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|
|Assume 10% down||50,000||30,000||20,000|
|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|
|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…