In the personal finance world, the decision to own a home or rent is a particularly frothy debate. Traditionally, the long-held belief goes something like this: a home is an investment and a path to building wealth. I’m here to put a gentle and understanding hand on your shoulder, but deliver the hard news that your home is no longer an investment or an even remotely efficient wealth-building machine (was it ever?). But can it still be a better long-term financial alternative to rent?
This will be the first in an on-again-off-again series as we consider selling our home over the next year. We plan to document all incurred costs of homeownership, and compare to what we likely would have spent if renting all along.
But as current homeowners, was it a mistake for us buy in the first place? What should you do if you are weighing home ownership? Quick, math!
The Case for Home Ownership as an Early Retiree
The FIRE community has taken on a staunch view of the pitfalls of home ownership, stirred by largely accurate articles like this one: Why Houses Are a Scam.
The Cliff Notes go like this: a home is not an investment, and for many people, could ultimately be a money-losing proposition once all unforeseen factors are considered. Costs include pesky items like mortgage interest, maintenance, property taxes, insurance, and most importantly, opportunity cost of not investing elsewhere. All true.
BUT…it’s not crazy to envision a scenario where young early retirees with a rental or slow-travel lifestyle later decide that they want to own a home, math be damned. And you can imagine all the intangible reasons. Warm apple pie in your own kitchen, putting sledgehammers through your very own walls, etc.
The problem with that shift in lifestyle though is that it’s difficult to obtain a mortgage without substantial income, and it can be a huge and unexpected hit to your retirement nest egg to buy a house in cash.
I thought this post summed up the sentiment well: The Honest Truth: You May Want More Than $1M Before Retiring.
As I’ve always cautioned, if you want to build a model of financial independence around renting, no problem. But be damn sure that you want to rent forever. I don’t know how you can be so sure, so I’d plan on a model that allows for the purchase of a home in the future, should you ever decide to change your mind.
Lower Risk with a Paid-Off Home
Having a paid-off home is a delightfully fantastic way to hedge against sequence of returns risk once we begin withdrawing on our savings. We won’t be living for free per se — insurance, property taxes, and maintenance costs are still incurred — but it’s pretty damn cheap.
Oh, and don’t think you are relieved of paying many the added expenses of home ownership when you rent! The rental price is often well above the mortgage rate for a good reason. No landlord worth their salt would rent without being able to cover all their (amortized) costs and reap a profit. It doesn’t always happen that way, but that’s the idea. You are paying their mortgage, maintenance, and all other costs for them.
So yeah, I like the idea of having a home that I own, especially if I have little to no income. The market is up? No rent payment. The market is down? No rent payment. No rent price increases, no last-minute notices to vacate. My house, my rules. All is nice and predictable, adding security to our early (and critical) years of investment drawdown.
Home equity is also a fat wad of additional net worth if we ever decide to sell and go back to renting. Or even better perhaps, a home can be a source of income if we decide to keep the property and rent it out.
But I’d be remiss to mention that there is an opportunity cost to owning a home: you can’t put that money into other investments. I know, I haven’t forgotten. We’ll return to that concept.
Our Home History and Property Appreciation
We purchased our first, only, and current home in 2013 for $374,000. We paid 20% down in cash, and took on a 30-year fixed-rate mortgage with a historically low interest rate of 3.5%. At the time of writing, we conservatively believe our home to be worth $580,000. This number is supported by an average of price estimates from Zillow, Redfin, and Homesnap, as well as a recent comp estimate from a realtor back in April. Our realtor estimated a value of $600,000 in April and emailed me yesterday with an estimate for $679,000. Go figure.
So, a lot of folks would do some simple (and incorrect) math to calculate the return on investment, if we were to sell today:
$580,000 (current value) – $374,000 (original value) = $206,000 (equity growth)
Investment growth = nearly 8% per year! Not bad, what a great investment!
Now, hopefully it’s clear that the above relationship is true only if (a) the original home was purchased with 100% cash, incurring no mortgage interest; (b) no upgrade or maintenance costs were incurred (always false); and (c) no fees are incurred to sell the home (false); and (d) no insurance or property taxes are paid (definitely false).
Let’s begin the chip away at that equity growth with some cold, hard facts.
What Have We Paid to Date?
Maintenance, Renovations, Etc.
To date we’ve spent around $30,000 in various renovations, repairs, replacements, and general up-keep. Some of this is a little tricky to track, because not all household spending is unique to homeowners. For instance, I always bought my own light bulbs when I rented. That’s still a thing, right?
Spending here includes precious moments like when baseball-sized hail destroyed our roof and siding (only paid insurance deductible).
There was also the time when we returned home from a climbing trip to find that our refrigerator had gone to heaven with a fresh two-month supply of Costco meat in the freezer. The smell stayed here on earth, filling our home with an ambiance not yet featured by Yankee Candle. *~Memories~*
So, after maintenance and renovations, our equity return is reduced to $176,000.
