Home Ownership: Pros and Cons
03 Mar 2017
Talk to anyone over the age of 50, and they will talk about home ownership as being a part of the “American Dream.” Now I’m not suggesting that home ownership is a bad thing. In fact, it can be one of the cornerstones of a solid financial foundation to building long lasting wealth. The problem is when we simply declare home ownership good, and all other forms of shelter bad. There are many other factors to recognize when evaluating if a home purchase is a good idea or not. We must walk through the home purchasing process to ensure that we are truly putting ourselves in a better financial situation.
Home Ownership as a positive
There are many advantages to owning your own home. One of these is that you are able to lock in your living costs when it comes to housing. This can make it much more efficient to predict future cash flows. If you happen to have a mortgage, then you are able to know roughly what your payments over a set period of time. Of course there will be some variation due to taxes and whatnot, but even if you don’t, you will still be dealing with those variables.
One of the issues with mortgages, is the many different types that are available. Ideally, you will be able to take out a long term mortgage at a fixed rate. It may be more advantageous to pay your scheduled payment and continue investing rather than paying off the home early. This goes back to comparing your personal Fair Rate of Return Goal to your effective interest rate on your mortgage. What I mean by this is the actual cost of the mortgage, once tax deductions and other costs or benefits have been taken into considerations. This brings up another positive.
Our government has given incentives for home purchases by offering special tax deductions and credits to those who own real estate. In addition to this, rental income is considered “passive” and has special tax rules that apply. Now don’t go out an buy rental property just for the tax benefits. That would be foolish. My point is that if it something that makes sense in your overall portfolio, then certainly be aware of the advantages associated with owning the asset. Buying anything simply for “Tax Benefits” when it doesn’t end up putting you in a better position for the future is simply spending. This may or may not be ok depending on your situation.
The Dark Side of Home Ownership
There are many examples of when the “American Dream” of owning a home turned into an “American Nightmare.” The good news is that with a little bit of forethought and advanced planning, many of these situations can be avoided.
Your Home is the only asset you own
It is dangerous to sink all of your funds into one asset class. Especially if that asset is one that you live in and don’t draw an income stream from. Think of when you do finally decide to enter retirement. Are you intending on selling the home in order to fund your future lifestyle? Are you certain that the value is going to increase? While prices have largely rebounded, I’m sure that many individuals thought their homes would only increase in value up until the 2007 housing crash.
You plan on living there a short period of time
There is a mathematical break even point when it comes to owning a property. This goes not only for rentals, but also where we hang our hat. Depending on how the home is purchased, and the type of real estate market it is in, it may make mathematical sense to rent. Particularly for young individuals or couples that know they will be moving shortly. Couple this with the hassle of going through the process of trying to sell the home. Renting also gives a certain level of flexibility if you are still moving upward in your career and need to move to a new location to take advantage of an opportunity.
Generally speaking, the shorter period of time you are intending on staying in a particular area, the more sense it makes to rent. Don’t get me wrong. We all know those stories of the people who purchased a home, left a few months later, and made money. Turns out, people like to talk about the times that they made great decisions. Less frequently do they share when things didn’t turn out quite so well. Homes are like other “traditional” assets. The longer period of time they are held, the higher likelihood of them increasing in value.
You don’t have an adequate cash reserve
Sometimes, bad stuff happens. You might move into a place excited to make it your own. Then the water heater goes out. Then the A/C goes out. Or a storm blows a tree onto your house (incidentally, ask me about this sometime). Not having the proper financial reserves in place, or putting all of your cash into a new home is a recipe for disaster. Sometimes there are things that occur outside of our control. When this happens, it is always wise to have a “buffer” or short term cash reserve between you and the unexpected.
The decision to purchase a new home is exciting. This is a huge opportunity to put you on a path for financial success. The issue is that it can just as easily put you on the path to financial ruin. At the end of the day, we need to recognize that a home is a form of shelter. It is a tool, and like all tools, can be used either properly or improperly. Just be certain that you have followed a decision making process to ensure that it is the former.
Today is the day, make it count!