It’s a line you hear all the time: “Your home is your biggest investment.”
For most people, the home is certainly the biggest expenditure, the biggest financial commitment.
But is it really right to view it as an investment? Many people did earlier in this decade, taking out risky, 100 percent loans to buy the most expensive homes they could get. As home prices continued to soar, they refinanced or took out home equity loans to draw out cash to fund other extravagances.
Then it all came tumbling down, leaving millions owing more than their homes are worth. If you treat a home like an investment that will spin off cash, don’t be surprised if it behaves like a stock or other risky holding, delivering deep losses when the music stops.
The sense that a home is a great investment is sometimes reinforced by stories from parents and others who bought homes decades ago. They paid $10,000 in the 1950s and sold 50 years later for $200,000.
But that 20-fold gain isn’t as stupendous as it looks. Over the long term, stocks return around 10 percent a year, doubling in value about every seven years. If you invested $10,000 in stocks and they doubled seven times in 50 years you’d end up with $1.28 million. Of course, taxes would chew into that, but you’d still have an awful lot more than $200,000.
In fact, the median home price in the U.S. rose from $7,354 in 1950 to $119,600 in 2000, according to the Census Bureau. Adjusting the numbers for inflation, prices went from $44,600 to $119,600. That’s really not so impressive.
Also note that none of these figures account for mortgage interest. If one took out a 30-year mortgage at 5 percent in the 1950s, interest would have nearly doubled the cost of buying the home, according to the Mortgage Loan Calculator. That would cut the long-term gain in half. The homeowner would also pay for maintenance and property taxes, reducing the “investment gain” even more.
Studies by Yale economist Robert J. Shiller show that over long periods home prices tend to rise about 1 percentage point a year above the inflation rate. So, if inflation runs at the long-term average of around 3 percent, home prices would grow at 4 percent a year.
Again, that’s just a look at price, not counting interest, taxes, maintenance and so forth. You’d do better with a Treasury security.
(By the way, if you want to gamble on home price gains, Shiller has two exchange-traded funds, Major Housing Up (Stock Quote: UMM) and Major Housing Down (Stock Quote: DMM))
Of course, you need a place to live, so some of the costs should be discounted as offsetting what you’d pay anyway as a renter. As a renter, you’d probably pay more every year forever, while the homeowner can freeze the principal and interest payments by taking out a fixed-rate loan. That means there are some long-term benefits to owning.
Keep in mind, though, that even if your home does appreciate nicely, so will others you’re likely to buy later. So any money you make on one home is likely to be spent on the next. Gains on your home value aren’t money in your pocket until you downsize.
What’s it all add up to? Potential “investing” gains are too low to justify buying more home than you need.
As a rule of thumb, try to keep your home ownership costs in line with what you would be willing to spend to rent an acceptable place. If that’s less than you could afford to shell out as a homeowner, the difference should go into long-term investments, such as mutual funds, rather than a more expensive home.
—For more ways to save, spend, invest and borrow, visit MainStreet.com.