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Is Home Ownership Worth It?
Megan writes in:
“My husband and I are looking at purchasing a home next year. My parents and siblings think this is a great move and are giving me info on buying a home and how great the investment is. His family is adamantly opposed and they say that homes are a money pit that just eat your wallet and barely appreciate historically. Which side do you think is right? My guess is that the truth is somewhere in the middle, which is what usually happens when you have two extreme opposing views.“
My view is somewhere in the middle, but I actually lean more towards your husband’s family than your family. I’m speaking from pure experience here – home ownership is a giant money and time pit.
The easy way that most people compare the cost of home ownership to the cost of renting is to compare the monthly mortgage payment to the rent and go for whichever option is cheaper for whatever housing you need. If you go strictly by that, then you’re going to find yourself in a pickle, because there are a bunch of additional costs for home ownership.
For the items below, I’m going to base everything on a $200,000 house in my area. The numbers will vary a lot from area to area – this is just to provide a concrete example of what I’m talking about.
Maintenance costs can be significant with home ownership. I usually encourage people to hold back 1% of their home’s value each year for appliance replacement and other maintenance tasks. With a $200,000 home, that adds up to $2,000 per year, or $167 per month.
Property taxes are also a significant expense. In my area, property taxes on a $200,000 home will end up being around $3,600 per year, or $300 per month.
Insurance is much heavier for homeowners as well. Rental insurance just covers the possessions, while homeowners’ insurance covers the possessions as well as the cost of the property. This will vary a lot depending on your exact situation, but I stick by the calculation given here, where it’s recommended to divide a house’s value by 1,000, then multiply the result by 3.5. This means the annual premium for the home being discussed here is about $700. For rental insurance, this article estimates $150 per year for insurance. Thus, for homeowners, the extra cost per month for insurance is about $45.
Just from these items, it’s very reasonable to figure that owning a $200,000 home versus renting will cost you an extra $500 per month, even if the rent and the mortgage are equal.
What about the factors that make home ownership less expensive?
The tax deductibility of mortgage interest is certainly one factor. During the first year of a 30 year fixed 4% mortgage for $200,000, you’re going to end up spending about $12,000 on mortgage interest. If we assume you’re in the 30% tax bracket and we also assume that only half of that interest is above and beyond the standard deduction (because you’d get some benefit from the standard deduction if you were renting), that’s $1,800 in savings per year, or $150 per month. This is a number that’s really hard to perfectly estimate because of the huge variation in personal situations, of course.
The appreciation of the home’s value is a highly variable factor. If the last five years have taught us anything, it’s that a home is not a savings account. My assumption would be that home prices will appreciate according to the historical average – around 3%. This would be an annual increase of about $6,000 for the home in question, or $500 per month.
However, there’s a catch. As the home value increases, so does the cost of maintenance (due to inflation) and the cost of insurance. For every $6,000 in value the home increases, the taxes should be expected to increase by $9 per month, the maintenance by $5 per month, and the insurance by $1.50 per month or so, which adds up to an extra $186 per year.
Here’s the reality of it, from my perspective. Home ownership devours your liquid money. Each month, you’re going to be spending more money if you own a home versus renting a place for roughly the same monthly payment.
However, that investment is, on average, recouped by the increase in value of the home. In fact, over the long haul, it’s more than recouped.
The problem comes down to cash flow. If you’re walking a tightrope just to be able to swing the monthly costs of home ownership and you slip and fall, you may not recover much of anything at all because you’re completely at the mercy of the short term housing market in your area. If it happens to be booming, you might be okay – if it’s not, you could be in trouble.
(We won’t get into the time factor, but suffice it to say that it’s much easier to just call a landlord when you have a problem than to try to handle it yourself or to call an expensive repairperson.)
So, what should you do? If I were in your shoes, I’d look carefully at the neighborhood where I was thinking about buying. Are there lots of houses for sale in that area? Does the neighborhood look nice or is it run down? I would lean toward buying in an area that seems in good shape without a lot of houses for sale, and lean away from buying in an area that seems run down with a lot of houses for sale.
Why? If you’re taking out a mortgage, you should be worried about the short term. What happens if the expenses are too much? What happens if someone loses a job in year two of that mortgage? You’ll probably need to sell fairly quickly and you’ll ideally hope for a small return on that sale. That’s going to be far harder to do in a run-down area.
During the housing collapse in 2008 and 2009, a lot of people discovered the hard way that they didn’t account for that short term and they found they couldn’t keep paying the bills. They also found that they couldn’t sell the property easily and get enough of a return. So, what did they do? They dropped the keys in an envelope, walked away, and found themselves with less money in hand and with a deeply tarnished credit report. That’s a risk of homeownership and it’s one that you should try to avoid. Make sure you’re buying a home you could re-sell easily.
The only exception to that is if you’ll be buying a property where the mortgage payment is significantly below your current rent. In that situation, you should be able to weather any storms that blow your way.
Again, this is just my take as an experienced renter and as an experienced home owner. We bought a home in an area where we could re-sell it easily if we needed to. In the end, I think it was a smart move, though our monthly living expenses certainly went up after the move.