In this series I am covering the 24 tell-tale signs that you could be in financial trouble. Over the next few weeks I will be presenting these signs, how to identify them and tips on how to address the issue.
Homeownership is part of the American Dream and many finance pundits insist you need to become a homeowner in order to be successful. While it is true that owning a home can be a significant key to building long-term wealth and financial stability this isn’t always the case. There are many instances where buying a home can actually do more harm than good, and occasionally ruining your finances.
Why Should You Buy a Home?
There are many good reasons to buy a home:
- Mortgage interest and generally property taxes are tax-deductible
- The possibility of not paying taxes on the profit made selling a home (up to certain limits)
- Increases your net worth by building equity
- Possible appreciation in value of the home
- Freedom to build, design, and fully control the look and feel of your dwelling
These are all nice benefits for owning your own home. You can save money on taxes, your mortgage payments build equity (albeit sometimes slowly) which can in turn be sold for a profit in the future, and you have almost complete freedom in regards to how you want your home, yard or garden to look inside and out. But when the positive reasons to buy a house there are negative reasons as well.
Why Shouldn’t You Buy a Home?
Even good things have bad counterparts:
- The tax benefits may not be as substantial as you thought
- Real estate values do not always go up, or increase fast enough to guarantee a profit when you sell
- If you are young or uncertain where the future is headed, owning a home doesn’t provide the flexibility to move on short-notice
- No more landlord. You are the landlord and when something breaks, you need to fix it yourself or pay to have someone fix it
- General maintenance can eat up a lot of time and money
Finding the Balance Between the Pros and Cons
Buying a home is a very big decision whether you are married or single. Each situation is unique and just because conventional wisdom leads you to believe you must own a home sooner than later doesn’t mean it is right for you. Take a look at your situation to see if the benefits will outweigh the many negative issues.
Ask yourself these questions: Will the tax benefit really have that much of an impact over your standard deduction? Are you certain you will be working in the general area for years to come? Do you have the time and money to put into maintaining the home? If any of these answers are uncertain you need to really consider whether or not buying right now is the right decision for you.
Some People Say You Can’t Go Wrong Buying a Home
Wrong. You can do great harm to your financial future if you buy a home for the wrong reasons. This is especially true for people who either like to move frequently or have an job situation that may lead to a move within a few years. If something arises that requires you to move from your newly purchased home within the first few years you are looking at the possibility of losing a substantial amount of money.
First, the real estate market is a bit unpredictable which can be seen in real situations recently. If you need to sell a few years after you buy do you think the value has increased enough to be profitable? Even if the value has increased greater than inflation will that amount be enough to cover the thousands of dollars in fees and closing costs associated with selling the home? Also don’t forget that in some areas a home may take many months if not a year or more to finally sell. If you are pressed for time you may have to substantially reduce the price to get rid of it in a timely fashion.
Second, homeownership simply isn’t for everyone. If you enjoy city life it can be virtually impossible to find affordable housing in or around the city. It may be far more beneficial to rent. For others they are simply too busy to tend to the issues that come from owning a home. If you have a lawn, it needs to be mowed. If you live in an area that gets snow in the winter your driveway and walkways will need to be cleared. If your water heater breaks you will need to go buy another one and have it installed. Young professionals can find themselves too busy to tend to these issues, and while they require time, more importantly they require additional funds that you don’t have to worry about when you don’t own a home. These types of things alone can account for hundreds or even thousands of dollars a year.
As you can see, just because the talking heads on TV or throughout the internet boast about how owning a home is almost a requirement to become wealthy doesn’t mean it is for everyone. Don’t feel like you need to rush into buying a home just because all of your friends are or that you feel you need to in order to start building equity instead of throwing away money on rent. Clearly there are benefits to owning a home but if you make the decision too soon or for the wrong reasons you can find yourself actually doing more harm than good.
Author: Jeremy Vohwinkle
My name is Jeremy Vohwinkle, and I’ve spent a number of years working in the finance industry providing financial advice to regular investors and those participating in employer-sponsored retirement plans.
Renting is not always a guaranteed loss. Actually, buying in some of the current markets is a guaranteed loss over almost any time frame.
You need to factor in the total costs of owning a home including up-front fees. You need to factor in the amount of money that you're going to pay in interest (not principal), which in the first 5-10 years, is a huge chunk of your mortgage payment. You need to factor in how much less it costs to rent and the expected returns that you could get on that money, minus capital gains taxes.
I live in the DC Metro area. I pay $1150 to rent a nice apartment. If I were to buy the same place it would cost me 350k.
My model assumes 7% real market returns (the average long term real returns) and a 6.3% interest rate (current long term interest rates for people with great credit). Based on my calculations, if I paid any more than 200k for that 350k home, I would be practically guaranteed to make less money over any time frame than if I hadn't bought at all.
The NYTimes has a nice calculator that runs the numbers for you. My own projections turned out to be substantially the same as those produced by the NYTimes calculator. The calculator can be found at the following address: http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?ex=1184990400&en=79c508dac7ecd2e9&ei=5070
Note that the default assumed rate of return used by the calculator is 5%, which is ridiculously conservative.
We decided that renting was a better option for us after we started looking at homes to buy. No one ever tells you about all the extra costs that homeownership incurs. We live in an area with high property taxes, yet a low cost of living. There aren't only property taxes, but association fees, mortgage interest payments, homeowner's insurance, and repairs which can run in the thousands per shot. While home hunting, we learned why so many of our friends who own homes are broke all the time, even if they have 2 incomes and no kids. Typically in this area, if you pay your mortgage completely off, the amount you pay in all of these fees are just like having an average apartment anyway.
Besides, we don't see renting as "wasting money", because we have a home, a roof over our heads. We invest in other ways, and are happy with our choices. People our age need to be careful that the choices they make are *their own* and not our parents' dreams. You should examine everything very carefully, and not just jump into something because it's what our society says you should want. Make sure you really want it first. Too many people our age ended up screwed from listening to their parents.
I think you're ignoring the main reason to buy a house: you don't have to pay rent! Rent is a guaranteed loss, and in order for the landlord to make money your rent has to be significantly higher than the maintanence costs of the residence.
When the housing market is going up, the increased value of your home will offset the maintanence costs and property taxes. When the housing market goes down, you will lose money, but remember: you were already losing all of the money you were paying for rent. So the risk is not that you might lose money, but rather that you might lose more money than you were already losing by renting.