“It’s the best investment I ever made!”
“Why haven’t you bought a house yet? You know you’re just throwing your money away on rent, right?”
Has anyone ever said those things to you? I know I’ve heard them multiple times. From friends. From family. From strangers on the internet. From just about everyone.
And while it’s true that buying a house can be a smart financial decision (though not as often as you probably think), your home is not an investment in the financial sense of the word, and you shouldn’t expect it to perform like one.
What Is an ‘Investment’?
The word investment is used in a lot of different contexts and can mean a lot of different things. But from a purely financial perspective, this definition from the Merriam-Webster dictionary works well: “the outlay of money usually for income or profit.”
That is, an investment is anything you put money into with the expectation that you will earn money as a result.
Stocks and bonds are investments because the expectation is that owning them will earn you money. College tuition is an investment when the expected result is a greater lifetime salary than the cost of the education.
This is different from other financial decisions that may be smart, but are not investments.
For example, you might choose to buy higher-quality furniture that costs more now but saves you money over the long term because it lasts forever. Most people would agree that that’s a good financial decision — but it’s not an investment, because there is no “income or profit.” The furniture costs you money, even if it costs you less than the alternative.
With that definition in mind, let’s turn our attention back to your home.
Why Your Home Is Not an Investment
Buying a house is a lot more like buying furniture than it is like buying stocks and bonds.
It costs more up front than renting does, which is why renting is often cheaper if you plan on moving within the next few years. But if you make a smart purchase, and if you stay in your home for an extended period of time, buying a house can cost you less than renting over the long term.
In other words, it can be a smart financial decision. But that doesn’t make it a good investment.
The key word here is “cost.” Even if it costs less than renting, buying a house still costs you more money than it makes you — at least for a very long time, and in many cases forever.
Let’s look at an example to see how this works.
Running the Numbers on Owning a Home
Let’s imagine that you purchase a home for $300,000. The details will vary greatly by situation, but for this example let’s assume the following:
- You take out a 30-year mortgage with a fixed 4.25% interest rate.
- You make a standard 20%, or $60,000, down payment.
- You pay 4%, or $12,000, in closing costs.
- You pay 1% of your home value each year in property taxes.
- You pay 1% of your home value each year on homeowners insurance.
- You pay 1.5% of your home value each year on maintenance and improvements.
And let’s also assume the following about the growth of your home’s value:
- Your home’s value increases by 3% each year.
- Inflation averages 2% per year.
- Using the Freddie Mac House Price Index for housing prices and data from the Bureau of Labor Statistics for inflation data, that 1% difference is right in line with the data from 1975 to today.
After 10 years, which is a pretty long time in the world of home ownership, your house will have increased in value to $391,432, which sounds great! After all, who turns down a gain of $91,432? Plus, you’ll have paid down some of the principal on your mortgage, earning you additional equity.
The problem is twofold:
- Because mortgages are amortized in a way that front loads the interest owed, you’ll only have about $200,768 in equity at that point. You wouldn’t get the full $391,432 in a sale.
- Factoring in insurance, property taxes, and maintenance, plus interest on the loan, you will have spent $279,315 to buy and own the house over those 10 years.
Which means that instead of a $98,326 gain, you’ve actually lost $78,546. And that doesn’t even factor in the cost of selling your home, which can be significant. (It also doesn’t factor in the various tax benefits of home ownership, which, while potentially valuable, are often overstated.)
It takes 29 years before the equity in your home outpaces the amount of money you’ve paid into it. And even then you’ll only have $23,969 to show for it, which translates to a 0.08% annual return. And again, that doesn’t factor in the costs of selling the home.
After 50 years, which includes 20 years mortgage-free, you’ll finally see a decent $131,746 return over what you’ve spent. Which sounds pretty good, until you remember that it’s been 50 YEARS and that your annualized return is only 0.43%.
Here’s the spreadsheet I used to come up with these numbers, if you’re curious:
And even then, this is all assuming pretty ideal circumstances. You stay in the same home forever. The value increases by the same, consistent amount every single year, above and beyond inflation (which is far from guaranteed). You never have to add to the home or account for other major repairs or improvements beyond the standard maintenance. There are no natural disasters.
Even in that ideal scenario, it takes 50 years just for you to end up with a 0.43% annual return.
It might have been a good financial decision, but it wasn’t a good investment.
The Right Way to Think About Buying a Home
Of course, none of this happens in a vacuum. Housing is the single biggest expense for most American households, and if you don’t buy a home, you’ll probably be paying to rent one that entire time – which carries its own costs and opportunities.
All I’m saying is that buying a home should be viewed differently than investing in the stock market, and that calculating the return is not as simple as subtracting your purchase price from the current value.
Buying a home really comes down to two basic questions:
- Does it faciliate a lifestyle that makes you happy?
- Will it save you money over the long term compared to the alternatives?
In other words, buying a house is a lot more like buying furniture than investing in the stock market. It might be a smart financial decision, but it’s not a true investment.
Matt Becker, CFP® is a fee-only financial planner and the founder of Mom and Dad Money, where he helps new parents take control of their money so they can take care of their families. His free book, The New Family Financial Road Map, guides parents through the all most important financial decisions that come with starting a family.