There’s no denying that for most of us, owning a home feels good. But does it make sense financially? Here we’ll consider some reasons why it may and some reasons why it may not.
Owning a Home Can Make Good Financial Sense
1. The total cost of homeownership ─ including tax breaks ─ can be less than renting. The government has long believed that homeownership is good for Americans and for America and has, therefore, supported homeownership in a variety of ways. One of those ways is giving substantial tax breaks to homeowners. One of the most significant of those is the mortgage interest on a first and second home, up to a certain maximum. When you sell the home, a significant amount of capital gains can be excluded from tax. If the home was your primary residence in at least two of the preceding five years, you can exclude $250,000 of gain if you are a single taxpayer, and $500,000 of gain if you are married filing a joint return. Mortgage points, private mortgage insurance, and property taxes are other tax breaks available to homeowners.
2. At the end of the mortgage term, you’ll have a rent-free place to live and 100% equity in the asset. Once you’ve finished paying off your mortgage, you’ll have a rent-free home in which to live. You’ll also have 100% equity in the asset that is your home ─ meaning you can sell it, leave it to your heirs, or even take equity out of the home with a reverse mortgage. For many people, the ability to have a home to live in rent free and an asset of substantial worth is an important part of their retirement plan.
3. If you lock in a mortgage rate for the term of your loan, the majority of your homeownership costs will be predictable. While you can’t predict how property taxes or other expenses might change, a major portion of your total cost of homeownership is your mortgage payment. So when you take out a long-term fixed-rate mortgage, you know with certainty how much your mortgage payment will be each month, no matter what happens in the market with interest rates, inflation, or investment returns.
On the Other Hand, Homeownership Might Not Make Financial Sense
1. When accounting for inflation, homeownership may not be a great investment. Robert Shiller, a Yale University economist and co-creator of the S&P/Case-Shiller Home Price Index, has warned against viewing homes as an investment. “Because people often forget to correct for inflation, they may have the illusion that the market is improving.” (Source: The New York Times, April 13,2013) Between 1987 and 2002, for example, the average annual increase in U.S. home prices was just 2.8% ─ barely over the average annual rate of inflation for the same period.
2. It’s typically more difficult for homeowners to relocate for work than renters. It intuitively makes sense that when you own a home, the only way you can move far away (unless you’re able to own two homes) is to sell the home you’re in. That concept is borne out in research as well: high rates of homeownership are aligned with lower labor mobility and longer commutes, according to research published in May 2013 by the Peterson Institute for International Economics.
3. The total cost of homeownership can be more than renting. Sometimes, the total cost of homeownership is less than the total cost of renting. But sometimes, owning a home is more expensive. One way to figure out if owning or renting is more expensive in your area is to calculate the price-to-rent (P/R) ratio:
- Find two homes ─ similar in location, size, and amenities ─ one for sale and one for rent.
- Divide the sale price of the home for sale by the annual rent of the other.
The economists’ rule of thumb is that when the price-to-rent ratio is higher than 20, the monthly costs of ownership will exceed the cost of renting. Generally, the higher P/R ratio, the less sense it makes to buy.
The decision to own a home ─ or not ─ is one that has to be made based on your own individual circumstances.
Copyright © Integrated Concepts 2013. Some articles in this newsletter were prepared by Integrated Concepts, a separate, nonaffiliated business entity. This newsletter intends to offer factual and up-to-date information on the subjects discussed, but should not be regarded as a complete analysis of these subjects. The appropriate professional advisers should be consulted before implementing any options presented. No party assumes liability for any loss or damage resulting from errors or omissions or reliance on or use of this material.