You’re probably familiar with the 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 125 years, the real return of homes has been just 69%! That’s less than 0.5% per year, on average. $1 invested in a home in 1890 would net $1.69 today.
Comparatively, how much would $1 invested in the stock market in 1890 have returned to you in real inflation-adjusted dollars? $2,625, or 1,553 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 8X that rate – 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 4%+ 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
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 a standard tax deduction.
2021 standard deductions are:
- $12,550 for single filers
- $12,550 for married, filing separately
- $25,100 for married filing jointly
- $18,800 for head of household
2021 standard deductions are:
- $12,950 for single filers
- $12,950 for married, filing separately
- $25,900 for married filing jointly
- $19,400 for head of household
In my mortgage tax deduction breakdown article, I highlighted a common scenario where you could end up paying $13,000 (mortgage interest + property taxes) that you’ll never get back. With the new math, post Republican tax reform, the math no longer works unless you have massive itemizations.
4. Price to Rent Ratio Might be Too High, where you Live
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 $1.5 million plus, while you might be able to find a solid 1-bedroom apartment for less than $2,500 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.