Mortgage Interest
If you take out a loan on a purchase, you always end up paying more than the sticker price. I pray this concept is not a surprise to anyone.
When we took on a mortgage, we knew we did not want to pay the minimum payment each month for 30 years. The reasons for this are many and surprisingly complicated, but at face value, paying the minimum would require us to pay nearly $560,000 (!!) instead of something closer to $374,000. It’s right there on your loan papers, and it stings. Ouch. No.
So we paid extra on our mortgage each month. The amount varied over the years, but I’d say we’ve paid about 50% extra each month on average, which includes the occasional lump sum dump in the pot. We’ll revisit the pros and cons of this approach shortly.
Even paying extra each month, to date we’ve paid $51,508 in mortgage interest. Gross.
That brings our returned equity down further to approximately $124,500.
Escrow: Property Taxes and Home Insurance
The only difference between death and taxes is that death doesn’t get worse every time Congress meets.
Will Rogers
Yum. Nothing tickles the loins quite like taxes and insurance.
Property taxes are simply the tax you pay to own property, and the rates vary considerably across the country. Our home in Front Range Colorado carries a tax rate well below the national average, 0.56% of assessed home value, compared to 1.211% at the national level. We pay about $2,300 in property taxes per year.
You can play with tax rates in your area with this online calculator.
High Deductible Insurance
For home insurance, we’ve elected to carry a high-deductible plan. The logic you ask? Well, we don’t like to pay extra each month just because of the irrational fear of what could happen. Insurance companies rely on the consumer’s “what-if” instincts to charge higher premiums to protect stuff that said consumer probably doesn’t need anyway. And most people have no choice — there’s no money to cover an unexpected event.
The beauty of being on the cusp of financial independence is that we can afford to cover an expense that would otherwise bankrupt many others. If a B-52 touches down through our kitchen window tomorrow, we’ll take it on the chin for $10,000 and go on with our lives.
According to Mr. Money Mustache, insurance might just be a tax on people who are bad at math.
But it wasn’t always this way. Early in our home-owning years, we paid much higher premiums. Our drive for financial independence re-framed our perspective here, much like it has so many other facets of our life. We took action and greatly lowered a recurring expense: Neat!
We now pay $1,050 per year to insure our home.
All in, once insurance and property taxes are considered, we’ve paid about $18,500, further reducing our returned equity to about $106,000.
Selling Costs
Selling costs are a real nice and often unexpected pain in the ass for homeowners. Just when we think we have a good thing going — selling our home for a sizable profit — we have to face the reality of substantial fees and expenses of sealing the deal.
Costs at this point are many and varied, including further renovations, repairs, and maintenance, to paying realtors and closing fees. I’ve only gone through this process as a buyer and not a seller, so I’m not going to speculate on what we will need to pay. However, this article suggests that selling costs can be in the range of 10% of the home’s sale price. Whoa daddy!
So if that’s the case, we’re on the hook for about $58,000! We’ve reduced our returned equity once again down to a paltry $48,000.
(As with most “here’s what you can expect” articles, we tend to find ways to not spend so much. But I don’t know, so let’s be conservative.)
Our Yearly Return on Home Ownership? 2%
In the simple model of home price appreciation above, I showed that our home price has grown from $374,000 to approximately $580,000 in 6 years, an average of 7.6% growth per year. Hey dude, 8% is the best long-term yearly appreciation we can expect in the stock market, so the American dream of home ownership is still alive and well!
Uh-hem. Wrong.
While that seems worthy of sparkling wine and bacon-wrapped finger food, once all expenses — both past and future — are incorporated, the net return is less than $50,000 over 6 years. That places the net percent yearly growth at 2%, a far cry from the off-the-cuff 7.6% yearly home price appreciation.
In fact, a 2% growth rate on this “investment” is barely keeping up with inflation, even in a hot urban market. Furthermore, 2013-2018 were record-breaking years of home price appreciation across the nation.
In other words, our time in the housing market is about as good as it gets and we are still barely keeping out of the red.
But We Would Have Lost Money Renting, Right?
When we last rented in 2013, we were paying $1,800/month for a small unit in the trendy big city. Yeah, that’s the old CC’s. Assuming we stayed that path, with some conservative price escalation, we would have paid $141,450 in rent expenditures over the last six years, as summarized in the table below. Hot damn I love a good table!
So, instead of paying $140,000 in rent with nothing to show for it, we bought a house and at least netted a 2% yearly return. Home ownership still wins! Right…?
Tune in Next Week…
I know, I just built you up like your favorite episode of Stranger Things. But I don’t want you binging so you’ll have to wait until next week to see how this saga ends.
Do Mr. and Mrs. CC find solace in owning their home, or are they psychologically burdened by the lost opportunity costs of their past? Will they recommend home ownership or not?
Tune in next week to clippingchains.com. And don’t forget to subscribe down below for email updates. This is going to be riveting!
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