One of the big arguments for home ownership or buying a house goes something like this:
“When you rent, you’re just throwing money away because you’re not building house equity. With your own home, though, that’s exactly what happens when you pay your mortgage: you’re building equity.”
At first glance, this seems like it could make sense. After all, when you end your lease and move to a new place as a renter, that’s sort of it. You don’t get to sell your home and walk away with the money you earned from the equity in the property.
When you own and want to move on, though, you do get to sell the house and exchange that equity for cash.
That’s the idea, anyway. But the thing is, if you buy a home in your 20s or 30s, you’re likely building less equity than you think.
How Much House Equity You’re Actually Building
You can run the numbers to see the reality of the situation before you buy.
Take a look at the amount of house equity you build in 7 years using this calculator from Bankrate. Let’s assume you plan to buy a $600,000 home with a 20% down payment. You get approved for a 30 year mortgage with a 4.5% interest rate.
(Add these numbers to the calculator if you want to follow along with this example.)
Assuming a flat market, you’ll find that you would only build $62,274 in equity between August 2018 to July 2025. That represents the 7 to 8 year average time frame that most people own a home before they sell and buy another.
Your gain of $62,274 in house equity would mean your mortgage would move from $480,000 to $417,726 — but you would pay a whopping $204,295 total, thanks to interest.
And when you include closing costs at 3% of the home’s value, that means you’ll sink another $18,000 into the deal — assuming you didn’t roll the closing costs into the mortgage as many do, which would make it even worse thanks to the interest on the loan.
At this point, you would have exchanged $222,295 for a little over $60,000 worth of equity.
This doesn’t even account for taxes, insurance, or the ongoing cost of upkeep for your home. Maintenance and repairs could run between 1% and 4% of your home’s value per year, depending on the age of the home and where you live.
Upkeep alone is usually enough to offset the “house equity building” aspect of home ownership over the average holding period of about 8 years.
“Building House Equity” Alone Is Not a Strong Enough Argument for Buying a Home
That short period of time you’re likely to stay in a house makes the home ownership argument a poor one for many.
Yes, you will most likely build equity eventually. But that requires you to stay put in the same home, in the same town, in the same community, for decades.
Most 20-, 30-, and 40-somethings who are ambitious, have big goals and dreams with serious career plans can’t commit to settling down in a single spot for the next 20 years.
There are, of course, exceptions. There always are.
You could get lucky with market timing and buy during a buyer’s market to score an amazing deal and sell during a seller’s market when buyers are going crazy with bidding wars to pay you $100,000 more than what your home is worth.
That’s possible, but not probable — and you don’t want to rely on luck, chance or timing to build your financial plan.
You can’t make a broad statement about owning always being a better option than renting, or that renting always equates to throwing money away.
It’s just not true — and in many real-life scenarios, the opposite is actually true: Owning a home may be a bigger waste of your cash than using some of your money to pay rent.
If You Want to Buy a House, Buy a House — But Don’t Call It an Investment
All this being said, I’m not saying “don’t buy a house.”
If you want to buy a house, set your goal and get after it. Many of my clients are already homeowners; others come to me looking for help about how to organize their finances so they can make their dream of home ownership a reality.
(And not only do I have home-buying, home-owning clients — but I also have clients who work as real estate agents.)
I would never tell you buying a house is always a bad choice. But I will urge you to question your assumptions and take the time to look at the numbers as they relate to your situation.
These are the kinds of projections and scenarios we run for clients at Beyond Your Hammock — and this is what it means to make smarter money decisions. Instead of working off assumptions, you get the real facts behind your financial life.
Along the way, I’ll encourage you to consider the consequences of making this big purchase, and how it might impact your other financial goals.
Because that’s what a house is, when you buy a single-family home you intend to use as your primary residence. It’s a purchase. It’s a utility. It’s a lifestyle choice.
But it is not a financial investment.
When you buy a home, you purchase a utility. Rarely are you making an investment that will provide a sizable return. In fact, the real return on single-family homes (after inflation) averages 1% or less.
Which could be perfectly okay. Again, think of home ownership as a lifestyle choice — and if home ownership and all that goes with it fits the lifestyle you want, then we can make a plan to get your finances to a place where it’s feasible to buy.
There Is No Shame in Renting (Especially When You Know You’re Not Missing Out on That Much House Equity, Anyway)
But, what if your lifestyle doesn’t require you to buy?
What if you’re like me and my wife, Kali, who actually don’t want to buy (now) because we’re not interested in the upkeep and the maintenance and the time homeowners must devote to their properties?
What if you love your current rental and it makes you happy? What if you love the amenities or the community and the location and couldn’t dream of leaving for anything else?
Well, keep renting or stay in your current home. Period. There is absolutely no shame in renting (nor does buying a house make you magically happier or more successful).
There is so much pressure from society, family and friends to buy a house — so much that it can get discouraging when you don’t own your own property.
But there’s good news for you: As long as you save a large percentage of your income (I usually recommend saving between 20 and 30 percent of your gross income) and pay down debt efficiently, it doesn’t really matter if you rent or own.
There’s another argument out there that goes right along with the building house equity rationale for buying, and its’ the “forced savings” argument. Some people say that buying a house is a way to create forced savings — and sure, it can be.
…assuming you need someone to force you to save.
If you’re like most of my clients, you already have the desire and motivation to save. You have a good handle on your cash flow and understand where your money goes each month.
The question isn’t “should I save?” or “how?” but “how do I save and invest in the best possible way to grow wealth?”
When you’re asking questions like that, you probably don’t need someone to force you to save. You have that covered already — so there’s no need to add the largest purchase you’ll likely ever make (while taking on debt to make that purchase) into the mix just to save more.
That’s actually where people get into trouble. They say, “oh this is great, it’s forced savings!” …and then they go crazy with repairs, upkeep, and renovations.
Don’t feel overly pressured to buy until the time is right for you (and it might never be, which is fine, too). Don’t worry about what other folks may say — after all, this is your money.