Owning a home is the “American Dream.” Your children running in the back yard, family holiday traditions, and you finally feel that you “dropped your roots.”
Question: What could be better?
Answers: How about being financially wealthy?
Most American’s hinder their saving ability and increase their personal consumption when buying their homes, a decision that can be financially crippling for their entire lifetime.
Before I dig into this subject further, let me make this clear, there are some exceptions to this rule. There will always be those examples of how someone put down 5% on a $250k house that later would be worth $1million just 7 years later. This article is talking about the average family and the average American Home (think Midwest).
We have too many “rules of thumb” when it comes to housing. Too many realtors and propaganda campaigns that are are aimed at pushing you into your “dream home.” The US government actually commonly takes time to makes policy to encourage home ownership. All signs point to home ownership as good, but have you ever stopped to think… why is there so much effort to get me to buy a home?
When I bought my first house for $126k and later sold that same house for roughly $160k (just 3.5 years later), there was roughly $24,000 of fees (both the buying and selling of transactions combined). Now of course I didn’t pay all of the fees, I paid roughly half of them in fact (more like 40%), and that’s a very common situation. The amount you actually pay out of pocket varies tremendously, but in reality most people don’t pay very much directly out of pocket. Most of the expense of buying and selling a house is completely on paper. Think about it, you get sellers assistance when you buy the home, and usually you end up losing 6-8% of selling price in costs out of the check you will receive. You usually have to contribute a down payment, which tends to be very small on average.
Let’s talk about actual fees (expenses that are gone forever).
There are plenty of fees every time a contract is written (buying or selling). In fact, below are what my buyers paid on their HUD statement, in addition to the realtor fees occurring in the transaction.
- Commission set dollar fee – $225 – often charged by realtor groups
- Origination fees – $1286.95
- Processing Fee
- Underwriting Fee
- MER Fee
- Appraisal Fee – $225.00
- Credit Report – $90.30
- Flood Certification – $6.00
- Flood Life of Loan – $9.00
- Title Service / Insurance – $1239.50
- Delivery Service – $20.00
- Attorney Fees – $75.00
- Seller Disbursement Service – $50.00
- Government Recording Fee – $104.00
- City/County Tax/Stamps – $476.00
- Home Warranty – $479.00
- Home Inspection – $300.00
- Carpenter and Termite Inspection – $250.00
Where I live, you can count on about 8 – 10% of the home’s value being generated in fees, commissions, or services. Homes are a real money maker for a lot of people. That’s why it’s important that our housing market continues to be strong, because our economy really needs it. A lot of people would lose their jobs if people stop buying and selling houses.
Back to the matter on hands, why is this home going to keep you in the middle to poor class? Well there a few reasons.
People Underestimated The True Cost of Home Ownership
This is something I cannot stress enough. A home might be appreciating in value, but the home is actually something that is used up. This might seem strange due to the fact it’s a building, but many components of the house simply don’t last. The furnace, roof, windows, siding, sidewalks, flooring, air condition, water heater, and much more, only have a limited lifetime. Going back to the rule of thumb for housing, a home costs roughly 1% of it’s value to maintain a year. So that $250,000 house should come in around $2,500 a year in just maintenance. Now of course that’s an average. When your air conditioner and roof go bad in year 2, that average means nothing to you at that moment. It’s not all big ticket items though, even the little stuff can add up in a hurry. Those $100 trips to a big box store where you leave feeling as if you bought nothing at all. Remember that 1% is without improvement or upgrades, just maintain.
People Overestimate The True Benefits of Home Ownership
“But what about the tax deduction!?”
My Reply: It’s overplayed tremendously, especially if you live somewhere with a low marginal tax rate.
Most Americans don’t even realize that you lose the standard deduction when you itemize! I would guess that 90+% of home owners do not know an approximate net tax savings per year or month they receive from owning their home. Also realize that the deduction gets smaller as you go along (because you have less interest).
People forget the Opportunity Costs of Home Ownership
You will likely buy a house larger than what you need, it’s very common for someone to buy for their future needs. It’s also likely you spend more money per month owning a house than you would renting. I’m not talking about the propaganda “net cost” which will work it’s black magic to take out the paper gains (equity and appreciation), I’m talking about actual cash flow. Cash flow that could have been put into investments. I promise you that if you rent a small place or buy a small home, meeting your actually needs today versus buying a large house, you will save hundreds a month. Let’s also not forget the down payment. All money that could have been invested.
If you invest just $100 a month in 8% return investments (compounded monthly) over the next 30 years (average term of mortgage), you would have $150,822 after those 30 years! You really don’t think your larger than needed house changes your cash flow a few hundred dollars? Take a harder look, most of the time it does. Remember this is cash flow, not “black magic” appreciation/equity.
Renting Is Actually Fairly Smart.
You rent the 1 bedroom when single and the 2 bedroom when married or dating while living together. You don’t buy more capacity than you actually need. You also have less utilities and sometimes it’s even included in your rent! Maybe you have a job change and end up moving entirely, avoiding the potential buying and selling costs of owning a home. Or perhaps you simply find another local job and move somewhere where you will use less gas commuting each day. All of the financial benefits you get from renting then invested, providing you with returns you never would have seen if you rushed into ownership.
People will common say that “rent includes all costs plus profit,” but the fact is, the profit kind of sucks and it represents a return on the landlords money (equity). It’s extremely rare for a landlord to be pulling over 10% return on real estate without considering a good year of appreciation or heavy, risky financial leverage. Even with appreciation, equity, and rents, it’s common for landlords to be hitting around the same as the stock market has averaged of the last four decades.
People act as if when they give a landlord $9000 a year in rent as if it is all profit, but it’s not. Taxes, insurance, and maintenance are just some of the expenses landlords occur. So maybe your landlord profits $2-3k off you a year, but who cares! The difference in consumption of space (potential extra unused rooms), utility costs, avoiding real estate fees, and capturing financial opportunities will exceed this amount. Not to mention, you have less responsibility and a huge amount of flexibility.
If you really want to be fair, consider the fact you usually lose 8-10% of your home’s value day #1. So that $200,000 house gives you -$20,000 day one! Suddenly the $2-3k profit the landlord takes from you each year looks like peanuts.
Just remember, $100 a month @ 8% is $150.8k after 30 years.
So lower your consumption, use only what you need, save, and invest. Don’t get bogged down by real estate you don’t need. If you are going to buy, consider what you need. That extra $300 or $400 a month really could be the difference between you and wealth. Also don’t forget that housing is risky too and we are entering unprecedented times. We have potentially rising interest rates, baby boomers selling off, and home ownership rates that are extremely low. Housing might not return to it’s bubbly days, days sparked largely by the social pressure to buy into the “American Dream.”