by David Bach
The Homeownership Dream – and the Results
From 2001 to 2005, the average homeowner saw the value of his or her house jump by more than 50 percent. Many homeowners doubled, tripled, and in some cases even quadrupled their wealth in just five years because of exploding real estate values.
Imagine that. Buy a home, live in it, build your wealth, get great tax deductions-and then retire rich. It may sound too good to be true.
Indeed, plenty of experts will tell you that the housing boom never happened. According to them, what we’ve experienced over the last few years was just a “bubble” that’s going to pop any minute now. Others insist that whether it was a boom or a bubble, it’s over. According to them, it’s now too late to get in on the party.
The American Dream is No Fantasy
I think both these positions are wrong. My view is that the American dream of building a nest egg by owning a home is no fantasy. Homeowners have been getting rich off their real estate for years, and they will continue to do so in the future. How can I be so confident about the real estate road to riches? Well, U.S. real estate values have been going up steadily for nearly four decades-an average of 6.3 percent a year since 1968, which is when the National Association of Realtors first started keeping track. According to Freddie Mac (a.k.a. the Federal Home Loan Mortgage Corporation), since 1950 U.S. house prices have never experienced a year-to-year decline nationally. Compare that to the S&P 500, a major stock-market indicator that has had no less than a dozen down years in the same period-or the market for U.S. Treasury bonds, which has fallen in 17 of the last 55 years.
Of course, just because home prices have been rising for the last half-century doesn’t mean they’re going to continue doing so. But real estate’s phenomenal track record is not the only reason you should want to become a homeowner. Here are five more:
1. Owning Is Cheaper Than Renting
People who say it’s cheaper to rent than to own are simply wrong. Under certain circumstances in certain markets (where real estate values are overheated and rents are low), there may be some short-term advantages to renting. But over the long haul, renting simply isn’t a good deal. If you don’t own your own home, you can easily wind up spending more than half a million dollars on rent during the course of a lifetime-and probably a lot more.
Assume you’re renting a house for $1,500 a month. Now let’s say you stay put for 30 years, during which the landlord increases the rent by 5 percent a year. Over those 30 years you will hand over a total of nearly $1.2 million in rent payments-and at the end, you’ll have nothing to show for it except a bunch of cancelled checks. To add insult to injury, you’ll now be paying $6,174 a month in rent!
Now let’s imagine that instead of continuing to rent, you buy the same home for $200,000 (this is just an example, and prices will vary greatly from market to market, especially in big cities where homes are typically much more expensive). Initially, your costs as a homeowner are likely to total around the same $1,500 a month you would’ve paid in rent. But these costs won’t balloon over the years the way rent would. That’s because your regular mortgage payment, which represents the lion’s share of your monthly outlay, is fixed (or, if you have an adjustable-rate mortgage, at least capped).
What will balloon over the years is the value of your house. Say it goes up by 6 percent a year, which is actually slightly lower than the national average. After 30 years, you will own a home that’s worth just under $1.1 million.
2. Homeowners Get Leverage
Leverage is what you get when you use what is called “OPM”, which stands for “other people’s money”-the other person in this case being your bank or mortgage lender.
Here’s how it works. Let’s say you buy a home for $200,000. With standard 80 percent financing, you make a cash down payment of $40,000 and cover the rest of the cost with a $160,000 mortgage from the bank.
Now let’s say over the next year or two the value of your house rises by 10 percent. So now it’s worth $20,000 more than you paid for it. If you were to sell the house at this point for $220,000, what kind of return would you have made?
If your answer is 10 percent, you’re mistaken. You take the $220,000 you got for the house and repay the bank its $160,000. That leaves you with $60,000-or$20,000 more than the $40,000 original down payment. In other words, you made a $20,000 profit on a $40,000 investment-which amounts to a 50 percent return.
As much as I like stocks, bonds, and mutual funds, there’s little chance any of them will produce anything close to that return in such a short amount of time.
3. Homeowners Get Tax Breaks, Renters Don’t
The best way to stay poor is to pay more than you have to in taxes. When you rent, you get absolutely zero tax breaks on your housing costs. But as a homeowner, you get the mortgage-interest deduction, which can effectively reduce your monthly mortgage payment by 30 percent or more.
4. Homeowners Can Earn Tax-Free Profits
Another way to stay poor (or at least middle class) is to keep letting the government take part of the profits you make from your investments. Buy shares of Google at $300 and sell them at $600, and you’ve made a bunch of money, but not as much as you think. This kind of profit is called a capital gain, and as with virtually all income, the IRS insists on taking its cut.
There’s one asset, however, that you can sell at a profit without having to pay capital-gains taxes to the government. You guessed it: It’s your home. Under current tax law, if you sell your primary residence, you don’t have to pay any capital-gains taxes on the first $250,000 in profits-the first $500,000 is your married.
5. Homeowners Become Savers
Each time you make a mortgage payment, you’re saving money. That’s because with each payment you’re reducing your loan balance a little-and that, in turn, is building your equity. (This assumes you don’t have an interest-only loan.) The longer you’re in your home, the more equity you build, the more you save-and the richer you get.
... If You Want to Be Rich, Don’t Rent
According to statistics complied by the Federal Reserve, the average homeowner is 34 times richer than the average renter. If you’re not a homeowner, this may depress you. But it shouldn’t. Why? Because-and this I can’t emphasize this enough-it’s never too late to catch the real estate wave.
Everybody has to live somewhere, and someone owns every place where someone lives. Why shouldn’t that someone be you? Obviously, no investment-not stocks, bonds, or real estate-goes up in a straight line forever. But over the long term in America (which is to say, 10 years or more), most experts believe that homeownership is an exceptionally smart way to invest your money.
Remember-as long as you’re alive, you have to live somewhere. So does everyone else you know. And because of that, homeownership will continue to be a great investment.