The Myth of Buying a Home

Have you ever heard your home purchase will be the biggest investment you ever make? Then why don’t you look at it as an investment? Purchase by the numbers, not how pretty it is. This report is why most people should not buy a home.

American Dream?

First take a brief look at the history of mortgages and home values. The modern mortgage started in 1934 after the Great Depression. Then only 4 in 10 households owned homes. The FHA was formed and helped to pull the country out of the Depression. Mortgage loan terms were limited to 50% of the property’s market value, interest only for five years with a balloon payment at the end. The FHA set up the 80% Loan to value, 90% LTV and more loans. That opened home ownership for average Americans. The FHA also started the trend of qualifying people for loans versus knowing someone. They also lengthened the loan terms from five to seven years to 15-year loans and eventually stretched that to the 30-year loans we have today.

Now you can see where the term American Dream came from. Prior to 1934 it was very difficult to buy a home, people only dreamed of it. I don’t want to get into the details of the history of mortgages and what happened each decade, but in the 70’s and 80’s interest rates got as high as 20%. This certainly kept home values down and limited who could afford them. The 90’s saw rates come down under 7%, LTV’s to 100% and terms are assumed to be 30 years as they are now. The conversation isn’t about when you will own the home but only how much the payment is, “it’s cheaper than rent”, or is it?

If you are looking at your home purchase as an investment in your future, it’s the worst investment you will ever make, and I can prove it.

The Numbers Don’t Lie

For sake of this argument we are going to have to make the following assumptions:

Sales Price: $200,000 (average 3BR 2.5Ba home in the suburbs of mid America)

10% Down Payment: $20,000 (is this even close to your reality?)

Interest Rate: 5%

Term: 30 years

Monthly Payment: $966.28 + taxes & Insurance = assume $1,100/mo

Monthly Home Expenses. Most people forget to calculate the cost of home ownership.

Exterior Upkeep (grass, shrubbery, snow removal, etc)

Gas for machines: $10

Time (assume 6 hours/mo): $150 (This could vary based on what your time is worth, assume $25/hr)

Taxes & Insurance: $134

Total: $294

Capital expenses: Lawn Mower, Weed Eater, Hedge Clippers (replacing every 5 years)

One Time Capital Expenses: Roof, Carpet, Water Heater, A/C, furnace, assume $20,000

The Average home owner moves every 13 years (up from seven years)

A thirty-year mortgage begins to pay more in principle than interest in year 17.

A home appreciates on average 3% per year.

Let’s look at the numbers

13 years Total of payments: $150,739.68 Home value: $293,706.75

Total of expenses: + $64,368.00 Payoff: - $136,655.07

Total out of pocket: $215,107.68 Equity: $157, 051.68

Equity – total out of pocket = -$58,056

At the 13-year mark you are still upside down over $58,000! Is that a good investment? It just so happens somewhere in year 17 the equity is more than the debt. So, you basically rent the home from the bank for over sixteen years before you begin to own a portion of it.

30 years Total of payments: $347,860.80 Home Value: $500,016.07

Total of expenses: $105,840.00 Payoff: $0

Total out of Pocket: $473,700.80 Equity: $500,016.07

Equity – total out of pocket = $26,315.27 or a 5.5% return after 30 years

Is that a good investment?

You do have $500,000 in equity that you can liquidate, but how much did that cost to get? $473,000 to get $500,000 over 30 years. If your friend asked to borrow $473 if he could pay you back $500 in five years? Two years? One year? Would you? Think about that, what is $27 worth in time. For the average home owner, the answer is about an hour.

It’s better to rent. Here’s why:

Assume you rented a similar house for $1100/mo, you still have the monthly upkeep expenses, but you don’t have the capital expenses of the roof, water heater, furnace, taxes, insurance, etc. break that down to $55/mo to invest and you have $17,800 (from the $20,000 down payment) to start with. You invest in a self-directed IRA. Assume the interest rates below over the two time periods;

13years Interest Rate 30 years

$62,596 8% $253,882.21

You can compare the numbers for yourself. Using a conservative rate of return of 8%, at the 13-year mark there is no question, renting is better. Of course, lenders know this, they watch the numbers closer than anyone else. The average is so good, they cannot loose. Should you keep the rental home for 30 years, you would come out on the short end versus owning if you only got an 8% return. However, according Dave Ramsey’s blog he often says, for example, that mutual fund investors can expect “average annual” returns of 12 %, based on the long-term performance of the S&P 500. From 1926 through 2010, his Web site says, the index's average annual return is 11.84%. Using the same numbers above, $17,800 to start and $55/mo at 11.84% interest, in thirty years you will have $665,319.54. What would you rather have? A home with equity of $500k or over $600K in cash?

Now let’s assume you rent an apartment, condo or townhome, everything is the same except your monthly savings/ investment goes to $294.

13 years Interest Rate 30 years

$125,792.37 8% $586,934.85

If we use Mr. Ramsey’s return of 11.84% over 30-years you would have over $1.3M.

The numbers don’t lie, renting is far more profitable as an investor. And buy the way, if you use a self-directed IRA you can invest in real estate with the money. I maintain real estate is the best investment vehicle there is, but you must buy right. If you look at your home as investment, your perspective will change.

Unfortunately, the American Dream is just that, a dream for most people. Who has the most money? The lenders are number 1. Look at the profit margins in what you pay versus the payoff. The actual investors are number 2. The average homeowner is trying not to go into foreclosure because they didn’t understand the contract language when they signed it. All they know is their family, friends and realtor said “hey, your mortgage payment will be a lot less than rent.” What’s worse is the amount of people who believe that and have no money to put down. Not only is their payback more, they must pay PMI (Private Mortgage Insurance). It’s to protect the lender should you default early in the loan and you are still upside down on your loan (owe more than it’s worth). You see when you buy there are closing costs that could be added to your loan. Credit life insurance, which is never required, but pushed. And because appreciation is over a long period of time it may have pockets of value going down.

Sadly, a large portion of people reading this will still argue that buying a home is better with the proof right in front of them that it is not. Hopefully the rest of you will understand so when it is time to buy, you interview realtors to get their perspective of home ownership. Ask them why should I buy? If the agent says cause your mortgage payment will be less than your rent, you should keep interviewing agents. You can ask a second question; “can you help me invest in a home?” That will confuse them at first. They will think you are an investor looking to do a flip or purchase for rental. You can tell them this will be your primary residence, but you want to purchase it like an investor would. They will show you a different set of houses than if you hadn’t asked, imagine that.

To bring back the American Dream we all must learn to buy right. Change your perspective to that of the investor or bank. Now that you know where your money goes and how banks make their money, you can prepare. Don’t let society talk you into buying until you are ready to buy right. Of course, you can do what investors do, let someone else pay your rent (or mortgage) by becoming a landlord first.

In closing, I have been a commercial/ investment real estate broker for 17 years now. I specialize in selling multi-family and single tenant triple net lease retail properties. I rent a two-bedroom townhome I live in with my son. Yes, I can afford a home, but I buy them right for other people to rent from me. Not only do I profit from renting, other people pay my rent. So where do you get homes to buy right? Well, the more people who keep buying the old way will keep a steady supply coming, but that is a discussion for another paper. Those of us looking at homes as an investment will live the NEW American Dream.