A lot of friends I know are buying, or in the market for houses. Knowing that I bought a house at the end of last year they come to me asking all kinds of advice. One of the questions I always ask is: “Why exactly do you want to buy a house?”
It’s a simple enough question, but too often the answer to it is 100% wrong.
“I’m sick of wasting money renting & It’s a good investment!”
If I ever have the “Why do you want to buy a house?” conversation with you and you answer with the above phrase you’ll notice I don’t reply right away. That’s because I’m suppressing the urge to slap you in the mouth.
I know a couple, fresh out of college, working their first entry-level real world jobs and recently engaged. Both are riddled with student loan debt, and the first thing they want to do is buy a house. Are you kidding me?!
Pay off your debt, start building a 401(k) balance, start contributing to a Roth IRA and get your future on track before you think about buying a house.
Too many people think “I’m paying $1000 per month in rent for my apartment, why shouldn’t I get a $1000 per month mortgage and build equity in something?!”
A) Once you see what kind of house you can get for the same mortgage payment as you’ve been paying in rent, you’re going to increase your budget immediately.
B) You’re forgetting all the hidden costs of home ownership. Property taxes, insurance, maintenance costs, maybe even an extra utility bill or two. The true cost of owning a home will be 50% or more per month when you factor in these variables.
“OK, but you still haven’t explained why a home isn’t an investment!”
Ok, here we go…
The average length of ownership in the U.S. is 7 years. For these examples I’ll assume everyone reading has excellent credit (to get the best interest rate) is above average and will own their home for 10 years.
The example below is for a 30 year fixed rate FHA loan with 3.5% down. Assuming a 4% annual interest rate, $4,500 per year in taxes & insurance and a 1% PMI (because no one puts down 20% anymore!) This is by far the most common mortgage scenario in the US today.
Your total monthly payment is $1457.25 and it breaks down like this.
Now lets say that after 10 years you turn around and sell your home for $300,000. You just made $100,000, right?! Not quite…
After 10 years you’ve actually lost almost $24,000. And that’s not even accounting for any maintenance or repairs that you’d have to pay for over those 10 years or the 6% fee you’ll be paying the Realtor when you sell.
Even if you’re one of the few these days you puts 20% down on the house you’re not looking much better. With 20% down your ROI is just over $37,000 after the same 10 years. Again, not adding in any maintenance or 6% Realtor fees when you sell.
Even in a scenario where you do come out ahead after selling your house, have you ever met ANYONE that pockets those profits and moves into a smaller, more affordable house? No, you move out of one house and buy a bigger, better, more expensive house the 2nd time around!
The point is, over the last 100 years the average annual increase in home prices was 3.3% per year. This barely edges out the inflation rate over that time which was 3.1%. 0.2% per year is NOT what I’d call a good investment. For comparison, the S&P 500 returns about 8% annually, Great Depression, dot-com bubble burst and our recent “Great Recession” included.
This post isn’t meant to talk anyone out of buying a house. If you plan on staying there a long time and your financial situation allows for it I highly encourage you to buy a house. A house is a place to live, a place to start and raise your family, a place to put down roots, create memories and grow old in. There’s just one thing it’s not – an investment.
Note: This article refers only to your primary residence. Properties that are purchased solely to rent out and generate income are obviously investments, and often very good ones.