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Is Buying a House a “Good Investment?”

As a Realtor, I don’t think buying a home is a “good investment.” However, I do believe it can be a great “personal financial decision.”

advice for buying a house
The House Buying Guide, Square Yards, Square Times Bureau, March 22nd, 2016

Here’s Why Your Home IS NOT an Investment

It’s Not Producing Any Income

Merriam Webster’s definition of investment is the outlay of money, usually for income or profit.

The purpose of a home is to supply shelter. Therefore, if your house isn’t producing any revenue, it’s not an investment. It is purely a home. If the house was making money, it would instead be a rental property or a flip.

Unlike an investment, you won’t be able to buy and sell at specific periods of the market to maximize your return. An example would be buying a property during a downturn, holding it, making improvements, renting it out until the market recovers, and finally sell at the peak of the market.

Trying to do the same with your primary residence would be cumbersome. Every time you sell, you’d have to move your belongings to another house just to do it all over again. Not to mention the various fees you’d have to pay, such as commission, attorneys, closing costs, repairs, etc.

All in all, more than likely, you’re going to be living in your home for good. If not, at least for a while. Regardless, your house cannot be a proper investment without an “”exit strategy,”” meaning you don’t know if or when you’re ever going to sell.

“What Is A Real Estate Exit Strategy?”

“Real estate exit strategies are plans in which the investor intends to remove himself or herself from a real estate deal. The decision to implement a sound exit strategy is crucial to success, as the correct approach will ensure maximized profits and minimal risks.” – Choosing the Right Real Estate Exit Strategies, Fortune Builders, Than Merrill

My Controversial Opinion as a Realtor

Contrarily, I don’t consider a primary residence as a good investment. However, buying a house can be a great personal financial decision. I repeat a home can only be a “good investment” if it’s making money.

Treating Your Home Like an Investment Can Be a Financial Disaster

Hypnotized by the Draw Period

You can pull equity out of your home with a home equity line of credit (HELOC), otherwise known as a second mortgage. However, taking out a HELOC can quickly get you in trouble.

One of the most attractive features of a HELOC is the draw period. This gives you the chance to pay the least amount back each month. But your minimum payments will only go towards the interest, not the principal. By doing this, you’re not paying off the loan at all. The original principal amount will still remain.

Once you reach your draw period, you won’t only pay interest. The principal will henceforth be applied. Now all of a sudden, that small monthly bill has turned into a much bigger one.

Taking out a second mortgage also increases the chances of foreclosure. This is because instead of one mortgage, you would have two to pay off. With this in mind, getting behind on your payments will have double the impact than it would otherwise.

Refinancing for the Wrong Reasons

Refinancing too often can eat up a vast amount of equity in your home, or in other words, decrease your percentage of ownership. Again, refinancing also comes with a long list of fees. You’re going to pay for closing cost, appraisal, inspection, attorney, etc.

Whatever you do, don’t treat your home like a savings account. For instance, taking equity out of your home to take a trip to Miami or buy a new car isn’t wise at all. But using the funds to make improvements would be valid because you would be adding value. You can avoid making stupid mistakes while refinancing doing your homework beforehand.

Lastly, here’s one thing you should always remember, do not make financial decisions for the moment. Always think ahead.

What Makes a House a Good Investment?

Knowing What You’re Doing

First of all, you need to get educated. What it takes to buy your first rental property isn’t the same as buying a place to live. If you don’t have the skills needed to become an investor, you need to acquire them. You can start by reading books about real estate investing and joining local real estate investment clubs. The latter will allow you to mingle with legitimate investors to gain knowledge.

With this in mind, please don’t seek advice from self-proclaimed experts on social media. Also, watch out for those “real estate gurus” who will try to trick you into paying for their bullshit seminars.

However, I do recommend BiggerPockets.com. This is a real estate investing site with a broad array of forum categories and thousands of legitimate investors. Furthermore, you can also find professionals in industries related to real estate. These are lenders, attorneys, contractors, inspectors, and etc. It is another excellent way to network, primarily because you can reach out to anyone at any time via private message.

