Interest rates will change, as will the rate of appreciation. It’s worth noting here that for purposes of this exercise, I assumed an appreciation rate of only 2.5 percent per year (the same rate as I used for inflation). If I change that assumption to say that home prices rise 4 percent per year on average over 10 years, the $700K home is then worth $1,036,171 after 10 years and the total increase in your net worth would be $528,671.

As I hope should be clear, renting a home in Santa Cruz for the long haul is an exceedingly expensive proposition, compared to buying a home. While the path to homeownership may not be one you’re ready to take today, you owe it to yourself – and your kids – to get on it as soon as possible.

Realtor Seb Frey is the author of the book Get It Sold! Besides selling houses, he gives seminars on important issues for homeowners and does a podcast, and has TV Channels, on Instagram and Facebook. Learn more on his website and reach him at [email protected]

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