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Should You Buy a Starter Home as a First-Time Home Buyer?

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Shopping for your first home can be a bit discouraging, especially in a hot housing market like Boston or the San Francisco Bay Area. In these areas, even modest single-family homes commonly sell for upwards of half a million dollars. For many Millennials, even raising the down payment on a house that expensive seems like a pipe dream.

If you’re in this position, the key to owning your dream house one day could be to buy a home that isn’t your dream house right now. By making your first home purchase an inexpensive “starter home,” you can build up equity that you can cash in to buy your “forever home” a few years down the road.

Buying a starter home is a common strategy for first-time home buyers seeking to break into the housing market. However, some experts caution that it’s not the right decision for everyone. Depending on your situation, you may be better off continuing to rent and saving up your money until you’re ready to take the plunge on your forever home.

Here’s what you need to know about the pluses and minuses of buying a starter home and how to decide whether it’s the right move for you.

Types of Starter Homes

Attached Homes Townhouse Trees

A starter home needs only one key feature: a list price that’s well below the average for your area. There are several types of homes that fit into this category, including:

Attached Homes

Any attached-unit home, which shares at least one wall with another home, is likely to cost less than a stand-alone house. This category includes condos, townhouses, co-ops (a form of cohousing), and semi-detached homes, such as half of a duplex.

Small Houses

Some stand-alone houses are priced below average because they’re too small for most families. With the average size of new U.S. homes at 2,426 square feet, according to the U.S. Census Bureau, houses as large as 1,500 square feet can be considered small houses. The most extreme examples are tiny houses, which have no more than 400 square feet of space and cost much less than full-sized homes.

Fixer-Uppers

Other houses sell for less than average because they’re not in the best condition. Buying one of these fixer-uppers and sprucing it up can be a great way to build equity, especially if you’re able to do the repairs yourself. However, renovating and repairing a fixer-upper takes a lot of work and often a lot of money, so you need to think it through carefully before making a house like this your first home purchase.

Homes in Less Desirable Areas

Finally, some houses are priced below average because of their location. Less desirable locations include high-crime neighborhoods, areas with subpar school districts, and suburban homes with a long commute into the city. However, depending on your situation, these “undesirable” locations might not be a problem for you. For instance, the school district doesn’t matter if you don’t have kids and don’t plan to have any soon, and a lengthy commute isn’t an issue if you’re a freelancer who works from home.

Advantages of Starter Homes

Rising Home Prices Scissor Paper Houses

The main advantage of buying a starter home is that it helps you get your foot in the door of the real estate market. When you buy a home, a portion of each monthly mortgage payment goes toward building up equity – that is, the share of the property that belongs to you. A few years down the road, you can sell the house, cash in that equity, and put it toward the purchase of your forever home.

Here are some of the specific things buying a starter home can help you do.

1. Cash In on Rising Prices

Normally, building equity in a house takes a long time. When you first start making mortgage payments, most of each payment goes toward interest on the loan, with only a small portion going toward equity. However, if you live in a hot housing market where prices are rising steadily, it’s a different story. From the very first day you buy it, the value of your new starter home will increase, and your equity will rise along with it.

A 2018 study by GOBankingRates identified 20 U.S. cities where home prices had risen by more than 10% in the previous year. If prices continue to increase at that same rate, a $200,000 home purchased in one of those cities today could be worth over $322,000 in five years. That would give you an extra $122,000 to put toward the purchase of your forever home.

If you live in one of these hot housing markets, buying a starter home is your best chance to get in on the ground floor and put those rising prices to work for you. If you sit on the sidelines and wait until you can afford your dream home, there’s a risk that skyrocketing home prices will outpace your income growth, keeping your dream just out of reach.

2. Take Advantage of Low Interest Rates

As of September 2018, the average interest rate for a 30-year mortgage was 4.9%, according to Bankrate. That’s higher than it was just a year ago but still relatively low by historical standards.

Buying a starter home now gives you a chance to become a homeowner and start building equity while it’s still fairly affordable. If you wait a few years to buy your forever home, rates could be much higher, and your dream home might no longer fit your budget.

3. Save on Expenses

Starter homes aren’t just cheaper to buy; they’re also cheaper to own. Several types of expenses are lower with a starter home, including:

  • Property Taxes. The amount of property taxes you pay usually depends on the value of the property. Thus, the cheaper your house, the smaller your tax bill.
  • Utility Bills. Because starter homes are usually smaller than average, they cost less to heat and cool. That helps you save on your utility bills.
  • Maintenance. Unless you buy a fixer-upper, your starter home is likely to have lower maintenance costs. That’s because you’ll simply have less space to maintain: a smaller roof, a smaller yard, and smaller rooms.