For more education on real estate investing, BiggerPockets also has daily blog posts, webinars, and podcasts. Their website also has many other helpful features not mentioned in this article.

Mark Ferguson’s Invest Four More is another excellent source of information on real estate investing.

Cash Flow

Any investment, be it property or stocks, must cash flow to be a good investment. If there is no money being made, you simply bought a liability.

Below, longtime investor Mark Ferguson explains how to analyze a rental property.

Mark Ferguson – InvestFourMore

Market Liquidity

There are two factors you should base your investment on: yields and liquidity. Liquidity decides if an asset can be sold quickly or slowly and if the price will be above or below market value.

In his article Why Investment Liquidity Is Important – Now More Than Ever, Dave Van Horn’s experience tells you why.

“In the late 1980s, I was a newly licensed realtor, and interest rates were coming down from a high of 18 percent. That’s right—18 percent.

“In fact, a little while later, I bought a home owner-occupied at 11 percent with six points. But it was actually 17 percent because I was self-employed and in business for less than five years. Ouch! Remember that the next time you complain about rates!

liquidity
Liquidity, Napkin Finance

“Fortunately, I owned it for many years, eventually selling it at a profit—proving there’s a deal in any market. But I digress.

“Anyway, back in 1987, the real estate company I worked for had a great training program. All the newbie agents had a senior agent train them in exchange for a percentage of our commissions. I was lucky enough to be coached by the” ‘top sales dog'” at the time.

“He was undoubtedly number one in listings and sales, and I learned a lot from him in that regard. However, his private real estate endeavors were another story.

“He had 25 rental properties back then, which is a considerable amount even today. I thought he really knew what he was doing. But not long after our training, he was losing all 25 rentals, filing bankruptcy, and was no longer a practicing agent.”

Homeownership Returns

The national average appreciation rate is 3.8% per year. However, the inflation-adjusted housing price growth has been less than 1% for the past 100-years. The average yearly rate of return from owning a home is generally between 8.6% to 10%. On the other hand, since its beginnings in 1926, the S&P 500’s average annual return is 10% to 11%.

home appreciation: good investment
How to Think About Home Price Appreciation, Compound Advisors, Charlie Billello, July 9th, 2020

Costs of Buying and Owning a Home

When buying a house, there are many hidden costs. This includes closing costs, home inspections, title attorneys, moving, etc.

The same goes for owning a home. That is, taxes, maintenance, insurance, etc., just to name a few.

Below is a wholesome example from Nick Holeman’s “Is Buying a Home a Good Investment?

“Congratulations to A & B, who are now proud homeowners. But as the two of them quickly find out, homeownership comes with many ongoing costs.”

“Their mortgage payment comes out to $984 a month or $11,808 a year using the inputs listed above.

“A & B’s property taxes cost $2,709/year, the median property taxes for all US homes with a mortgage. This comes out to a property tax rate of 1.08% a year ($250,000 home price / $2,709 in property taxes = 1.08%). Homeowner’s insurance costs them an added $1,083/year, which is the national average.

“Since A & B’s down payment was less than 20%, they also must pay private mortgage insurance (PMI). Assuming they have a FICO score of 704, the national average, their PMI will cost about $1,196 a year. Note that this payment will usually no longer be needed once their home equity reaches 20% of the home value.

“Lastly, they have to worry about ongoing maintenance and repairs that come with owning a home. The exact amount of these ongoing costs is difficult to predict. Still, a common rule of thumb is that you should plan on spending about 1% of the home’s purchase price each year on home maintenance. 1% x $250,000 = $2,500 a year in maintenance and repairs.

“Altogether, these costs add up to gross housing costs of $19,296 a year. However, this isn’t the full story. It means A & B no longer has to pay rent or renters insurance by owning a home. These cost savings should be subtracted from their gross housing costs to find the actual net annual homeownership cost.

