It is considered a known fact that home ownership is a part of the American dream. But don't for one second think that home ownership is all sunshine, rainbows, and ice cream sandwiches. There are serious trade-offs that you should know, understand, and accept before signing on the dotted line.
1. Mortgage debt -- a marriage you can't divorce
According to the Census Bureau, the average home price in 2010 was $272,900. A traditional mortgage will finance 80% of that, or just over $218,000. The Census Bureau also reported that median household income in the U.S. was just over $51,000.
Are you comfortable owing over four times your total gross income (before taxes)?
You may be thinking, "But if I don't buy a house, I'm throwing away my money to a landlord with rent!"
Would you rather be "throwing away" your money to a landlord, or to a bank? Because if you bought that $272,000 average American house with a $218,000 loan at 5% for 30 years, you'd pay over $52,000 in interest to your bank of choice over the first five years alone!
Before the house was paid in full, you will have paid that bank over $203,000 dollars -- in interest alone!
2. When you own the house, you pay for the maintenance and repairs
Landlords get a bad rap. A respectable, professional landlord can make life orders of magnitude easier. They are your on-call repairman, plumber, hardware store, and lawn maintenance company.
Air conditioner compressor breaks on the hottest summer day? Landlord will take care of it. Snow storm knocks a large branch into the yard? Landlord will take care of it. Bathroom drain cloggs? Landloard will take care of it.
Nothing like a surprise $5,000 expense (with interest) to ruin those summer barbecue plans.
3. How long did it take to save up that down payment?
In our "average American" example, our potential homebuyer would have to put down a payment of $54,000 to qualify for the traditional mortgage. After closing costs and miscellaneous expenses, let’s call this a round $60,000 just to purchase the home and get a loan approval.
That means that in truth, this buyer needs a decent bit more than $60,000, though. The bank will not make a loan for a borrower who is putting 100% of their liquid assets into the home. Banks like back-up plans, and without some cash cushion, there is no real back-up plan.
So now, our typical American, must save somewhere in the neighborhood of 150% of their annual income to comfortably afford the down payment.
It may make more sense to take that $60k to $75k savings and invest in a target date fund, or an index fund. Those investments are liquid, they can be rebalanced, they don't require property taxes, and their toilets won't overflow, forcing you to pay a plumber to come out on a holiday.
4. Buying a home is not an investment
This final point will be hard to swallow. Buying a home is not buying an investment. It's buying a highly leveraged forced-savings account.
According to data from Freddie Mac, the inflation adjusted return for an investment in a home bought in 1970 is just over 27% through the second quarter of this year. That's a 27% return over a 43-year holding period!
If buying a home isn't an investment, then what is it?
It's a forced savings account. Along with that healthy dose of interest that goes to the bank every month is also a sliver of principal pay-down. Over 10 to 20 years, those principal payments can add up to a good bit of equity. So for those individuals who have trouble putting money aside in savings every month, this is an attractive feature.
But the point is, don't buy a house thinking it is a panacea for financial woe. If you want to maximize your investments, look elsewhere. If you want real estate exposure, consider a REIT. Don't be fooled into thinking that buying a home is a one-way ticket to the good life.
If you are still sure you want to join the ranks of homeowners, go for it. Your decision is thoughtfully considered, you've done the research into the upsides and the downsides, and you're making your own decision.
Personal finance and managing money is as much or more art than it is science. There is never a single right answer that applies across the board. We must all consider the risks, the rewards, and our own personal situations, and then act thoughtfully.
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