This article has been updated for the 2023 and 2024 tax years. You’re probably familiar with the following script: 1. Go to school., 2. Get a well paying job., 3. Find a significant other., 4. Buy a home together. Let’s cut it short right there.
The “American Dream” of home ownership is instilled in us from an early age as something to aspire to. Many even consider it as a right of passage into adulthood. And worst of all, buying a home is often viewed as a sound financial decision.
It’s all crap.
I followed the script and have actually come out quite well to this point – I’ve been above water on both of the homes I’ve owned, I haven’t had any major disasters (yet, thankfully), and I’ve stayed within my financial limits. Best of all – I’ve mostly enjoyed the chore.
There are many good reasons to buy a home, but there are at least equally as many bad ones – most of which tend to be on the financial side of the equation. Home ownership, if exercised without caution, can bankrupt families. I don’t write this from the perspective of someone who was burned on a bad deal, rather, someone who is aware of all the trappings and wants to make sure you go in with your eyes wide open.
1. Your Home is Not an Investment
Let’s start this off by killing the biggest home myth – your home is not an investment. Here is the summary as to why: the return is crap. “Investments” are assets that you put money into and expect to get more money back in return. The more return, the better. Home prices, by nature, stay level with inflation, but don’t outpace it. In fact, over the last 127 years, the real return of homes has been just 72%! That’s less than 0.56% per year, on average. $1 invested in a home in 1890 would net $1.72 today, adjusted for inflation.
Comparatively, how much would $1 invested in the stock market in 1890 have returned to you in real inflation-adjusted dollars? $13.28, or 7.7 times as much!
That ought to put a spike through the “a house is a great investment” myth.
2. Home Ownership is a Money-Drain
Let’s just pretend that those 0.5% annual returns on price are something you are excited about. You’d be overlooking some harsh realities, if so. The 15 or 30-year mortgage interest rate you’d be paying to get that return is roughly 12 or 14X that rate, respectively, already pushing you into negative territory. Tack on another 1% for PMI, if you can’t hit a 20% down payment, and you’re already 7%+ in the hole.
And this doesn’t even begin to factor in the very real (and significant) costs of all of the following:
- property taxes
- home maintenance
- home repair
- renovation/upgrade costs
- home insurance (or an umbrella policy add-on)
- utility expenses
- liability
When we get stuck in “have to buy” mode, we rarely consider the total cost of homeownership. We shouldn’t. Housing costs average 31% of income across all income groups, and as much as 40% for lower income groups. That can leave very little room for income loss in your budget, and no room for saving.
Yes, you can hopefully recoup some of your equity when you sell a home and renting has its own costs as well, but they are typically much less risky, at a lower percentage of your income.
3. The Mortgage Tax Deduction is Not Worth it
Unless you itemize your taxes and have huge deductions, any tax break you get from being a home owner is a losing proposition. Why? You can’t add a mortgage interest deduction on top of the standard tax deduction.
The standard deductions almost doubled in 2018 as a result of tax reform. Here is what they are for 2023 and 2024.
2023 standard deductions:
- $13,850 for single filers
- $13,850 for married, filing separately
- $27,700 for married filing jointly
- $20,800 for head of household
2024 standard deductions:
- $14,600 for single filers
- $14,600 for married, filing separately
- $29,200 for married filing jointly
- $21,900 for head of household
Meanwhile, also post 2018 tax reform, the maximum state and local tax deduction (SALT) was limited to $10,000 per filer ($5,000 if Married Filing Separately).
In my mortgage tax deduction breakdown article, I highlighted a common scenario where you could end up paying close to $14,000 (mortgage interest + property taxes) that you’ll never get back as close to 90% of Americans are taking the standard deduction, post tax reform.
4. Price to Rent Ratio Might be Too High, where you Live
Every potential homebuyer should consider an important metric to determine if it makes sense to rent or buy: the price-rent ratio.
Price-rent ratio equates to: average home sale price/(average rental price x 12).
As a general rule of thumb:
- Price to rent ratio of 1 to 15 = typically better to buy than rent
- Price to rent ratio of 16 to 20 = getting in to risky buy territory
- Price to rent ratio of 21 or more = much better to rent than buy
To make this metric truly worthwhile, however, you have to consider how much space you truly need. Most homes are 3+ bedrooms, while most apartments are 1-2 bedrooms. If you can get buy on less space, you’re going to come out even further ahead as a renter. As an extreme example, buying a 3-bedroom home in San Francisco is going to cost you $2 million plus, while you might be able to find a solid 1-bedroom apartment for less than $3,000 per month.
Space needed is a great segue to my final point.
