I am moving into a new apartment in about three weeks. Every year when my apartment lease is up, I have a decision to make: I can renew my lease, I can end my lease and rent a new apartment, or I can end my lease and buy a house.
The “American Dream” part of me wants to buy a house, but the “Smart Personal Finance” part of me knows better. Home ownership is definitely right for some people, but not for me. There are a lot of things about owning a home that scare the crap out of me. For example, did you know that homes and new cars are very similar in that both lose an incredible amount of value as soon as your purchase is complete?
Your gut reaction might be to think I’m stupid to compare buying a home to buying a new car, but the comparison works for the first few years of home ownership. Just take a look at the data and see for yourself.
Buying a $100,000 Home
Pretend you are about to take out a mortgage on a $100,000 home. When you take out a loan for a house, you have to pay closing costs. These are usually 3-5% of the total value of the loan. If you put 20% down on your house, that means the closing costs on an $80,000 home loan will be between $2,400 and $4,000. Let’s take a number in the middle and pretend closing costs are $3,000. So to get into a $100,000 home, it’s going to cost you $20k of a down payment plus another $3k in closing costs.
Initial Investment: $23,000
Total Cost of Home: $103,000
We need to keep this $23k number in mind, because this is our investment and we would like to get this back when we sell the house. Now let’s look at how long it will take to get that initial investment back if we sell.
Selling a Home is Expensive
Have you ever wondered how those real estate agents make money? They have to be making money somewhere Each agent (the buyer’s and seller’s agent) gets 3% of the final purchase price of the home, which means it is going to cost you 6% of the value of your home just to sell it.
You could try to sell your house without a realtor, but that is a complicated mess when you consider all the paperwork and legal things that go with buying a house. I’m no expert so I don’t know the specifics, but I know it is pretty complicated and getting a realtor is the way most people go.
In the following calculations, we will assume that the amount of your mortgage (after accounting for taxes, insurance, and mortgage interest tax benefits) is the same as what you would have paid in rent if you had rented a place to live. In reality, owning a home is almost always more expensive than renting, but this assumption makes calculations easier and is, in general, a pretty fair assumption.
What If You Sell Immediately?
Let’s pretend that you bought your house today, and tomorrow you get a new job out of state and want to sell your house, or you find out you’re having a baby and want a bigger house, or you lose your job and can’t afford your house, or any number of reasons why you’d want to move.
Usually it takes three to six months to get someone to pay you fair market value for your house, so to unload it right away you would probably have to sell at a discount. Let’s say you can get $90,000 to sell quickly. Then we have to take out 6% to pay the realtors and you barely have enough left to pay off the mortgage.
$90,000 Sale Price – $5,400 Realtor Commission – $80,000 Loan Balance = $4,600, Loss of $18,400 or 80%
Holy baloney! You just got boned! You basically lost your entire initial investment. The obvious lesson here is don’t buy a house for a day, but the real lesson is that you have to be prepared to sit on a home 3-12 months if you want fair market value when you sell. Otherwise, you are going to have to discount the price and lose money.
Sell After A Few Years
For a more realistic situation let’s say you live in your house and pay your mortgage for some period of time, and then some life situation requires that you move. You have enough time to plan ahead and leave your house on the market for 6 months to get fair market value of $100,000. Let’s look at how many years it will take to get to our breakeven number of $23,000.
Let’s use a 30 year mortgage with a 5% fixed APR. We will also assume a 1,000 annual appreciation of home value, which I think is generous in today’s market.
1 Year
$101,000 Sale Price – $6,060 Realtor Commission – $78,820 Loan Balance = $16,180, Loss of $6,820 or 29.7%
2 Years
$102,000 Sale Price – $6,120 Realtor Commission – $77,579 Loan Balance = $18,301, Loss of $4,699 or 20.4%
3 Years
$103,000 Sale Price – $6,180 Realtor Commission – $76,275 Loan Balance = $20,545, Loss of $2,455 or 10.7%
4 Years
$104,000 Sale Price – $6,240 Realtor Commission – $74,904 Loan Balance = $22,856, Loss of $144 or essentially breakeven
Homes Only Make Sense When You Hold For Years
There are so many variables when you buy a home that it’s pretty much impossible to come up with any concrete rules about home ownership, but in general you have to hold for a minimum of 3-5 years before you can break even on your investment. That can be much longer or shorter depending on how much the home appreciates or depreciates, how much money you put down, how much work you do on fixing the house, etc.
The bottom line for the average home buyer is that you better be damn sure you are going to stay in that house for at least three years. If you aren’t sure of that, then you have no business buying a house unless you are looking to lose a lot of money.
Kevin McKee is an entrepreneur, IT guru, and personal finance leader. In addition to his writing, Kevin is the head of IT at Buildingstars, Co-Founder of Padmission, and organizer of Laravel STL. He is also the creator of www.contributetoopensource.com. When he’s not working, Kevin enjoys podcasting about movies and spending time with his wife and four children.
I totally agree. I think it’s sad that so many people were determined to live the American Dream and bought houses they couldn’t afford and now they are totally up a creek. So many of these people didn’t even question the American Dream. There is nothing wrong with apartment living, and often it’s the most economical thing to do! Especially where you are. Holy cow! Property taxes and HOAs will kill the budget in no time!
