Why a Home is Still a Good Investment
March 21, 2013Today is the first day of spring and among other things, that means many people will begin the process of buying a home. Despite the crash in the real estate market a few years ago, real estate remains a great investment. In fact, it can often make the difference of whether someone is able to retire. Here are some reasons why:
1) The process of buying a home benefits you even before you actually buy it. That’s because the mortgage company acts as your defacto business partner in the transaction and unlike during the real estate bubble, mortgage companies will only partner with you if your finances in shape. That makes it like going through boot training for your finances. You’ll want to check your credit report and fix any errors you find, keep your credit score high by making on-time payments, improve your debt-to-income ratio by keeping debt to a minimum, and save for a down payment and emergency fund. You probably already know you need to do these things but many of them might not feel so urgent…until you face the prospect of not getting your piece of the American Dream.
2) With real estate prices and interest rates at record lows, owning can actually be cheaper than renting. This is especially true if you’re in a high tax bracket because of the tax deductions you get on the mortgage interest and property taxes. Just be sure that you’re factoring in all the costs of ownership like maintenance and repairs.
3) Even if you spend more to own, it’s probably still cheaper to own in the long run. First, rents increase over time while you can lock in your mortgage payment for up to 40 years. Second, that mortgage will eventually be paid off while the rent will continue forever.
4) It’s a form of forced savings. By making your mortgage payment every month, you’re building equity over time. Yes, you can do the same thing by getting a cheap rental and investing the difference but how many people would really do that as consistently?
5) You can benefit from leverage. Some people argue that stocks make a better investment because their long term returns are higher. There is some truth in that. Over long periods of time, the stock market has averaged a real rate of return of 6-7% while real estate barely edges inflation. But that leaves out the impact of leverage. Let’s say you purchase a $100k property with $20k down. If that property goes up 3% with inflation, your return on that $20k investment is actually 15% ($3k/$20k). On the other hand, stock prices are too volatile in the short term to buy them on margin (you can be forced to deposit cash or securities if the stocks decline in value) and if you do, the interest rates tend to be higher and are not tax-deductible.
6) Your home equity can be a retirement asset. Once the kids are out of the home, you can downsize and reinvest the difference. There’s also the possibility of taking a reverse mortgage. However, this should generally be considered as a last resort because of the high fees and likelihood you won’t be able to pass your home on to your heirs.
7) The gains can be tax-free. As long as you’ve lived in the home for 2 out of the last 5 years, $250k of gain ($500k if the home is owned jointly) is tax-free. If you invest in stocks or other investments, you’ll typically owe a 15% capital gains tax.
For all these reasons, owning a home can be one of the best decisions you can make. Just be sure not to buy more home than you can afford. Otherwise, that home can turn from an asset to a liability.