The money you save on these expenses can go into your house fund, ready to help you purchase your forever home.

4. Resell When You’re Ready

When the time comes to sell your starter home, you can be pretty confident of finding a buyer quickly. There’s always plenty of demand for starter homes since they’re such a popular choice for first-time home buyers.

According to Trulia, competition for a dwindling supply of starter homes caused the median list price for these homes to rise by nearly 10% between 2017 and 2018. If this trend continues, you should have no trouble selling your starter home after a few years for a tidy profit.

Disadvantages of Starter Homes

Wooden Home Cash Bag Outdoors

Despite the advantages, buying a starter home isn’t a no-brainer. There are some problems involved in any home purchase, plus a couple of other problems specific to starter homes.

1. Higher Cost Than Renting

Although starter homes are cheaper than larger homes, they still cost more than many rentals. According to Trulia, the mortgage payments on the average starter home in 2018 would eat up over 40% of the average first-time buyer’s income. On top of that, owning a house comes with costs that renting doesn’t, such as property taxes, maintenance, homeowners insurance, and possibly higher transportation costs if you move out to the suburbs to find a house you can afford.

Add up all these expenses, and the monthly cost to own a starter home could be quite a bit more than you’d pay to rent a home of similar size. You might be better off continuing to rent and investing the extra money so you can put it toward your forever house later on.

2. Limited Choices

The high demand for starter homes means you don’t get a lot of choices when buying one. Trulia notes that even as prices for starter homes have risen, their quality has declined. The average starter home today is smaller, older, and more likely to be in need of repair than it was six years ago.

It’s also hard to find starter homes in the most desirable neighborhoods. Buying one could force you out into the suburbs away from your job and your friends. This, in turn, could add up to a much longer commute and possible social isolation, two major sources of unhappiness.

3. Risk of Falling Prices

As the real estate crash of 2007 to 2008 proved, property values can go down as well as up. If the housing market drops soon after you buy your starter home, you might suddenly find yourself stuck with a home that’s worth less than you paid for it.

If this happens, your starter home could turn into your “for the foreseeable future” home. Instead of selling it for a profit and trading up to your forever home, you could end up having to stay there until the market recovers. Fortunately, the always-high demand for starter homes means you might not have to wait as long as people living in bigger houses.

4. Capital Gains Taxes

When you buy a starter home, you’re probably expecting to live in it for at least a few years before trading up. However, sometimes life throws you a curve ball. For instance, maybe your job transfers you to another city and you have to move. Or maybe you suddenly discover you’re having a baby, and your starter home is now too small for your growing family.

Unfortunately, if you end up having to sell your starter home in a hurry, you could face a steep tax bill. Normally, when you sell your primary residence, you can make up to $250,000 in profit, or $500,000 for married couples, without having to pay capital gains tax. However, this exemption only applies to a house you’ve lived in for at least two of the last five years. So, if there’s a chance you won’t be able to keep your starter home for at least two years, buying it might not be worth the risk.

Factors to Consider

Piggy Bank House Budget Cost

Buying a starter home isn’t a one-size-fits-all solution. Whether it’s right for you depends on your lifestyle, location, and finances. If you’re thinking about buying a starter home, here are some factors to consider.

1. Your Budget

Before taking the plunge on any home purchase, you need to figure out how much house you can afford. To determine this, look at all the costs of buying a home, not just the down payment. Experts such as Neale Godfrey of Forbes and Julie Park, a real estate agent interviewed by U.S. News and World Report, warn that first-time home buyers often underestimate closing costs and other expenses of homeownership, such as:

  • Property taxes
  • Maintenance, repairs, or renovations (especially if they’re buying a fixer-upper)
  • Homeowners insurance
  • Utilities
  • Yard care
  • Moving costs
  • Transportation costs (if they’re moving from the city to the car-dependent suburbs)

That’s a lot of factors to consider, but there are tools that can help. First, consult a home affordability calculator, such as this one from NerdWallet. It looks at your income, other debts, location, and down payment to figure out how much you can spend on a house without overstretching your budget. The site also has a tool to help you calculate your closing costs.

