“Why not buy a larger home with a bigger yard? It’d be a great investment.” A friend of ours asked us this question when we mentioned how it might be nice for Baby Moneyaire to have a bigger yard to play in. We’ve recently been looking at single family homes with a yard. However, Mr. Moneyaire and I know that a home is not a great investment.
It’s conventional wisdom that owning a home is a great way to build wealth. After all, you build equity in your home by owning it and as the property value goes up so does your wealth, right? Well… sort of. In practice, your home isn’t a great investment. Hear me out. I know we’re told that homeownership is the key to financial success. What’s actually true though, is that the right home can help you build financial success. There are a several things working against your home being a great financial investment. However, homeownership can be an important and critical component to your financial strategy, if you do it right.
When I own a stock I don’t pay taxes on it when I hold it, just when I sell at a profit. But the house I own, I pay property taxes on it every year. If I fail to pay my property taxes every year, the county I live in can take my house and sell it to someone that will pay the taxes, even if I own my home outright or I’m current with the mortgage. Because of this, most banks require you to escrow your taxes with them. Escrow is when the bank forces you to make monthly tax payments as part of your mortgage towards the property tax which they then pay on your behalf.
Banks know that skipping a property tax payment can put a property – and their mortgage investment – into jeopardy. Banks want to mitigate as much risk as possible when they give you a loan. One of the ways they do this is by making sure you make those tax payments.
In some parts of the country taxes can be as high as 2.3% of the value of the property you hold every year. We live in a state, county, district and township that require us to pay pretty darn high taxes because we have really nice services. We live in an area with an excellent school system, nice public services, like an award winning park district, library, community college, not to mention city services like snow removal, police and fire. All these services cost money, and are paid for largely by property taxes.
Mo’ Money Mo’ Taxes
Our home’s value has appreciated quite well since we purchased it at the bottom of the housing bubble. When we first moved in our taxes were about $4,500 a year. This year’s property taxes went up to $7,100. We’ve lived in our home for about 12 years now and have paid about $60k in taxes over that period.
You can write off some of your property taxes when filing your taxes with the IRS every year; however, that’s capped at $10k.
Now, there are parts of the country where the real estate taxes are pretty low. We have friends who recently moved to South Carolina and live in a beautiful home with ample square footage and they pay just under $1,000 a year. That’s less than their monthly tax liability when they lived in Illinois. However, they have to pay A LOT more in insurance because they’re right on the water. Which brings me to my next point: insurance.
If you live in a single family home you’ll have to pay for homeowners insurance for the entire structure, inside and out. If you live in a condo or townhome you’ll be responsible for studs-in typically. In these dwellings you’ll need condo insurance which covers things like cabinets, appliances and personal belongings. The average home insurance rate for a single family home in the United States worth $250,000 is $1,383. If you live in an area prone to hurricanes, flooding or fire, insurance could be a lot more and you may need additional riders to cover your home. The more your home is worth, and the more valuable the contents, the more you’ll pay in insurance.
If you have a mortgage, most banks will require you to have homeowners insurance. Again, the banks want to insure their investment. If you are mortgage free, you can skip getting insurance, but you put yourself at a huge risk for losing the home and everything in it if disaster strikes.
Most folks purchasing a home have to get a loan, or mortgage. In order to get a loan you usually have to pay the bank a fee just for the loan and then, you’ll of course pay interest on that loan until it’s paid off. The way mortgage loans are structured, for the first several years you’ll be paying more in interest than on the principal of the loan so your equity stake grows slowly. For example, the first mortgage payment you make on a hypothetical 30 year mortgage of $300k at a 4.25% interest rate will be $413 in principal and $1,063 in interest. You’ll be paying more interest than principal for about 15 years of the loan. This is a calculator you can use to help you see the amortization schedule of a loan.
Write off your interest
You can write off the interest you pay on your mortgage on your taxes. You can deduct the interest for the first $750k of your home loan. There are no income limits. This article can help you figure out if itemizing your deductions is better than taking the standard deduction. For most tax payers, taking the standard deduction makes the most sense. According to the non-partisan think tank, Tax Foundation, in 2019 only about 13.7% of filers itemized their deductions.
However, instead of deducting interest payments, it’s a lot cheaper to just pay less in interest in the first place. As interest rates rise, that interest just takes more of your money.
Maintenance, Remodeling and Upgrades
I LOVE watching HGTV and all the home remodeling shows. For the most part the costs are mostly glossed over. More time is typically spent bashing builder grade. On these shows, issues with plumbing, electric and sewer are just mild headaches. It’s not realistic.
In order to keep a home running, looking good and relatively up-to-date, it takes quite a bit of maintenance, time and eventual remodeling. And money. Lots of money.
Less than a year after we moved in to our townhome, our furnace went out in the middle of January and our AC was nearly 15 years old. The HVAC company we used offered to give us a discount to replace both. It was an expense we had anticipated, but not so soon after moving in. It cost us $7,000 to replace these systems and about $200 a year in maintenance. Recently, we had an outdated primary bath that began leaking into our kitchen. It needed an overhaul. We got pretty middle-of-the-road finishes and changed some plumbing and structures around. It cost us north of $25k for the work and materials, even after Mr. Moneyaire demoed and painted himself.
