Is Your Home a Good Investment?

Posted by Badger Coach on May 29th, 2014

For decades, homeownership has been viewed as a good investment. In fact, many “wealth building” gurus teach their followers to use homeownership as a foundation to building wealth. Then the housing collapse of 2008 took place, causing many homeowners to lose their homes to foreclosure, while the “lucky” homeowners were left owning homes that were worth less than their purchase price.

Today, these same gurus continue to teach would-be homeowners the same thing. It seems like the gurus and their students have not learned their lesson and are suffering from, what is jokingly referred to as, delayed intelligence disorder.

Mortgage Myths

Someone once said, “An opinion is a belief one refuses to reconsider.” This is certainly true when it comes to building wealth through homeownership. The media, print magazines, the financial services industry, real estate industry, banks and home building associations all say: that your home is an asset, it’s a great investment, it offers huge tax deductions, and it’s a built-in savings plan. They also say that it’s better to own a home than it is to rent and throw away money each month. In short, they believe homeowners can build wealth by going into debt. However, the truth of the matter is that for most homeowners, homeownership is a big liability, a lousy investment, and offers very little savings in the form of a tax deduction.

Home is an Asset

When does your home become an asset? The answer—when you have paid off the mortgage and are renting out your home, for income.

Home is a Good Investment

According to MacroTrends, from April 1981 to Jan 2014, the Federal Housing Finance Agency (FHFA Housing Index) has remained negative on an inflation adjusted basis. Robert Shiller, Noble Laureate and Yale Professor, states that house appreciation rates for U.S. homes during the periods 1900 to 2012 have averaged an inflation-adjusted annual price increase of 0.1 percent. If inflation were not a factor, then home appreciation rates increased at an average rate of 3.0 percent per year. During this same period of time, the S&P 500 (stock market) averaged 1.86 percent per year on a price return basis, and 4.94 percent without factoring inflation. Based on these numbers, over the long term, past performance price return comparisons between housing and the stock market run pretty close to each other on an inflation adjusted basis.

Another way of measuring whether a home is a good investment is to perform simple back-of-the-envelope addition and subtraction (see table 1).

Table 1. Homeownership Rate of Return

Home Appreciation Rate
Loan Rate
Inflation
Rate of Return
4.2%
-4%
-3%
-2.8%

In this example, the interest on the loan and inflation are deducted from the home appreciation rate, leaving you with a -2.8 percent investment return. The investment return would be much lower if the down payment, closing costs, repairs, and mortgage payments were added.

A cost benefit analysis also reveals why homeownership may not be a good investment (see Table 2).

Table 2. Cost Benefit Analysis of Homeownership

Number of Years Since Last Purchase or Refinance

 30

Original Purchase Price
 $375,000
Current Home Value
 $882,000
Down Payment
$75,000
Closing Costs
$12,000
Annual Home Value Growth Rate
3%
Total Interest Paid
$216,000
Compound Interest Return
0.88%

The numbers used in table 2 assumes the homeowner is in a 25% marginal tax bracket and that she did not refinance her home once she purchased it. It also assumes she did not remodel, do any repairs or pay private mortgage insurance (PMI). These numbers also exclude the total value of her payments that went towards the principal on her mortgage loan. If all of these numbers were factored in, the compound interest return number would be negative.

Mortgage Deductions

A big reason that many people go into hundreds of thousands of dollars in debt to buy a house is because of the tax deductions. These tax deductions apply to the interest on the loan, mortgage insurance premiums, and property taxes. However, in order to take advantage of the tax deductions, you must itemize your taxes. And yet, according to a recent joint study conducted by the Urban Institute and The Brookings Institution Tax Policy Center, “70 percent of tax payers claimed standard deductions on their 2010 tax returns.” In essence, only 30 percent of tax payers itemized deductions during 2010.

