Pros and Cons of Home Ownership as an Investment
A Family's Home is Usually its Biggest Asset
In America today the vast majority of the population own their own home.
Throughout history people have always had a desire to possess a piece of land which they can call their own. Part of the lure America has had for people since its earliest days has been the opportunity to own one's own land.
For most Americans their home is their biggest investment in terms of the money involved to purchase the home as well as their biggest single asset in terms of value.
The media and academia periodically wring their hands with concern over reports showing Americans having one of the lowest household savings rates among advanced industrialized nations of the world. However, others soon follow with new data showing that, when homeownership is factored in as savings, the gap is narrowed considerably. In other words, instead of putting all their money into cash savings vehicles, Americans use much of their savings to build equity in their homes.
Owning One's Home Generates Costs Rather than Income
While home ownership might be a form of saving, it is not a very liquid form of savings as you usually cannot easily pull your cash out. It is also not much of an investment in the sense that it generates expenses rather than an income stream which investments are expected to deliver.
All investments require the investor to put money, time, expertise or some other asset of value into the investment. Many investments such as investing in real estate to rent, your own business, etc. also require additional infusions of cash to cover on going expenses. However, the difference between your home, which involves on going expenses, and another type of investment is that other investments are expected to yield an income stream in excess of these expenses while one's home does not do this.
This is not to say that real estate is not a potentially good investment option. Real estate can be a good investment option as explained by Mark Knowles in his Hub entitled Real Estate as an Investment. However, what I am saying here is that you should not look upon your home as a savings or investment vehicle, the main reason being that in order to profit you have to sell it which usually then leaves you without a place to live.
However, this does not mean that owning your own home does not make financial sense as there are many financial advantages to owning your own home. Before looking at these financial advantages lets take a look at the costs and other considerations which differentiate home ownership from other income producing investments.
Ongoing Costs of Homeownership
Mortgage: The first consideration is the cost of the loan. Most people cannot afford to pay cash for a home so they have to borrow and this generally takes the form of an amortized loan in which the loan is paid off in equal monthly installments over a period that is usually between fifteen and thirty years.
To calculate the total cost of the interest on such a loan simply take the principal and interest portion of the loan (also called the P&I - don't include the escrow or impound portion of the payment which is the portion as this part of the payment is for taxes and homeowners insurance) and multiply it by the number of payments made over the life of the loan (to get this multiply the number of years the loan was made for by 12 to get the total number of payments - for a 15 year loan this would be 180 months, for a thirty year loan this is 360 months) and then subtract the original price of the home from this number and you will have the total interest you can expect to pay on the loan.
Depending upon the interest rate and term, the total interest you will pay can be three or more times the price of the house.
One way to significantly reduce the total interest you will pay on the loan as well as the term is to utilize a bi-weekly payment system which I have described in my Hub on bi-weekly loan payment methods
Property Taxes: The next major on going expense is taxes. The major revenue source for most local governments is property taxes whose rates are based upon the value of the property. City governments, county governments, school districts, etc. all rely primarily on property taxes for revenue.
Frequently, the mortgage lender includes one-twelfth of the estimated annual property taxes in the mortgage payment and then pays the taxes with these funds when they come due. The reason for this is that, just as your lender can foreclose and take the home and sell it to get its money back if you fail to make your mortgage payments, so too can a local government take your property and sell it to recover unpaid taxes. Since the government has priority over the lender if both are owed money, the lender makes a point of collecting the tax money from you in monthly payments and paying the taxes when they come due.
Once your loan is paid off, you still have to continue paying property taxes or lose the home so this is an ongoing expense of home ownership. Also, in addition to being an on going expense, taxes tend to increase regularly which usually results in your mortgage payment increasing every year or so even if you have a fixed rate rather than an adjustible rate loan.
Property Insurance: Homeowners or hazard insurance is another expense that is often included in your loan payment. This insurance protects you, and your lender, against financial loss in the event the home is damaged or destroyed by fire, weather, etc. A lender will require you to maintain adequate insurance coverage so long as you have the loan as they stand to lose if the property is destroyed. Again, this cost continues even after your loan is paid off - that is unless you want to gamble and risk losing all you have invested in the home in the event of fire, storm etc. An empty lot is usually not worth much.
Homeowners Association Dues: If your home is a condominium, co-op, townhouse or other home in a development that includes common property and a homeowners association you will also have to pay a monthly homeowners association fee.
While homeowners associations generally don't have the power to foreclose and take the property, they can place a lien on your property and prevent you from selling the property until the back fees and collection charges are paid. It is a good idea to read the CC & Rs (Covenants, Conditions and Restrictions) carefully before agreeing to purchase a home with a homeowners association as these documents describe all the other rules that go with the home besides the homeowners association fees.
Many people discover too late that there are other restrictions they can't live with such as limitations on pets or rules that require that all vehicles to be parked in the garage and the door kept closed, etc. Breaking the rules results in fines which also become liens against the property thereby forcing the owner to get rid of the pet/extra vehicle, etc. or the home.