5. We Buy More Home than we Need, and then a Bunch of Crap to Fill it
When we buy homes, we often think 10, 15-years down the road as to how much space we think we’ll need. I made this common mistake and bought a bigger home than needed. Bigger homes result in:
- higher mortgage costs
- higher insurance costs
- higher maintenance costs
- higher energy costs
- higher renovation costs
- and higher property tax costs
And homes today are bigger than ever. The average home size in the United States for new builds is 2,392 square feet today, it was 1,660 back when the Census started recording it in 1973, a 44% growth!
To make matters worse, we then buy a bunch of furniture and decor to fill all of those empty, unused rooms. And then buy storage lockers to store all the useless unused crap to make room for new crap. George Carlin once said, “Your house is a place to keep your stuff while you go out and get more stuff!”. Sad, but true.
Adversely, downsizing your home could be the smartest financial move you can make.
I’m not saying that everyone should avoid homeownership altogether. Rather, fully consider the realities, risks, and financial downsides of owning a home versus blindly following the script.
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Great great points here. Many of the benefits of homeownership that people tout (mortgage deduction, appreciation) are not that valuable in the end, especially when you consider the costs to upkeep a home and the fact that most people end up buying much more house than they need. A home is only an investment if you’re a successful home flipper or landlord.
There’s another very big reason why home ownership can be a financial disaster, and it actually fits in with your introduction. The dream is go to school; get a good job; find a significant other; buy a home together. But the reality for a lot of people involves a fifth step, which is divorce. Depending on the balance of who owned what at the time the couple got married, divorce can cause you to lose half of the value of the equity on your home anyway. I’ve been there, and it’s making me think very hard about whether I would want to still own my own home if I were ever to enter into a relationship again.
I don’t know much about this topic – but you would lose half the value of the equity that was gained post marriage, right? I.e. if you had $200K in equity going in, that would remain with you.
But it’s a really tough question. While your argument is valid for the median case, how should one go about evaluating it for your particular geography. In my case, the rental costs in silicon valley ahve been going up by 10% for last 3 years. Right now my friends are paying less for their mortgage (after 20% down) than I’m paying for rent.
biggest problem with buying a home is it ties you down and limits the jobs you will take. Since people buy a bigger house than then usually need, most will commute longer than when they were renting.
Silicon Valley is scary on either side of rent vs. buy. Buying a house there is extremely risky, particularly if another recession hits or one loses their main source of income. Renting is pricey, but it’s much more conservative.
Considering a house as an investment is even less than stated. The return on an investment is not measured by the increase in value, it is measured by the amount the sale nets compared to the cost. So a house that cost $100,000 and sold for $150,000 may on the surface look like a 50% gain, but the true gain has to take into the account ALL the costs of acquiring and selling the house. So a $100,000 house with the additional cost of Mortgage, taxes, closing costs, and realtor’s fees for the sale may have a total cost of $140,000. So the real gain is only 7%, not 50%.
One of the reasons for owning a house is that in the long run, ownership can be less expensive than renting. So then people buy larger (and more expensive) and destroy the reason they decided to buy in the first place.
On the other hand, some people will not save, so buying larger becomes a sort of forced savings at a poor rate of return, but that poor rate of return is better than the nothing they would have if they frittered away that money. You see it all the time, people have equity in their house and no retirement savings. If not for the equity, they would have no value.
The concept of a larger house being an investment was true after WWII for people who were more mechanically inclined and a significant number of people had been trained. Returning GI’s would buy a bungalow and in their spare time would build onto the house, making it larger and more valuable. But the costs for the increased size were only the materials because the owner did all the work in their spare time (work in their spare time doesn’t take anything away from their paying job so the time doesn’t have that cost).
Agreed – all great points!
A very good thought provoking article.
I find it very sad that in todays society far too many people chase a “perceived wealth”. We are judged on the car we drive, the clothes we wear, the technology we use (iphone etc) and of course the size and location of our house.
Yes it is nice to live in a nice house but nice houses don’t have to be big.
Whether home ownership is a good or bad financial decision is based to a large extent on where you live. I do agree with what this article is saying. From a personal point of view we are looking at selling our house and going into rented. This is not from a financial decision but to give ourselves flexibility as we move into the retirement phase of our life.
While I agree with some of your points one has to wonder what kind of return you get from giving someone else $1000+ a month for rent. You see nothing back on that. Buy new at the lowest interest rate possible and pay it off as quick as you can. Buying new theres less maintenance cost, paid 125K now worth 225K, it’s paid off next year after 18 years. Currently renting it for $1400 a month. Thats not a bad investment when you consider that everyone has to live somewhere.
There is potential to come out ahead and everyone’s situation is different. That is why I left leeway at the end of the article with “I’m not saying that everyone should avoid homeownership altogether. Rather, fully consider the realities, risks, and financial downsides of owning a home versus blindly following the script.”