This study also reveals that tax deductions have very little impact on the after-tax income increase that one hopes to receive from itemization. The following chart (see table 3) highlights two facts: (1) Itemization is claimed more often by tax payers in higher tax brackets and (2) itemization raises a homeowners after-tax income by no more than 4.4 percent, provided the tax payer was in a 35 percent tax bracket.

Table 3. Homeownership and Tax Deductions

  

Itemization Characteristics and Benefits by Statutory Tax Rate, 2010
Statutory Tax Rate
 Percentage of Tax Units That Itemize Deductions
Increase in After-Tax Income Due to Itemization (Percent)
0 3.9 0.7
10 16.2 0.8
15 37.0 1.3
25 65.5 2.4
26 (AMT) 97.9 3.7
28 (regular) 79.6 2.4
28 (AMT) 98.6 3.6
33 70.9 2.3
35 89.4 4.4
All 30.1 2.1
Source: Urban-Brookings Tax Policy Center Microsimulation Model (version 0509-7). After-tax income is cash income less individual  income tax net of refundable credits, corporate income tax and payroll taxes.

Built-in Savings Plan

Another reason that people think homeownership is a good investment is because they believe it provides a built-in savings plan. They forget that in order to access the built-in savings, they must have good credit, must take out a loan, and then repay the loan with interest. Another point to consider is that if homeownership truly offers a built-in savings plan, the value of the savings plan (equity) should never decrease in value.

 Homeownership vs. Renting

The final reason that people favor owning a home is that they believe people who rent are throwing money away. The problem with this belief is that it is based on the misguided notion that the homeowner owns her house while she is paying it off, when in fact the homeowner does not own the home she lives in until she pays off her mortgage. So, in essence, the homeowner and the renter are renters. Both are renting the space they choose to call home. The homeowner is renting from the bank on a lease-to-own program, and the renter is renting from a property management company.

Furthermore, the term homeownership is a misnomer. It offers a false sense of security and control. A more appropriate term to use would be, what I call home-loanership or home-owership. These terms capture the true nature of what happens when a person takes out a mortgage. They owe money on the home until it is paid off in full. Additionally, homeownership should be viewed as a place to lay your head at night, and that the only ones building wealth from homeownership are:

–      Real Estate Agents

–      Mortgage Brokers

–      Home Inspectors

–      Title Companies

–      Construction Companies

–      Banks

–      Uncle Sam

Origins of the Word Mortgage

From an etymological point of view, the word “mortgage” has Latin, Old French, and German roots. In Latin, the word “mortuus” can be translated to mean—“to die.” In the Old French, the word “mort” can be translated to mean “dead.” And the word “gage” has German roots and can be translated to mean “to pledge.” In short, the word “mortgage” can be translated to mean “death pledge.” Given the fact that so many people work themselves to death to pay off their mortgage, this seems to be an appropriate meaning.

 Conclusion

The next time someone tells you that homeownership builds wealth, remember that: (1) homeownership is a bad investment for the vast majority of homeowners, (2) it offers very little in the way of tax savings when compared to the overall expense in owning a home, (3) home equity is a built-in loan program but not a built-in savings program, and (4) homeownership may actually cost more than renting when all expenses are calculated. The only advantage, for most homeowners, in paying a mortgage over paying rent is the homeowner can own the house one day.  Also, if your home is “under water”, do not worry about it if you are able to  make the payments. Why? Because your home is not an investment. If you want your home to become a “good investment,” learn how to use collateral to access risk-free capital, at preferred interest rates and flexible repayment terms, instead of using home equity to do it. But be extremely careful, as some of these Collateral Access Programs (CAP) can cause more harm than good.

 

Resources: 

Calculator: How Much Is Your House Worth

Housing Data: National Association of Home Builders (NAHB)

 

 

 

Disclaimer

The opinions expressed are those of the author and is for educational purposes only, and not an offer to buy or sell securities. As always, please consult with a qualified legal, tax, investment or insurance professional before making any financial decision. Investing involves significant risk, even the loss of capital. Invest only what you can afford to lose. Guarantees provided by an insurance company are based on its claims paying ability.

 

 

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