Friday, December 18, 2009

Costs To Consider When Buying A Condo

This posting is NOT going to be about 1) the decision whether or not to buy or 2) about finding the area that is most desirable.  Instead, I am going to assume that the potential buyer has already arrived at generally what they want and is now trying to decide among several potential purchases by comparing the costs associated with the ownership of the properties.  One would think that it would be simple to compare these costs, but I see people (even smart young attorneys) screw this up all the time.  I attribute this to their inexperience and the fact that the real estate deal is complicated and their eyes are on the wrong ball.  I'll explain further below.
One way in which people get their costs wrong is by comparing purchase price to purchase price.  However, you can't really tell which condo is more expensive based on the purchase prices.  Stop.  Read those last two sentences again.  If your first reacation is "Well, what else would they compare?", then please read the rest of this article carefully and you may save yourself thousands of dollars.

How to really determine price
What you really want to compare is your net monthly cost of ownership.
  1. We start with PITI - Principal, Interest, Taxes, and Insurance
  2. Include any additional charges (like assessment, heat or water)
  3. Finally, calculate and apply the tax impact to arrive at the net monthly cost of ownership

Not All Costs Are Tax Deductible
These are tax deductible:
  1. Mortgage Interest
  2. Property Taxes
These are NOT tax deductible:
  1. Mortgage Principal
  2. Insurance
  3. Assessment
  4. Additional Charges 
Of the non-deductible aspects, the most important one that people frequently overlook is the cost impact of the assessment.  We will see the impact further in an example below.

Why The Difference In Deductibility Is Important
When an expense such as mortgage interest is deductible, it means that the government is effectively chipping in to pay some it by not taxing you on that part of your income.  This can have a pretty big impact.  For example, assuming that your top marginal rate is 33%, if you have deductible mortgage interest of $600, then that $600 is deducted from your income.  You would have been taxed a total of $200 (33%) on that income, but now you are not.  The total cost to you really is only $400 - the original $600 outlay minus the $200 in tax savings.

Consequently, when something is deductible, your real net monthly cost for that aspect is significantly reduced.

Applied Example
Let's say you are a young attorney and you have decided to purchase a 2 bedroom condo in the West Loop area of Chicago.

Here is a first condo that you are considering:
Price: $330K including unit and 1 parking space

Here is a second condo that you are considering in the same area:
Price: $330K including unit and 2 parking spaces

At first glance, you might think that these condos were similarly priced.  The second condo is $30K more expensive, but includes the extra parking space - and parking spaces typically go for around $30K in the area.

However, the actual real net monthly cost for the condos is massively different - about $475/month different, in fact.

Let's do the math below.  We will assume that the cost for insurance is the same for both condos.  We will also assume that the purchaser is putting $40K down.  Here is a calculator to determine mortgage payments - we will assume that the purchaser is getting a 30 year fixed mortgage at 5%.We will also assume that the purchaser is in the 33% tax bracket.

Digging deeper, we find for the first condo that:
Assessment: $928/mo
Taxes: $7859 = $655/mo
Amount financed= $290K ($1557/mo)

Thus, the net monthly cost of ownership for the first condo is:

928 + (655+1557)*.67 = $2410/month

For the second condo:
Assessment: $546/mo
Taxes: $4236 = $353/mo
Amount financed= $320K ($1718/mo)

Thus, the net monthly cost of ownership for the first condo is:

546 + (353+1718)*.67 = $1934/month

Thus, the difference in net monthly cost is $2410-$1934=$476/month - even more importantly, the condo with the extra parking space is actually far less expensive to own.

Why Did The Numbers Come Out This Way
With the second condo, the mortgage payment is slightly higher, but the assessment and taxes are greatly reduced.  This is especially important in the case of the assessment because the assessment is not tax deductible.

To put this in perspective, realize that with a 30-year fixed loan at 5%, the monthly mortgage payment
per $100K is $537.  Apply the 33% deductability, and the true cost is $360/month.  That is, every additional $100K of mortgage that you take on really only costs $360/month.  Conversely, the difference in assessments between the two condos is $382/month - which is even more.

This means that if instead of the second condo on which we financed $320, we decided to buy a larger condo on which we financed $420K  - then that additional cost of $360/month would still be less than the difference in assessments.  We could buy $100K more condo and it would still cost us less because the assessment of the first condo is so high.

Note that these are real numbers.  When buyers first enter the market, they assume that condos with a similar purchase price will have similar assessments and taxes.  This is absolutely NOT the case.

Why This Is Important

  1. The difference in net monthly cost  - $476/month - is large and can have a real impact on your budget and savings - it could even represent a large fraction of your student loan payment!
  2. The sizable difference in net monthly cost was ABSOLUTELY NOT apparent from the initial comparison of the purchase prices.
  3. Being smart with a large purchase like this can save you far more on a monthly basis than you could ever hope to save up by skipping Starbucks or bringing your lunch to work.
  4. Also recognize that if you had to choose between paying $360/month more in assessment vs. paying $360/month more in mortgage insterest, then pay the mortgage interest because you will have bought "more house" and in the typical market the condo will appreciate.
Best of luck in your purchasing decision!  And DO THE MATH!


  1. Thanks for sharing those good info about condo buying. You really gave valuable information here.
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  2. The decision to become a homeowner is one of the most important decisions you’ll ever make in your life.

  3. Wow, I didn't know there were so many unanticipated expenses involved in the process. I suppose it's a fact of life that whenever you go to get something, always bring extra cash to make sure you can afford any possible setbacks. I'm looking for a condo myself and I'll be sure to consider the principle, taxes and interest when I look to purchase.