Is Buying A House Still Worth It?
To buy a home or to not buy a home. That is the million-dollar question. Every year, millions of Americans wrestle with this question when it comes to their living accommodation. Is it better to buy it? Or is it better to continue renting? Or maybe just live in an RV full-time? So in this post, we are going to deep dive into an age-old question and see if we can find a workable solution.
01 - Pros of Home Ownership
Let’s first start out with some of the major benefits of home ownership. And the first key benefit isn’t actually money-related. It’s emotional stability.
Emotional Stability
When I was 10 years old, I was evicted from our house. It had only been a couple of years since we immigrated from Korea as a family, and we struggled to find our place in this new country. My parents made some unfortunate financial decisions and which led us to lose our home.
I remember it vividly like yesterday. A representative from the bank came to our front door to give us the notice and I could tell he didn’t want to be there either. Looking back, I kind of felt bad for him. But nonetheless, he did his job and we had to find a new place to live.
We moved around several times for the next few years. To me, it felt like almost every few months. And with that experience etched in my mind, I vowed that I would never want to put my kids through something similar if I could help it.
Homes don’t just represent financial wealth, but they also represent social wealth. It provides a stable foundation to raise a family. A place where kids can associate a place with emotional stability and warm memories.
Community
Another non-financial benefit to owning a home is the community aspect. Most often, neighborhoods, where people purchase their homes versus rent, have a deeper sense of connectedness with their community.
This most likely has to do with the fact that when we buy, we plan on staying in that neighborhood for a longer period of time. We plan on sending our kids to the local school. We plan on spending our weekends at the local park more often.
Thus we can feel more plugged into the local community as well as with our neighbors. Of course I can’t say that this is with all neighborhoods. I lived in apartment complexes where we are actually closer to our neighbors than in neighborhoods where we owned.
Most Common Way To Accumulate Wealth
The third, but the most often talked about benefit to owning a home is that it is the most common way to accumulate wealth. According to the Survey of Consumer Finances, the homeownership rate in the U.S. was 65% in 2019. And of those who owned homes, when we look at different incomes households we see an interesting find.
For the highest-income households, homes represent 34 percent of their total assets. But for the lowest income households, homes represent nearly 75 percent of their total assets. What this means is that, while a home may not be the majority of wealth for high-income earners, for lower-income families, it is the biggest chunk of their wealth.
And this isn’t too surprising when you think about it. Homes are forced savings in a way. Each month we are paying down our mortgage, and with that, we are slowly but surely building up equity. In addition, if there is a home appreciation that adds to our wealth as well. But of course, owning a home isn’t all butterflies and roses. There are some serious costs associated with owning a home that you want to consider in your decision-making.
02 - Cons of Home Ownership
One-Time Costs
The first serious cost of owning a home is the hefty one-time cost. The first time you buy a home you should expect to put down anywhere between 3%–20% of the home’s purchase price as a downpayment. In some parts of the country, 20% could easily be 6 figures.
After saving for your down payment there will also be closing costs which will be roughly 2% to 5% of the home’s value. These closing costs include application fees, appraisal fees, origination and underwriting fees, and many more that we regular people will have a hard time understanding.
While some sellers may cover these closing costs for buyers, this depends on you or your real estate agent’s ability to negotiate. And real estate agents aren’t cheap. They are one of the other big costs of buying a home. Real estate agents typically charge a 3% commission for every home they help buy or sell.
If there are two real estate agents involved in the transaction, one for the buyer and one for the seller, that means 6% of the total value of the home will be paid in commissions. On a $400,000 home, an average home price in the United States, this comes out to $24,000 total. $12,000 for each real estate agent. No wonder we have so many real estate agents in this country.
When we total up all these one-time costs, the down payment, the closing costs, and the real estate commission, we could be looking at close to 30% of the value of the home. On a $400,000 home, this would come out to roughly $120,000. We won’t cover rent in this post, but I’m pretty sure renting a place doesn’t come with an initial one-time cost anywhere close to this number.