However, when you factor in property taxes, mortgage interest, PMI, cost of selling, maintenance/upkeep, homeowner’s insurance, and the opportunity cost of not investing the spread, it’s definitely not the “no brainer” that many think it is.
Yes, there is some cost involved but by this time next year I’m receiving a $1400 return every month on my investment. What kind of comparison on the stock market equals that? And I had to live somewhere during that time. Equity rocks. Also, if the markets crash, I lose my job and fall on hard times I still have a place to live at no mortgage or rent cost. I just can’t see how home ownership isn’t a great investment.
This is an interesting post. I’ve gone back and forth on whether I am pro-owning or pro-renting. I think the biggest advantage to owning is that eventually you will pay $0 for housing, where as renting you will always pay for housing. I agree that I wouldn’t look at owning as an investment though.
I’d love to talk to the homeowner whose housing costs are $0 :P Aside from maintenance in the range of 1% of house value per year (averaged), you have to pay 1-3% of the house value depending on location to rent your property from the government. A paid off $200k house will cost you about $5k a year, and for that plus the $200k in locked up equity you get to realize an annual return of $1k if you believe the 0.5% figure noted.
Your fifth point, “We Buy More Home than we Need” is often the single reason that ties all the other home buying problems together.
1) as an investment – Buy the amount of home the same as what you would rent so that the money you spend is providing a service that you pay for. When buying large, the extra size and cost(improperly thought of as an investment) is a non-performing asset that you are paying for. When someone wants to spend more as an actual investment, they can buy a duplex so that renting the second unit makes it a performing asset.
2) If you buy more, you spend more in multiple ways.
3) At best, the mortgage deduction will reduce your expense at your marginal tax rate, but no matter what the rate the larger your interest costs are the more your costs after the tax break.
4) There are two parts to this. First, if you buy more expensive than you would rent, you have changed your personal price to rent ratio. Second, a price to rent ratio that is greater than the historical average for any given market, type of building, and neighborhood can indicate a housing price bubble. If people were paying attention to price to rent ratios in 2006, no one would have bought anything before the housing bubble broke.
That’s why I love the tiny home concept!
Where does length of home ownership fit in, e.g., 15 yrs?
My 30 yr old son & daughter in law rent and are considering buying a condo and then sell within 5 yrs to buy bigger.
I advised against this believing they’d lose money.
They’re DINKs in Atlanta and pay $1350/mo for a nice apartment.
Thanks.
K
Consider this, when you pay rent, you are paying the owner an amount to cover all the homes monthly expenses, along with the maintenance, taxes, etc, plus a profit in their pocket on top of that. If you own, all other things about the property equal, you are just paying the actual costs, no profit, and you can DIY to save money on the actual costs. Then look at what happens when you are finally paid off…suddenly the principal and interest portion no longer applies, when you are renting, the rent payment doesnt go down when the owner has paid it off!
Say you went on a conservative 15 year mortgage and your P&I was $1,000. After it is paid off, you have an additional $12k a year for the rest of your life, where the person renting is still covering that $12k a year through their rent…and they just keep on paying it, a differential of $24k annually. Ignoring inflation and potential investment income, this is $360k in the home owners pocket over the next 15 years.
If you strictly look at a home increasing in value, then it does not make sense. If you look at impact of cash flows…it certainly does.
I’m very bullish on the housing market long term due to inflation. It is unbelievable how compound interest adds up over time. I was doing a calculation on one of my rental properties, and just a 4.8% increase every year in rent or housing value resulted in a 80% increase over a 10 year period.
Perhaps it is a different animal out here in San Francisco and in Manhattan. But housing prices have skyrocketed and made homeowners very, very wealthy over the past 20 years. I wish I had bought more in New York City in 2000.
Sam
Curious for thoughts on the following… we own 2 condos in SF that we want (and need )to sell and buy a home in SF and have accumulated about 70 percent equity in our current property. . The question is if we sell and buy a new home should we put in 20 percent or less and pay PMI and hold the remaining $ in other investments… why? housing appreciation in SF has been remarkable and there is a good chance there could be a slowdown in the local economy or those w money to buy to lower cost areas as tech talent can work remotely more so now than ever or god forbid a large natural disaster (equake)… should the housing market hit the skids in 2-5 years and our house loses >10% (or 25% in a castastrophic event)value and or we lose our job then that would allow us to walk away and hopefully have $ left in other investments ( yes and take a credit hit for 7 years) …
If market continues to gain then we wouldn’t make as much in our home due to PMI payments but would hopefully have much greater than 1% +home value growth by investing elsewhere…. (that’s a separate question of where). Question is predicated on owning about 1.6 M of real estate currently with a 500k mortgage and purchasing a 1.8M property to get more space for our family another 300k in stocks and 200k in high interest savings vehicles .
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