For most Americans, home ownership is viewed as a symbol of freedom and financial success. You can paint the rooms and renovate without permission, play the music louder, and raise your family in a place that feels more like a home than a house.
The availability of mortgage lending and historically-low interest rates makes this dream a reality for many young professionals who are eager to go from renters to owners. This desire to own property often results in confirmation bias when comparing the costs of renting with buying. The issue with this mindset is that it usually starts and ends with comparing the cost of rent payments vs. mortgage payments – “why pay $1,200 to rent that 1-bedroom apartment when you could own a 3-bedroom house for the same monthly payment?”
I do believe that home ownership can provide lifestyle value and potential asset growth, but let’s measure twice and discover the hidden costs of this major decision before taking action.
The True Cost of Home Ownership
- Mortgage Interest: A $350,000 mortgage with a low 3% interest rate over 30 years costs $181,221 in interest. This increases the initial mortgage balance by 34%, with a ‘true’ mortgage cost of $531,221 (and that’s assuming no inflation). If sold at the end of the term, the home would have needed to increase in value by at least 1.4% per year to recoup this additional cost (again assuming no inflation). Home mortgage interest is a ‘below-the-line’ deduction for income taxes, but most homeowners are not able to itemize their deductions. ~90% of tax filers currently take the standard deduction, receiving no additional tax benefit from paying mortgage interest.
- Taxes & Insurance: Property tax rates apply to property values, ranging from 1% to 2% in most U.S. counties. As property values increase, so do these tax payments. Homeowners, flood, windstorm, liability, and other insurance policies (including deductibles) also add significant costs. These expenses are usually wrapped into rent payments as well, but are often neglected when calculating a new home purchase.
- Maintenance & Repairs: Ongoing home maintenance and repairs can really add up, with some of the most expensive repairs not covered by insurance! Replacement and repair of sewage lines, major appliances, HVAC systems, water heaters, landscaping, pest & mold damage, general wear and tear, and personal property above actual cash value must be paid out of pocket – unless other cost-ineffective, supplemental policies are purchased.
- Transportation: Depending on your location, buying a home farther away from where you work can add quantitative and qualitative transportation costs – including gas, tolls, wear & tear, insurance, mental stress, and time. Have you considered the cost of living within biking or walking distance of your workplace?
Is my primary residence an investment?
We often hear that “renting is like throwing away your money,” and that it is important to build equity in a home as a part of your total investment portfolio. As a financial planner, I consider a primary residence as more of a lifestyle decision and liability than an investment, unless the property provides recurring cash flow (renting out a room). Home values may appreciate, but this movement in price is a form of systematic risk – meaning that values within an area usually rise and fall together.
Being “house poor” by having a majority of net worth tied up in an asset that doesn’t provide cash flow can cause stress, especially if the homeowner is over-leveraged (mortgage flexibility) or under-prepared for unexpected expenses (the value of emergency funds). Real property for personal use should slowly become a thinner slice of your asset allocation pie as you move through the wealth accumulation years. We ultimately want our homes to provide lifestyle value, and not to become a financial burden. Make sure that your portfolio is configured in a way that will provide you flexibility, and not turn your asset into a liability – especially by the time you hope to retire.