Tuesday, March 13, 2007

Why Your Home Isn't the Investment You Think It Is

I have been looking at homes and housing markets in Jacksonville to plan for a prospective home in the early future. Looking at the way the city is set up and the way of life that people are accustomed to, I should either buy a condo at the beach, or a single family home (an independent home siting on a private lot). Condos at the beach go for over $400,000 which make them above my price range. Now that I know that a single family home is my aim, what should by budget be? What drives my budget? A monthly mortgage payment, of-course. What should my mortgage be? I would be comfortable with a low $1000 mortgate payment including taxes and insurance. So, I have created a spreadsheet that you can view here .

I also came across an article in today's wall street journal that speaks about why some people bank too much on their homes as a nest egg (retirement fund) and why that is not the right thing to do. Some people think buying is better than renting.

Here is a part of the article. I hope I am not infringing on copyrights doing this:
Q: But it's certainly better to buy a house than to pay rent.

A: That depends on when you buy, and how long you own. Buy at the wrong time -- like during the kind of buying frenzy that much of the country has just experienced -- and you could well end up wishing you had rented instead.

Boom market or bust, home buying has so many extra costs -- from upfront "points" paid to a lender to title insurance and appraisal fees -- that over the first five to seven years, a renter who invests the equivalent of a down payment in stocks could easily do better overall than a house buyer. Compounding that problem: Most homeowners move within seven years.

As the ownership timeline stretches out to 15, 20 or 30 years, however, the buyer will almost certainly do better than the renter, especially given the tax benefits of paying mortgage interest over traditional rent and the big rebate when the owner finally sells.

But the typical buy vs. rent argument clouds the more important point: A house is an inefficient way of building wealth.

Q: But I have to live somewhere! And I have to pay something for a place to live. Certainly it's better to pay "deductible" mortgage interest than rent.

A: Buying a house with a long-term mortgage is just another form of renting.

Mortgage interest is rent that you pay to your lender for the use of its money rather than to a landlord for the use of his house. Yes, the government picks up a portion of that with the tax deduction, but most of your monthly payment neither builds equity nor is deductible. It just goes down the same black hole that sucks up any other renter's money. And it takes 20 years before a typical borrower pays more principal each month than interest.

"I have to pay something" is a rationale that home buyers use for going deeply in debt and paying tens or hundreds of thousands of dollars in interest to buy a house that, they mistakenly believe, will make a big profit for them down the line.

These two answers made sense to me and got me thinking. The spread sheet was an outcome of that thinking process. I just hope I make prudent financial decisions. I thank all my friends and colleagues for their patience that are current home owners / renters that I keep pestering with my many small questions on home-ownership.

Update, April 2007:
My further investigation here: link

1 comment:

Anonymous said...

You are missing a key point here. If you finance your home with an interest only loan, you will pay less than renting to live in a likely appreciating asset, while maximizing your tax deductions. This is teh best of both worlds. Less near term cash outflow,(which you could invest in the market), and an equity stake in an appreciable asset. Of course yoru house could depreciate, but so could your stocks. In addition, for your low low down payment on $100,000 house you can earn 2% -20% on that entire amount, while investing that down payment of let's say $20,000 ,you only earn maybe 11% in the market on that 20k. This is what the stock broker boys and girls never fully disclose, and why real estate has and always will be a nearly gauranteed form of wealth creation.