By: Andrew Rosen, CFP®, CEP®

Owning a house is one of the more tangible milestones of the American Dream. While I strongly advocate owning your own house, there is “the right time” to do so.  Oftentimes, people rush into their purchase and buying too soon. This can negatively affect your finances and leave you with instability.  It’s common to see people default into buying as renting is simply not an option or undesirable. No matter what, you should always think twice before buying a house (or any other major financial decision).

Back to the beginning.

Americans have an obsession with home ownership.  But, do you know from where it came? Let’s take a step back into the early 20th century when home ownership was unlikely (and unexpected).  It took The Great Depression of 1929 and the Presidential election of Franklin D. Roosevelt to change that. How, you ask?

To escape the worst recession in our country’s history, Roosevelt needed to jump start the United States’ economy. He did so with a series of policies to combat and stabilize the economy.  He called this group of varying economic policies The New Deal.  One key component was the Home Owners Loan Act (HOLA) of 1933.  Roosevelt had three main points when it came to home ownership:

  1. The economic impact of owning a house was enormous. It is said building a home creates the equivalent of 3 full-time jobs.  On top of that, there is the purchasing of appliances and materials for upkeep. What a great way to jump start our economy (and he was right).
  2. If people own a house, they will have a greater sense of pride and attachment to their homeland, in this case the United States (remember, these were times of heavy immigration).
  3. Home ownership needed to be more affordable and accessible for the average American.

The HOLA of 1933 helped by:

  1. Providing relief to troubled mortgage borrowers.
  2. Lowering the principal down payment required from 35% to the more common 20% known today.
  3. Extending the possible loan term from 5-10 years up to 30 years.
  4. Providing relief to lenders, as well, by purchasing mortgage directly from them.

That’s great for the Economy, but is it great for me?

We’ve established home ownership as a historical boon for our economy.  But, the question remains – how does it translate to personal finances? For starters, I don’t believe one’s biggest asset is their house. In fact, I rarely consider it as an asset when doing financial planning.  If anything, a house is a place to live and eventually leads to a lack of a mortgage payment.  In my 15 plus years of experience, I’ve yet to see someone retire, sell their million dollar house, downsize to a $200,000 house, and pocket the difference for life expenses. Most often I encounter people who move to an equal-valued, newer home or they parlay their one million dollar home into two retirement homes of equal value.

For clarity, I want to dismiss a major misconception. If you purchase a house for $350,000, pay it down to $250,000 through the years, and sell it for $350,000 six years later–YOU DID NOT MAKE $100,000.  You actually made nothing or even lost money.  True, you will get $100,000 out of this home when you sell it, but since you paid a bank $100,000 plus all of the interest, you simply gain those dollars back.  If you sold the same home for $400,000, you wouldn’t profit $150,000.  You’d simply profit the $50,000 over what you paid.  If it took 6.25 years for your $350,000 house to increase in value to $400,000, your annualized growth rate would be a 2.92% rate of return. Assuming no inflation, then that isn’t bad.  However, given that inflation averages 3.22% annually, your housing investment makes you less than what the house should be appreciating. You profit in real estate by selling a house for more than your purchased price.

Let’s talk more about that “profit.”  Your $50,000 proceeds on the sale (assuming selling a $400,000 home purchased for $350,000) occur if you didn’t have any remodel or repair expenses over that period. Any home maintenance deducts from your profit. For example, you refurbish your basement and install a new roof costing you $25,000.  Now, your profit is halved: $25,000.  Additionally, the $25,000 gain in this example is only profit if you borrowed at a 0% interest.  Let’s say you did purchase this home putting down the standard 20% and received a historically low interest rate of 4% over 30 years.  This would leave you with a $284,000 30 year loan.

Typical mortgages front load the interest, so your payment would be $1,360.16/month. That doesn’t include taxes or insurances. Of that first payment, $410.49 of it would be principal while the remaining $949.67 would be interest.  Compare this to the last payment on this mortgage which would be $4.51 of interest and the remaining $1,355.65 is principal.  It will take you 6.25 years to pay the $280,000 to $250,000.  This equates to $67,100.60 of interest payments over that time period (as opposed to $34,000 of principal payments).  Now your $25,000 of equity is actually negative -$42,100.60.

Let’s keep this ball rolling.  I’ll assume you purchased this house through a realtor.  The cost with 1.5% transfer tax, one year of taxes, one year of insurances (assuming $3,500), and attorney/title/mortgage fees is roughly $12,750.  Let’s take that away from the -$42,100.60 of loss you currently have.  That makes -$54,850.60.  Finally, to realize this $50,000 of “profit,” you must sell the home again most likely using a realtor, at their normal 6% commission rate. Again assuming a 1.5% transfer tax, that equates to another $30,000 of expenses which must be added to your current -$54,850.60 of losses. Now we are at a cool -$84,850.60 of losses (if you held this home for 6.25 years, purchased for $350,000, and sold for $400,000).  This doesn’t take into account other expenses not noted here like annual property taxes or home owners insurance.

In summary, purchasing a house for $350,000, now worth $400,000 over 6.25 years using my assumptions above will leave you negative -$84,850.60!

Who should and who shouldn’t buy a house?

I am not saying purchasing a home is a bad thing. However, I do suggest taking a hard look at the time frame.  Purchasing comes with a lot of great benefits, but it is also very costly.  Depending on your situation, it may have a significant effect on your personal finances.

Depending on your area and timeframe, renting may be a viable option.  If you are going to stay in your house for at least 7 years, then I’d say ownership is worth discussing.  If not, the cost can be quite daunting, especially for someone just starting out.  Remember, a house ties you down.  If you are younger, or have a job that may cause you to travel, I highly suggest you consider renting.  If you think you will outgrow this house in a few years, why tie yourself to something that may be difficult to sell? Home owning limits your options. Keeping your investment liquid allows you to act when a more appropriate time arrives.  When you rent, you have no real estate tax, much cheaper insurances, and typically no maintenance.

All that said, I do think there are great reasons to own a house. The biggest reason is at some point you’ll pay it off completely. That’s one less fixed expense to worry about.  That makes retirement planning easier and flexible.  Furthermore, there are great deductions afforded homeowners, especially when the intent is to stay in the home for a long period of time.  At that point the math slowly starts to work in favor of the home owner.  Finally, if you don’t feel you would take those additional $84,850 expenses from the example above and save/invest them elsewhere (assuming rent is the same cost as mortgage) then purchasing may be right for you.

My personal experience.

Too often I see people who are so fixated on home ownership that they can’t see the forest through the trees.  Personally, I’ve had both good and bad experiences in home ownership. I lost a lot of money when I sold my first home and it hampered me in my ability to purchase a second. I would have been much better off if I had rented all those years. Learn from my actions; take a step back and ask yourself: why am I purchasing?  Understand your time horizon, stage of life, needs, and most importantly analyze the costs of purchasing rather than renting. There really is a time and place for everything–purchasing a home is no different.

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Andrew Rosen

In his role as Financial Planner, Andrew forges lifelong relationships with clients.  He coaches them through all stages of life and guides them to better achieve their life goals.  For more information about Andrew or the other firm partners, Kyle Hill and David Levy, click the link below.

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