I don’t blame anyone who wants a house. I think I want one eventually, but I definitely don’t want one until I’m ready to live there for a LONG time.
yeah…I have a dream house in mind for sure! It changes every so often, but it’s exciting to think about having a place to call home for a long time. I liked PDITF’s post about his decision to rent recently. I like the idea that people explore their options.
When I calculate our net worth, I actually write off the expected realtor and other selling fees. Even though we have no intention of selling anytime soon, doing this keeps me in line with what I define as our net worth, which is what I could have in cash if I liquidated all assets and paid all debts. This actually puts us in a state that I call ‘Treading Water’. We’re not technically underwater in our loan because the estimated value is above our mortgage balance, but if you factor in the selling costs, we come in slightly below.
It’s great that you actually consider those fees. I think there are a lot of people who value their house at the sale price instead, which really isn’t correct unless they plan to sell without a realtor.
I personally never plan on purchasing a home. While it can be considered an investment, with the loan you are essentially renting for 30+ years. You also have to ask yourself does owning your home offset the cost and worries of maintenance and upkeep? Not for me. I also have no desire to be tied down to one place, and what better way to tie you down than a mortgage.
Amen brotha! I might want a house one day, but there’s nothing about owning a house right now that gets me excited.
While your young, I say move often! However, I’m not sure that you would NEVER want to buy a home.
Owning a home outright vs having to pay mortgage/rent is probably the biggest factor in determining your living expenses upon retirement. Total ownership will still have maintenance and taxes, but ideally, I think you would want your recurring mortgage costs to drop to zero if possible.
But what do you think? Is paying off a mortgage an unsustainable mentality in modern America?
-It seems that total ownership is virtually ‘un-affordable’ in many parts of the country.
-The modern job market often requires people to move all over the country or world.
-Many educated young people don’t seem to want to live in the same place for long periods of time even if they could.
-Once many American debtors get any kind of equity in their home they often upgrade to a bigger more expensive home never attain total ownership.
It’s an interesting discussion. All of the retired people I know have their homes paid off. I can’t imagine having to fund mortgage/rent forever, but maybe that’s the new future (by choice or necessity)?
When I look at the housing market right now, I just don’t see anything that makes me want to buy. When you understand how expensive it is to get out of a house, it’s truly discouraging to look at prices.
The market hasn’t changed much (except for tighter credit) since the housing bubble collapsed, so until something changes the economics of buying a house, I think more and more people will continue to rent.
We have rented for 10 years now because we do not want to settle permanently in this area (though 10 years seems semi permanent :)). We also don’t have the money for all of the upkeep, taxes, etc.
Throughout the years, people have tried to convince us to buy, but we are standing firm. A house is a great thing when you can afford it, and I don’t just mean making the mortgage payments. Thanks for a great post.
I agree with you that there are a lot of variables to consider however, i dont agree with your almost blanket statement against homeownership. One of the biggest variables you have forgot to mention above isopportunity cost. How much is your monthly cost of the apartment vs the loan. The above mentioned mortgage probably saves an additional $ 200 a month over a comparable apartment.
That being said there are literally hundreds of variables that go into homeownership calculation including negative points to cover closing fees, repair, and additional tax benefits such as charitable donations that were not above the minimum deduction. When i purchased my home i literally spent hundreds of hours calculating all of these and will be happy to share the spreadsheets with fellow thousandaires
I will agree with you on the main point of this post. Homeownership is usually a long term committment (unless you get an 8k tax credit)
I’m a huge believer that you should only buy a home if you plan on staying at least 5 years, if not longer. That way, you should hopefully recoup your costs.
Also, there is always renting the home out!
We bought our house a couple years ago with the thought that we would buy again or build in 7-10 years. We also intend to rent our current residence which will be a great side income. If we can avoid losing on those fees than we will.
True. I am looking to sell my 2004 Toyota Rav 4 that I bought new. I was amazed that selling it to the dealer I should expect to get 67% of my cost. I thought it would be much lower. I don’t drive many miles but I thought cars were suppose to depreciate 25% or so the day you drive off the lot. If so it only depreciated 7% for the next 7 years!
Five years of home ownership at a minimum before I’d consider buying a place, with a strong understanding I could be living there for at least 10. This isn’t a pair of shoes people, you don’t change your house when you get bored of it.
I’ve heard that saying that you should stay in a house you bought for five years. Nice breakdown on why! Gone are the days of flipping houses.
Kevin, good analysis. Owning a home has all kinds of unexpected expenses too. Many times the home inspector says everything is fine and then within the first few years you have to replace the air conditoner, furnace, plumbing, roof, etc. You can’t trust a home inspector that was suggested by the realtor as they want to be recommended again.
We might sell our home & move closer to our adult children, but I have a hard time wrapping my head around living in an apartment. So many apts. are not in very good condition and you can’t do what you want with the place. To get a nice apt. costs quite a lot. We might buy another home, put down about half the price of the house (from the sale of our present house that we own 100%), & take out a mtg. for the rest. The monthly payments would be much less than rent. Of course then we have money tied up in the house that could have been used for travel. We will still be able to travel, just not out of the country much.
Yep, home ownership is not the best deal for people who move all the time…of course, I’d still probably at least rent a house if I ever decided not to own. I cannot go back to apartment living now – I am spoiled…