To calculate transportation costs, check out the H+T Affordability Index. It shows what percentage of their income residents in a particular area typically spend on housing and transportation. It can also provide details such as the average number of cars per household and the average cost of owning a car. This is especially useful if you’re comparing homes in different areas.

To estimate moving costs, try the Moving Cost Calculator from Moving.com. It can show you the approximate cost of a move based on location, home size, and services. Finally, to figure out your overall ownership costs, look at the Home Cost Calculator from Angie’s List. If you input a home price, mortgage loan details, and location, it can give you an estimate of costs like utilities, property taxes, insurance, and repairs.

2. Your Local Real Estate Market

Once you know what it would cost you each month to own a house, you can crunch some numbers to see how that compares to the cost of renting and which is likely to benefit you more in the long term. Here are some questions to ask:

  • How Does Renting Compare to Buying? If you’re currently renting a home, add up the amount you’re spending right now – including rent, utilities, and transportation – to live where you live. Then compare that to the total amount you’d spend each month if you bought a starter home. If you don’t pay rent now, or if you’re moving to a different area, you can check out rental costs in your chosen neighborhood on Trulia.
  • Are Home Prices Rising or Falling? If home prices in your area are rising, buying a starter home today could be a good investment because you can probably sell it for a profit in a few years. However, if they’re falling, there’s a good chance you won’t get back the money you put into your starter home when it’s time to sell. It might be a better idea to wait until the market bottoms out so you can buy on the way up. To see which way home prices in your area are trending, go to Zillow and look up the location of your current home or a possible starter home you’re interested in buying. Click on “Zestimate history and details” to see how your home’s value and general home prices in the area have changed over the past several years, as well as how they could change over the next year.
  • Are Interest Rates Rising or Falling? If interest rates are on the rise, buying a house now gives you a chance to get your mortgage while they’re still relatively low. However, if they’re falling, you could save money by waiting a bit longer.
  • What Could You Make Investing Your Money Elsewhere? Even if home prices are rising, a starter home isn’t necessarily the best investment you could make. If renting is much cheaper than buying, you might do better renting and investing the extra cash somewhere else. Look at the current yields for low-risk investments, such as CDs, Treasury securities, and municipal bond funds. Then use an investment calculator, like this one from Bankrate, to figure out how much you could make with one of these investments over the next few years. If it’s more than the amount your starter home is likely to grow in value, renting and saving is a better bargain.

3. Your Current Needs

By definition, a starter home is one you aren’t expecting to live in for the long term. So yours doesn’t need to be big enough for the six kids you expect to have some day or be in a neighborhood with the best schools for those kids. However, it does need to be a place you could be happy living in for the next few years.

One of the most important factors is location. Homes in or near the city center usually cost more, especially if they’re in upscale or trendy neighborhoods. Moving out to the suburbs will give you more space for your housing dollar, but that doesn’t necessarily mean it’s a good idea. If you absolutely love your current neighborhood – or if you really hate the idea of a long commute – you’ll be happier staying in that neighborhood, even if it means continuing to rent until you can save more money.

Another possibility is to stay close to the city center but choose a smaller home, such as a condominium or townhouse. Again, this is a question of what’s most important to you. If you love being in the heart of the city and living a car-free lifestyle, a condo in a city neighborhood could be a good choice. However, if what you want from your next home is a yard where you can plant a garden or let your dog run around, a condo won’t be a good fit for you.

4. Your Future Plans

According to a 2015 U.S. News story on starter homes, experts generally agree that it’s not a good idea to buy a house unless you expect to live in it for at least five years. That means before you buy, you need to consider not only your current lifestyle but also your plans for the future.

For instance, if you plan to raise a family someday, think about how soon you want to start. A tiny one-bedroom cottage could look like the ideal starter home for you or you and your spouse. However, if there’s a chance you’ll be bringing up kids there, you’ll probably need more space – and that means more money.

Similarly, if you already have at least one child, consider the local school system. If your child will be starting school while you’re in your starter home, it needs to be in an area with good schools, which will also add to the price. That’s something you’ll have to factor in when figuring out the relative costs of buying and renting.

If your plans for the future are up in the air, buying a home may not be a good idea right now. For instance, if you’re working at a company that could suddenly relocate you across the country with only a few months’ notice, that doesn’t give you much time to sell your house. You could end up having to sell at a loss, and if it’s been less than two years since you bought the house, you could even owe capital gains taxes.