“Their rent was $13,776 a year, and their renter’s insurance was $187 a year, so their total housing costs as renters was $13,963. After we subtract this from their gross housing costs, we are left with net housing costs of $5,333 a year.”

Buying a House Can be a Smart Financial Decision If…

Your Life Is Evolving

Suppose you’re starting or growing a family and need more space. In that case, it makes more sense to look towards buying a home instead. For instance, perhaps you might want a large backyard for your kids and dogs to play in. Not to mention you will also have more control over the use of the property as an owner.

As a renter, you typically have to follow rather strict guidelines. For example, some landlords don’t allow pets or parties. Many apartment complexes don’t let their tenants have a grill on the balcony or terrace in the same fashion. It’s seen as a safety hazard.

Breaking the rules could lead to getting kicked out. However, that isn’t the case with homeownership. The only reason you would get kicked out of your own house is that you defaulted on the mortgage.

Although when buying a home in an HOA community, there will also be rules to follow. The same applies to condominiums. But for the most part, you will still have a lot more flexibility than a renter.

You’re Financially Stable

For most mortgage loans, you’ll need a credit score of at least 620 and a debt-to-income (DTI) ratio no greater than 43%. To calculate your DTI, add up your monthly bills and divide the total by your gross monthly income. The final number, which will be in the form of a percentage, is your DTI.

Having a lower credit score will lead to a higher interest rate. A higher minimum down payment might also be required. However, depending on the mortgage type, the minimum down payment amount can range from 3% to 20%.

You Plan on Staying for a While

It usually takes an average of at least 4 to 5-years to break even after buying a house. Therefore, it doesn’t make sense to buy a home if you plan to move after a few years. In that case, it will be better to rent instead.

Home prices rise with inflation. Since 1891, home values appreciated 3.2% before inflation (nominal) and 0.3% after inflation (real).

You Pay Off Your Mortgage Early

Many people aren’t motivated to buy a home because they don’t want to be tied down with a mortgage. Although a 30-year mortgage can feel more like 300-years, it doesn’t have to. This can be done by making extra payments towards your principal to reduce the debt faster. By doing this, you will also pay less in interest as the debt grows smaller.

Moreover, a snippet from Jeff Brown’s article Your Home Is a Better Investment Than Bonds, gives an excellent example of how making prepayments can be beneficial.

“A homeowner with a $300,000 mortgage for 30 years at 4 percent would pay $1,432 a month in principal and interest. By adding about $150 a month in prepayments, the loan could be paid off five years early, reducing total interest charges by about $40,500. Without the prepayments, the homeowner would still owe nearly $78,000 after 25 years.”

After all, an extra $150 per month would save you $37,500 by paying off the loan five years early.

What Makes Buying a House a Bad Choice?

Not Doing Your Homework

Many millennials regret their home purchase because of hidden costs, such as taxes, insurance, and maintenance. For this reason, it pays to do your homework, thus allowing you to form a budget.

However, according to wealth manager and self-made millionaire David Bach, not buying a home is a big mistake for millennials. This is because the average homeowner today is 38 times (2017) wealthier than a renter.

David Bach said the smartest investments he’s ever made were the three homes he’s bought. He elaborated on his success with homeownership to CNBC.

“I first bought a home in San Francisco. It skyrocketed in price. I moved to New York and bought another home, which also skyrocketed in price. My net worth has gone up millions and millions of dollars, simply because I’ve lived.”

He also stated you can easily spend half-a-million dollars or more as a renter for 30-years. For example, $1,500 a month for 30-years is equal to $540,000. As a result, the landlord will become over half-a-million dollars richer over this period at your expense.

David Bach also backs up the statement I made about how important it is to do your homework before buying a house.

“Do the math. Look and see what things costs, starting with the smallest options. This way, you’re really clear on your goals, and you won’t just say to yourself, ‘I’ll never afford this.'”

Getting the Wrong Mortgage

For instance, having an adjustable-rate mortgage (ARM) with its fluctuating interest rates may not be the best option for you.