Ongoing Costs
But we can’t stop here as regards to the costs of owning a home. There are ongoing costs as well. And this is outside home mortgage payment. After paying for the home itself we will also need to pay property taxes, maintenance, and insurance.
Property taxes vary based on the size of the home and where you live, but if you happen to live in a high property tax state and own a large home, this can be quite significant.
Insurance works in a similar way. There are certain risks associated with living in certain areas that might make your insurance be higher or lower. For example, in California where I live, the risks of dry fire and earthquakes are higher. Thus insurance companies factor in that risk when they calculate the homeowner insurance premiums.
Insurance payment that you want to avoid as much as you can is Private Mortgage Insurance, also known as PMI. Anyone who puts down less than 20% of their home’s value typically has to pay for private mortgage insurance in addition to homeowner’s insurance. This will cost you anywhere from 0.5%–1% of your loan value annually. So if you have a $400,000 mortgage, you are looking at an additional $2,000–$4,000 per year for PMI. Therefore aim for at least a 20% down minimum when purchasing a home.
Lastly, the ongoing maintenance of a home can be considered from both a financial and a time perspective. While the financial costs will vary depending on where we live and when our home was built, we should anticipate 1%–2% of our home’s value in annual maintenance costs.
On a $400,000 property, this comes out to between $4,000–$8,000 per year keeping our home intact. And I can tell you from first-person experience this is quite true. Our home was built in the late 1950s and it feels like something needs repair or replacement every few months. The boiler dies one year. Next year the A/C vents need replacement.
And it isn’t just the financial costs associated with maintaining your home that is most costly. The time costs are significant. If you own a home, it might feel like you have a part-time job as a maintenance guy. Whether you are scheduling repairs or doing it yourself, home maintenance can take up more time than you might have initially thought.
The financial and time cost of home maintenance I feel like is one of the most overlooked costs of being a homeowner. Unlike being a renter, when things break, you, as the homeowner, have to own the problem and to fix them. Or find someone who can come and fix it for you.
Not The Best Investment
The third cost of owning a home, and I believe this is the most significant, is that it actually isn’t the best investment. Robert Shiller, the Nobel Prize-winning economist, and co-creator of the Standard & Poor’s / Case-Shiller home price index reflected this assumption based on his analysis of home values from 1915 to 2015.
Over this hundred-year time period, do you know what the average inflation-adjusted annual return for home values was? 0.6% a year. And what’s also notable is that most of that return came after the year 2000.
Anytime you look at something as an investment, we want to compare it to what an investment in another asset class would have done in the same time period. This is called the opportunity cost of investment and it is a good way to assess the value of that investment.
For example, My wife and I moved into our current neighborhood about 10 years ago. There was an older couple next door to us that had been living in their home since it was first built - in 1957. Given the nosey person that I am, I looked up how much they paid for their home when they first purchased it over 60 years ago. Whopping, $27,000.
They sold it for $700,000 in 2017, 60 years later. You might be thinking, wow, they made a killing in that investment. $27,000 to $700,000. However, do you know how much they would have today if instead, they invested that $27,000 in a low-cost S&P 500 index fund in 1957 and just held it until 2017?
Slightly over $9 million dollars ($9,268,045). Yes, you heard me right. If you are impressed by $700,000, imagine $9M. My neighbor's home appreciated by a little under 6% annually (5.58%) but the stock market appreciated by slightly over 10% over the same time period (10.22%).
The 5% difference doesn’t look that much on paper, but when we compound it over 60 years, it results in a difference of $8 million dollars. Despite my neighbor living in California, which has had one of the best multi-decade returns in U.S. real estate history, their house earned them roughly one-eighth of what a similar investment into a broad market S&P 500 index fund would have earned them.
Of course, we do have to consider the fact that if my neighbors had invested the money in the S&P 500 versus buying their home, they would have still needed to find another place to live.
