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Is a townhouse a good investment?

August 15, 2014

By Richard Barrington | MoneyRates.com Senior Financial Analyst, CFA

401(k) plan a good idea

Q: My wife and I are currently renting, but we just saw a townhouse for sale in California wine country that would be perfect for us. However, the only way we could buy it would be if I borrowed from my 401(k) to make the 3.5 percent FHA down payment. Is that a terrible idea? Also, are townhouses good investments, and is this a good time to buy?

A: Breaking your question down into its component parts, here are some answers to the issues you have raised.

  1. Is borrowing a down payment from a 401(k) plan a good idea? Your need to borrow for a relatively small down payment raises some questions about your cash flow. Borrowing from a 401(k) means you will miss out on any investment earnings while you are repaying what you borrowed. If you have to borrow against your 401(k), you should have a budget plan for repaying the amount in as little time as possible, and if you have been unable to save up for a down payment, you also might find it difficult to repay your 401(k) plan in an accelerated time frame.
  2. Is a townhouse a good investment? With any property, the keys from an investment standpoint are the pricing and the location, but with a townhouse you are in effect buying into the association that runs the complex. Beside checking out the current fees, you should ask about what those fees have been historically, so you can get a feel for how quickly they are rising. Also, spend some time around the complex, so you can see whether it is well-maintained and whether you will be comfortable with your neighbors.
  3. Is this a good time to buy? California is home to some of the nation's most expensive real estate markets, but at least prices are not yet back to the peak levels of the housing bubble. Perhaps the thing that most makes this a good time to buy are current mortgage rates. Those rates are still among the lowest in history, so you would be getting a break on borrowing costs. Current mortgage rates have only a slim margin over a rising inflation rate, so you might not want to count on rates staying as low as they are now.

Real estate is an especially hard market to predict, in large part because each property is somewhat unique. However, what matters most when buying a home is not where the value might be in five or 10 years, but how readily the mortgage payments fit into your budget. Only if you can comfortably make those payments -- and especially if they compare favorably to your rental expenses -- does the decision to buy make sense for you.

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