Say you have an ARM loan with a 5 to 1 ratio. This means your interest rate will change once for five straight years. Then it will become fixed at the most relevant interest rate after year five. For all you know, the interest rate you get stuck with might be sky high or the lowest in history. Needless to say, getting a mortgage with a fixed rate is highly recommended.

the different mortgage types
What Is the Right Type of Mortgage for Me?, Piedmont Advantage Credit Union, December 24th, 2019

Then there are interest-only mortgages, otherwise known as balloon loans. How it works is for a set period (usually 3 to 10 years), you’re only paying interest. After that initial period is over, the principal is finally applied to your monthly payment, making it a traditional mortgage note.

Unfortunately, during the financial meltdown of 2008, some people didn’t know any better and ended up buying a house they really couldn’t afford in the long run. This is why many people are underwater on their mortgage, meaning they owe more than the home is worth.

Not Shopping Around

When buying a home, the two most important things to shop for is homeowner’s insurance and a mortgage.

When shopping for homeowner’s insurance, you need to understand it first and then decide how much coverage is necessary. The next thing to do is see what perils are and aren’t covered. Suppose you’re buying a home in a flood zone. In that case, you will need to purchase flood insurance, which is separate from a standard policy.

Just like any other product or service, the prices and discounts will vary per provider. First, you need to find an insurance company that offers coverage in your area. Next, check their ratings and find out what customer service options are available. A few examples would be 24/7 support through the providers’ website, live operators, or local agents.

Equally important is shopping for a mortgage. As mentioned above, you do not want to get stuck with the wrong mortgage. For example, if you’re a first-time homebuyer, looking at loans that require at least 20% down might be far out of reach. But getting an FHA loan with its minimum down payment of 3.5% could be your best option.

Credit score requirements and interest rates will vary per lender. Some lenders also charge more fees than others. Another thing to look at is the repayment terms. For instance, would it make more financial sense for you to have a 30-year or 15-year mortgage? Other things to look for are mortgage points, and the annual percentage rate (APR).

Maxing Out Your Budget

Just because the lender says you’re pre-approved for $350,000 doesn’t mean you can comfortably afford a home at that price point. Instead, you might find that spending no more than $320,000 will be easier on your wallet.

You really should follow the 28/36 rule. No more than 28% of your gross monthly income should go towards household expenses.

Likewise, no more than 36% of your gross monthly income should go towards your total household debt. This simple ratio can quickly help you determine how much house you can afford. Below are two examples from Julie Compton’s article “How much house can you afford? The 28/36 rule will help you decide.”

“When calculating your household expenses, Sethi says to consider everything your mortgage will include: the principal, interest, taxes, and insurance, or PITI.

“In total, your PITI should be less than 28 percent of your gross monthly income, according to Sethi.

“For example, if you make $3,500 a month, your monthly mortgage should be no higher than $980, which would be 28 percent of your gross monthly income.”

“To determine your debt-to-income, calculate the dollar amount of monthly debt you owe divided by the dollar amount of your gross monthly income.

“For example, if you have $1,000 of monthly debt and make $3,500 a month, then your debt-to-income ratio would be .28.”

Overbuilding for the Neighborhood

Real estate is not the same as playing a game of Monopoly. In reality, you can only force but so much appreciation to a property. Although homeowners add-on all the time, you wouldn’t want to make the house insanely larger than all the rest. Another example would be installing Carrara marble countertops in a home situated in a middle-class neighborhood.

Other good examples of overbuilding for the neighborhood are having a metal roof installed. But in contrast, all the other homes have asphalt shingles. Or being the only home in the community with a stone-veneer front façade while the rest have vinyl siding.

The Unforeseen

Divorces, death, recessions, etc., are all unexpected. After two years of being married, the average divorce occurs, and both parties often agree to sell the house.

If you lose your job during a recession, you might not be able to pay your monthly note for long. Then the next thing you know, your home goes into foreclosure. There are a million and one “unforeseen” events that could happen at any moment. Given these points, it is essential to build an emergency fund.