Furnishing and Maintenance Expenses
Then there are the costs of furnishing. While apartments often come furnished, it is up to the buyer to furnish a home they own. Home buyers often have some furnishings but usually end up having to purchase additional furniture and appliances to fill the home. Homes often come with appliances but even here, appliances tend to break down and need repair or wear out and need replacement. With your own home you have to pay for the repair or replacement as there is no landlord to call for this.
Finally, don't forget maintenance and repair for the home itself. Again there is no landlord to take care of this. It is a good idea to invest in some basic tools - hammer, screw drivers, pliers, wrench and plunger (for unplugging stopped drains and plugged toilets) for starters along with a spade and rake for the yard.
Also, unless you live in a place like Tucson, Arizona where most homes don't have lawns and the occasional snowstorm rarely leaves more than a quarter inch on the ground you will need a lawn mower and a snow shovel. These tools will enable you to handle basic routine maintenance and repairs. If you are the do it yourself or handyman type who likes to undertake major projects you will, of course, require additional tools.
For the really big jobs have some money or a line of credit ready as there will be times when the furnace gives out or needs major repair, the roof leaks and needs repair or other major repair or maintenance problems. Sometimes insurance will cover the cost (such as if the damage to the roof was caused by a storm rather than age) but other times you, as the owner, will be responsible for the costs.
Financial Advantages of Homeownership
So much for expenses. While there are many expenses associated with home ownership and the investment in the house will not result in a stream of income, there are financial advantages to owning a home.
No One Can Tell You When to Move Out: First of all, it is yours and so long as you pay your mortgage and taxes your chances of having it be taken away and being forced to move are small. Your choice to move or not to move is basically up to you and not some landlord.
Tax Advantages of Homeownership: Then there are the tax advantages. Under the current Federal and most state income tax laws the amount of interest you pay on your mortgage and property taxes you pay every year can be deducted from income for tax purposes. This deduction can take a noticeble bite our of a person's income taxes. Even though the rent people pay to rent homes or apartments, is set high enough to cover their unit's portion of the landlord's mortgage interest and taxes on the structure it is the landlord and not the renter who gets the tax break. So, while renting includes interest and tax expense, only owners of their home get to take this deduction.
There are other deductions, such as medical expenses, which can also be used to reduce income for tax purposes. For most of us these usually are not large enough to reduce income by as much as the standard deduction that everyone receives automatically so it doesn't make sense to use them. But for homeowners the interest and property taxes are usually greater than the standard deduction which means that a homeowner can add these other deductions to further decrease their income tax liability.
Building Equity Over Time: While owning a home is not the same as putting money into a savings account, it can be a savings plan of sorts as a portion of each month's payment goes toward reducing the loan balance thereby increasing the owner's equity in the home. In the past this equity was not easily accessible. However, with financial instruments like home equity lines of credit and easier ability to refinance a mortgage means that homeowners can tap their equity when they need it.
Homeownership is an Inflation Hedge: Real estate values also tend to increase with inflation which means that during periods of inflation, home values rise and keep up with inflation while cash in savings accounts depreciate in purchasing power. Worse still, while inflation erodes the purchasing power value of cash in savings accounts, the interest earned on this savings is taxable as income, while the home increases with inflation and generates taxable deductions. Also, inflation causes rents, along with other prices to rise but holders of fixed rate mortgages will not see their interest rate or payment (other than the tax impound portion) increase.
Because homes tend to appreciate with inflation homeowners will be in a better position to purchase a home during a period of inflation because the value of their equity will tend to rise with inflation thereby providing them with a down payment on a new home from the proceeds of the sale of their existing home while renters who have been putting money into a savings account toward the purchase of a home will see it decrease in purchasing power despite their regular additions to it.
Decision to Buy Depends Upon Individual Needs and Circumstances
Like other things in life, homeownership is neither a good financial move nor a bad one it just depends upon each individuals situation and future plans.
However, buying a home, rather than renting, solely for the purpose of investing or saving is not a good idea because, even though it will allow a person to build an asset that can later be converted to cash for a child's education, retirement, etc., converting it to cash to pay for the education, retirement, etc. will leave the person without a roof over their head.
Links to my other Real Estate Articles
- A Mayor and His Mortgage - A Tale of Financial Disaster
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- Negative amortization
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- Increasing Equity With a Bi-Weekly Mortgage
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- Doubling Your Money with the Rule of 72
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- Refinancing a Mortgage
Refinancing generally refers to the process of getting a new mortgage loan and using the proceeds to pay off ones existing mortgage loan. It can also refer to obtaining a new loan on your car and using the...
- Condominium Ownership
In the case of town homes and patio homes, each unit sits on its own plot of land, which is usually very small, and the owner generally owns that land and, often a small surrounding yard. The rest of the...
- Hazard Insurance - What it is and how to buy it
Hazard insurance refers to insurance that protects property owners against financial losses due to fire, storms and other natural hazards that can damage property. These other disasters can include...
- Tenancy in Common
Tenancy in common is a legal term that refers to property held by two or more people with each having ownership of a certain, undivided, portion of the property. Each person has access to and use of the...
- Leasehold Defined
A leasehold is a form of real estate ownership. When we speak of a lease, most people have the image of a standard rental agreement for an apartment or business property. This type of lease is for a short...
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