But wait, there’s more!
We’ve also had to replace all our windows and carpeting, finish our basement, put in recessed lighting and painted. We turned our loft into a legal bedroom. Added built-ins. Replaced all of our appliances as they’ve broken down. We’re pretty prudent when it comes to our maintenance and remodels and its still expensive.
A lot of homeowners put themselves in a tough spot by taking on a mortgage at the maximum of what they can afford. It makes regular maintenance and upgrades really risky to take on and can be a precursor for more consumer debt.
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Homeowners Association fees
Another fee that has become more common are Homeowner Association fees. These fees can be as little as just under $100 per year to hundreds per month. Our HOA covers our exterior maintenance (excluding our deck), landscaping, snow removal and a variety of other things like group homeowners insurance. A few years ago our association replaced the roof on all the homes in the community using our dues reserves. We are lucky that our association is well funded and we didn’t have a special assessment to cover the cost. However, we pay dues every month that are budgeted for long term and regular maintenance. If we don’t pay our dues, the HOA can put a lien on our home or even force us out of it to recoup unpaid HOA dues.
Not all homes are part of an HOA and some HOAs don’t cover maintenance or insurance. If they don’t, then the responsibility of upkeep is up to the homeowner. Some folks love yardwork and gardening. I’d rather not mow the lawn myself or spend weekends landscaping. Nor do I want to worry about our roof. If we have any maintenance issues such as a leaky roof or a seal that needs to be replaced on the garage, our association takes care of it for us. Its expensive but not much more expensive than if we owned our own home and were responsible for all the exterior maintenance and repairs.
Owning a home costs a lot of money in a very direct way. The mortgage, property taxes, HOA dues, lawn care, maintenance, remodeling etc. But what’s not discussed as much is the opportunity cost. If you weren’t busy fussing over your yard or spending money fixing up your house or furnishing it, how could your time and money be otherwise used?
We’ve asked ourselves this question and the answer has been to buy other properties, fix them up and then rent them out to other people for a profit. We also have invested our time and money into the stock market. The opportunity cost we’ve saved on is using our “disposable” income towards things that make us money instead of cost us it. Instead of using the money we’ve worked for towards bigger housing costs, we’ve decided to direct that money into investments that make us money, i.e. we put our money to work.
A common argument is that the value of a home is worth the investment, so the bigger the better. That’s mostly not the case. A big reason for that is you can’t use the equity in your home easily.
An Illiquid Asset
As you build equity into your home, your net worth certainly grows. However, the money you “put into your home” isn’t easily accessible unless you sell, get a home equity line of credit (HELOC) or secure a cash out refinance.
HELOCs and refinances can cost hundreds or even thousands to purchase and have to be paid back in interest.
When you sell your home, you’ll have thousands in fees you’ll need to pay. If you use a realtor, you’ll have to pay their fee for their services. On the buy side, you’ll have closing costs which include title fees and insurance, legal fees, inspection fees and mortgage fees and some areas of the country even require you to purchase property transfer taxes or a fee to the local government for buying or selling a home.
When a home is a good investment
I’m not saying that buying a home is a bad investment. We own our home. We love where we live and our home. There are many benefits to homeownership. However, buying more than you need or paying more than you can comfortably afford, that’s not going to help you.
Buying a home that meets your needs and is below your means and redirecting the savings towards investments can be a wise component of a financial strategy.
We purchased our home and it’s one of the best financial moves we’ve made. Our home’s value has gone up considerably. If we sold our home today we’d recoup most of what we’ve put into it in terms of interest, taxes, maintenance, remodeling and HOA dues. We’d be close to breaking even. However…
Breaking even is not a great investment.
The biggest advantage homeownership has given us is the opportunity to direct our time and money towards investments that have made us money. We bought a smaller modest home cheaply after the housing bubble burst. The mortgage and real estate taxes are well within what we can afford. If we rented a similar home in the same neighborhood, we’d be paying more in rent than we currently pay on our mortgage. We bought at the bottom of the housing market and our monthly mortgage reflects that. Even as home prices and rents increase, our mortgage hasn’t. In fact, after we refinanced our mortgage, we were able to secure a lower interest rate and we’ll pay less towards it overall.
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Your home isn’t a great investment.
I hate to say it; your home isn’t a great investment. Home is a special place and has more value than how much you can get for it. Treat it as such.
Every parent wants the best for their child. We certainly want Baby Moneyaire to have enough space to play and grow in. Moving into a larger home with a yard has been on our minds. We might even do it. However, it wouldn’t be a great investment.
We certainly could afford a larger home and commensurate costs. But is that a priority for us? Will it make us, and more importantly, Baby Moneyaire happier? Maybe. Or maybe an extra vacation to see Baby Moneyaire’s Nonnie and Papa will. Maybe its staying in our awesome neighborhood. Or maybe its allowing me to stay home to dote on her. We can always go to one of the many parks surrounding our home for a game of catch. We are after all subsidizing it’s existence.