Being Financially Irresponsible

Making frivolous purchases can cause a lot of damage to your credit score. No matter how small the purchase, if you’re carelessly using a credit card, the outstanding balance will quickly add up. Before making any big purchases, it’s essential to run the numbers to make sure you can actually afford to take on more debt.

Store cards from places like Macy’s and Footlocker have insanely high-interest rates. Sometimes as much as 25% or more. Having multiple store cards and using them carelessly will contribute to the death of your credit score. And, of course, prolonging the journey to homeownership. In brief, if you don’t have any, don’t fall for the okey-doke. If you do have them, get rid of them ASAP.

Remember, the lower your credit score and the higher your debt-to-income ratio, the higher your mortgage interest rate will be. You will also have fewer options to shop around for rates. All in all, I recommend that you do your research to gain more financial literacy. Having a lack of knowledge can lead to costly and long-lasting mistakes.

Why Should You Rent Instead?

Simply put, if you’re not willing to commit to what it takes to own a home, you’re not ready for homeownership. Then again, maybe you’re personally prepared to own a house, but just not financially. In a word, it’s best to continue building up your nest egg until you’re ready financially.

buying vs renting a home: buying a house is not a good investment if you cant afford it
Renting vs. Buying a Home, Greater Greenville Area Homes, J Michael Manley Team, October 20th, 2019

Benefits You Can’t Take Advantage of As a Renter

Tax Benefits

One of the most significant advantages of owning a home instead of renting is tax incentives. Things such as the interest on your mortgage loan and capital gains (up to a certain amount) are tax-deductible.

Homeownership Builds Wealth

homeowner net worth: good investment
It’s Official: Homeowners Are Worth Over 40X More Than Renters, Cornerstone Home Lending, Inc., November 3rd, 2020

The next point is relatively straightforward. Homeowners typically have a much greater net worth.

“According to the Federal Reserve’s latest Survey of Consumer Finances, homeowners have 44.5 times more net worth than renters. Since 2016, homeowners’ median net worth was $231,400 (a gain of 15% since 2013), compared to $5,200 (a loss of 5%) for renters.” The Path to Financial Freedom: How Homeownership Builds Wealth

Freedom and Control

You will have much more freedom and flexibility as a homeowner. Like I’ve said before, as a renter, you’re likely to go by more rules. For example, if you have a dog, no one can tell you that dogs aren’t allowed in your own house.

On the contrary, however, many landlords are opposed to having pets on the property. If you enjoy entertaining, homeownership can allow you to host a summertime cookout. In contrast, if you’re renting a single-family home or an attached unit, the landlord may disallow such a thing.

Lastly, you will have more creative control as a homeowner. As an example, as a renter, you will have to get the landlord’s permission to paint the walls a different color. In the final analysis, what you see is what you get.

Over time, your mortgage note will decrease, whereas your rent will increase

In a lease agreement, there will generally be an escalator clause. An escalator clause means the rent will periodically increase. But with a mortgage, you can lower your principal and interest by making extra payments each month.

On top of that, refinancing (when necessary) can allow you to get an even lower monthly payment. Eventually, you can have a monthly mortgage note cheaper than the cost to rent.

The Conclusion

As has been noted, I don’t believe buying a home as your personal residence is an “investment” per se. If the property isn’t making money, it’s a home. Though, people typically use the word investment as a figure of speech while discussing homeownership.

But I wanted to clarify the difference between an investment and an excellent personal financial decision.

If you have your finances in order, then buying a home can be a great decision financially. Especially if you plan to stay for a long time or forever. Of course, many unforeseen factors, such as getting laid off, can make owning a house a financial burden.

All things considered, only you can decide if buying a house is the right choice.

pros and cons of homeownership
Both Images: Rent vs Buy: The Pros and Cons of Homeownership, PennyMac Loan Services, LLC, Alena Savchenko, April 16th, 2019
pros and cons of renting

You can start by using the 28/36 rule. That will give you a general idea of what you can currently afford.