Tips for Buying a Starter Home

Pre Approval Calculator House

Even if you’re sure buying a starter home is the right move for you, it’s best to proceed with caution. Take the time to plan your purchase and find the right starter home, in the right neighborhood, at the right price.

Here are some tips from the experts on shopping for a starter home.

1. Plan Ahead

When you buy a starter home, remember that you plan to sell it and move on eventually. Before you even buy the house, you should have an idea of how long how you intend to live there and what you plan to do with it when you move out.

Will you sell the house or rent it out and become a landlord? Figuring this out ahead of time will help you make strategic decisions about which neighborhood to choose and how to maintain the house. For instance, if you plan to sell it eventually, you’ll want to choose home improvement projects that add value for future buyers. If you’re renting it out, you might choose finishes that require less maintenance in the future.

2. Get Pre-Approved

Mortgage lenders recommend lining up your home loan before you start shopping for a house. The process of getting approved for a mortgage can take a long time, and you don’t want to risk missing out on the perfect home while you’re scrambling to secure financing. Having a pre-approval letter from a well-known, local mortgage lender will make you much more appealing to sellers, improving your odds of getting your ideal starter home once you find it.

3. Choose the Right Neighborhood

Since you’ll be living in this home for at least five years, it’s important to choose a location that fits your needs. Depending on your lifestyle, that could mean an up-and-coming neighborhood in the heart of the city or a family-friendly suburban location.

Another factor to consider is whether the neighborhood will appeal to future buyers or tenants in a few years. A home in a desirable location will be much easier to sell or rent out after you move on.

4. Stick to Your Budget

Experts warn against spending too much on a starter home. It’s easy to get swept off your feet by a big house with fabulous amenities, but the whole point of buying a starter home is to keep it affordable. Straining your budget too much now could hurt your credit score, making it harder for you to get a mortgage when you’re ready to buy your forever home.

5. Pay Attention to Expenses

When you’re trying to figure out whether a starter home fits your budget, don’t look only at its price. Make sure to factor in the closing costs and costs of ownership, such as maintenance and property taxes. In particular, consider the cost of repairs and renovations if you’re buying a fixer-upper. By the time you finish rewiring the house, adding a second bathroom, and redoing the kitchen, it could end up costing as much as you would have spent buying your forever home right off the bat.

6. Get a Thorough Inspection

home inspection is a crucial part of the home-buying process. If possible, accompany the home inspector and take notes so you’ll have a clear idea of what condition the house is in. This will help you figure out whether you’ll need to replace anything big, such as the roof or the furnace, during the time you own the house. If you find that any major systems are on their last legs, ask the seller to lower the price to make up for the cost of replacing them.

7. Be Flexible

Don’t expect your starter home to have everything on your wish list. After all, you won’t be living there forever. Figure out what’s absolutely essential to you, such as the right location or a backyard, and be willing to compromise on the rest. Also, remember that if a house generally fits your needs but lacks one feature you want, such as a garage or a deck, you can always add it. Just be sure to figure out how much the addition will cost and factor that into the purchase price before deciding if the home fits your budget.

8. Don’t Over-Improve

Although you can improve your starter home to make it fit your needs better, experts caution against upgrading it too far. If you put too much money into your starter home, you may not be able to recover that money when you sell. Focus on home improvements that add value to your home and don’t put a lot of money into deluxe kitchens and baths that won’t pay you back.

Final Word

If you’re still not sure if buying a starter home is the right move for you, don’t do it – or at least, don’t do it right now. Buying your first home is a big decision, and you should take all the time you need to consider your options. Continuing to rent for a little while longer can’t really hurt you, but buying a house that doesn’t fit your lifestyle or your budget is a hard decision to undo.

Most importantly, don’t buy a house just because you feel like that’s what you’re “supposed to do” at this stage in your life. Just because buying a house is the right move for most of your peers doesn’t mean it’s the right move for you. Your life and circumstances are unique, and only you can decide whether becoming a homeowner makes sense for you at this point in your life. Deciding to rent now doesn’t rule out buying later on; the housing market will still be there whenever you’re ready.

Which would you rather do: buy a starter home and trade up, or wait until you’re ready to buy your forever home? Why?

Amy Livingston
Amy Livingston is a freelance writer who can actually answer yes to the question, "And from that you make a living?" She has written about personal finance and shopping strategies for a variety of publications, including ConsumerSearch.com, ShopSmart.com, and the Dollar Stretcher newsletter. She also maintains a personal blog, Ecofrugal Living, on ways to save money and live green at the same time.

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