The Mortgage Myth – Why Your House is NOT an Investment.

When I tell people that their house is likely not a great investment, they tend to call me names, throw their drink at me and often recoil in horror. Now, don’t get me wrong, I’m not suggesting that a house is a financial asset, or that housing decisions should be based on a financial analysis. Quality of life issues are more important. However, there is a common belief that a primary residence is a great investment. But, before you make that leap for the big house that’s way over the budget, and justify the purchase as an investment that will pay off you may want to run the numbers. The numbers often don’t support this conclusion.

Don’t believe me? The math is easy, take the purchase price of your home, add all of the mortgage interest and property taxes that you will pay, for as long as you plan to own the house, deduct the estimated tax savings from your interest and tax deductions. Also, don’t forget you’ll have to pay a commission when you sell it. Here’s an example:

    Purchase 1 Purchase 2   Difference
Purchase price   500,000 300,000 a 200,000
Assume 10% down   50,000 30,000   20,000
Mortgage   450,000 270,000   180,000
Pmt 30 yr loan   2,148 1,289   859
Interest paid, 10 years (4%)   162,647 97,588 a 65,059
Assume 1% taxes, 10 years   50,000 30,000 a 20,000
Tax savings at 30%   -63,794 -38,277 a -25,518
Ending principal   355,419 213,295 -b 142,124
Total cost a 648,853 389,312   259,541
           
Projected selling price 7% annual appreciation   696,650 417,990   278,660
Less commission 6%   41,799 25,079   16,720
Net Selling price   654,851 392,911 b 261,940
           
Gain after 10 years   5,998 3,599   2,399
           
Cash realized from sale   299,432 179,616 b 119,816
           
Cash savings 10 years         139,725

This is a quick analysis, a common decision that we go through when buying a house. Where do I set the budget. Do we buy the $300K house that fits our family, or do we make a bigger “investment” and buy the fancy $500K house that will impress our friends? In this example assume we plan to sell the house in about 10 years when the kids go off to college. Maybe the bigger house is a little more than you need, but it’s a “good investment” and we’ll benefit when we downsize, right?

Based on a 4% interest rate, 1% property tax rate, 30% tax savings on interest and taxes, and a 6% commission at sale, then after a whopping 7% annual appreciation rate on the property, your overall gain at sale is essentially nothing, less than nothing if we factored in the other costs (insurance, HOA etc). Meaning that you paid as much for the house in total than what you sold it for…. Not really my definition of a good investment. Most people will feel really good selling that $500K house and getting almost $300K from the sale, that’s a great gain!! What do you mean it’s not a good investment? Thats YOUR MONEY, you essentially made an interest free loan to the real estate/mortgage industry. You’re just getting back the cash that you paid for your down payment, principal and interest on the loan. Your house is therefore a savings account that bears no interest. And, if you don’t get a relatively high rate of return of 7%+ you’ll actually have a loss…

 

Again, I’m not advocating renting over buying, there are a variety of benefits to buying a house over renting. The biggest benefit is that you get some of your cash back when you sell, which is a huge benefit, it’s just not a gain. Plus, a house is a lot more than just an economic asset, it’s where we raise our kids and live our lives. However, if you’re buying more house than you need because you believe your house is a great investment, then you may want to run the numbers and see if that’s actually true. Based on the above analysis, spending $200K less on a house creates a $139,725 economic benefit over 10 year (likely much higher if the money is invested at a reasonable rate of return). Which you can use to invest in an asset that you might actually recognize a gain on, or better yet, pay off your mortgage early so you can benefit from the appreciation of the housing market.

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