03 - Tae’s Thought: Home Ownership In The Long Run Wins
Alright, you heard a lot of pros and cons for home ownership. Hopefully, they aid in helping you make a decision to buy or not to buy. Especially in the current uncertain housing market. However, I do want to give you my personal take on home ownership.
Regardless of all the downsides of home ownership that I shared - the initial costs, the on-going headache, and its lackluster performance compared to other investment classes, I still think homeownership wins in the long run. Let me share with me a few reasons why.
Forced Way To Build Wealth
One is that it forces you to build wealth. Though your home is unlikely to be a stellar long-term investment, when you own one, you are building your wealth regardless. When you pay down the mortgage, it automatically increases your equity in your home. You owe the bank less, and thus you own more of your home.
And when you live in your home long enough, though the appreciation may not be as stellar as the stock market, your home has a great chance of appreciating. And data shows that home ownership is the norm for most wealthier Americans.
According to the Survey of Consumer Finances, the homeownership rate in the U.S. was 65% in 2019. However what is interesting is that if you look at households with higher levels of income and wealth, homeownership increases. According to the US Census of Bureau, the homeownership rate was almost 80% for those households with an income greater than the median income.
What this shows is that for wealthy Americans, whether by strategic decision or accidental run-in, homes play a major role in their total wealth. The bottom line is that wherever you are in the income spectrum when you own a home, it will automatically be a source for wealth building. Even if it isn’t done strategically or in the most optimal way to grow wealth.
Stability For A Family
The second reason isn’t directly money related, but I personally consider it my favorite reason for owning a home. And that is that a home provides stability for a family. And I don't mean that if you don’t have a home, you are not providing family stability. I’m not saying that at all.
I know of tons of families that move frequently and their family is way more stable than mine. The difference is that these families move because it's their choice, not because they have to. I shared with you earlier that one of the most memorable memories I have as a child was being evicted from our home. It forced us to move constantly afterward trying to find a stable place to live. Probably one of the reasons why I try so hard today to provide a consistent home for my kids.
When you buy a home, you likely will remain in the neighborhood for many years. This means you will be more plugged into the community and with your neighbors as well. Though it isn’t the best reason to buy a home. And something that may not be a priority for everyone, it was definitely for me.
04 - So When To Buy A Home?
Alright, if you are convinced that buying a home is indeed the best decision for you right now, let me go over some key criteria. Because choosing to buy a home is not a simple decision. There are a lot of risks involved. So if you want to avoid being foreclosed on like what happened to my family, it's crucial that you buy a home when you can meet the following conditions:
10 Years
Condition number one is that you want to see yourself living in that specific neighborhood for at least 10 years. Given that the transaction costs of buying a home could be up to 10% of the home’s value, you want to ensure that you stay in the home long enough to make these costs worthwhile.
20% Down
Condition number two is that you want to have at least 20% of the home value in cash as a downpayment. 20% is important because it shows that you have the financial responsibility to save sufficient cash over time. You also avoid the dreaded PMI, Private Mortgage Insurance that could cost you 0.5% to 1% of your loan value annually. This literally adds no additional value to your homeownership, so you want to avoid it like the plague.
Steady Income
The third condition is that you want to have a steady income before you decide to buy a home. There is a reason why banks ask for your pay stubs and job history going back a couple of years. Without a steady income, you are at high risk of defaulting on your mortgage.
Home expenses will be one of the biggest expenses in your budget so if you don’t have a stable career with a stable income, you really want to think twice before buying that home regardless of how the housing market is doing or how low the interest rate is.
Stable Family Life
The fourth condition you want to meet before buying a home is to have a stable family life. If you are currently single, but looking to get married in the near future, you don’t want to limit your options with a home. You never know where you might meet your future spouse. And what would happen if you did meet Mr. Right or Mrs. Right and you want to build a family? You will need to sell your home and upgrade to a larger home if you want to have a large family. In the long run, you could be paying more in transaction costs.
