In everyone’s fantasy life, you live in a gorgeous home, with sunlight streaming through the kitchen windows onto your quartz marble-veined countertops as you make morning coffee, evenings spent by a cozy fireplace with an easy one-switch gas turn-on, framed by a reclaimed wood mantle. I am the queeeeeen of fantasy home design, it’s quite clear HGTV was created for me.
Yet one of the hardest financial feats in life is BUYING your own home. It’s not easy, but it can be your single. Greatest. Building. Block. to creating wealth. Was that weird to read, with all the .’s?? The point was to jar you, because it really can be such an advantage. Now, owning a home isn’t always for everyone, you have to assume responsibility for repairs and upkeep on the home, and in some markets, especially if there is rent control, the lower rent could be a better path IF you take the savings vs buying, and invest it wisely. Here is a calculator so you see what works for your finances. In my life, owning property has been the smartest move I made over the years, so I do want to discuss the potential in buying!
The daily perks in visceral appreciation are lovely – the ability to choose whatever countertops, faucets, flooring (I’m currently alllll about wood-look tile floors – I mean, look at the featured image at the top. What’s not to love? And it’s tile, so super cleanable, scratch-proof, pet-proof)……coming back to the point. Owning allows whatever decorating choices you love. But the fundamental math of ownership is what’s incredible over time. That’s a key note – immediately it can be challenging saving for a down payment, and taking the purchase plunge. But over time, the growth can be such a wealth escalator!
Let’s lay out why. The benefit stems from what you already have heard, that houses are an appreciating asset – I’m sure you get why, since the population keeps growing, we basically always need more places to live, therefore having a home means you have an asset that is continually in greater demand. Let’s say you bought a home for $164,000 in Jan 2015. And after 5 years you sell it for $225,000 in Jan 2019 – these numbers are actually the median home values in the US according to Zillow (link w/cool chart you can play with).
That’s a 37% increase in value, from $164K to $225K…and annually, a 6.5% growth rate, compounded annually. Compounding means you get 6.5% on top of your 6.5%…..so you start at $164K, then add 6.5% to that, it goes to $175K in Jan 2015, then THAT number goes up the next year by 6.5%, to $186K, and so on. Do note – this isn’t guaranteed, this annual rate, but it is how the US market has generally moved the last 5 years. Here’s some data to show prices since 1940, so you can see that up is the general direction for housing prices.
BUT WAIT! Here comes the kicker! Most people can’t actually pay the full $164,000 for that house – so they get a mortgage for the house (63% of Americans have a mortgage). So assume you put down 20% on the house….doing math together, you drop a digit to get 10% = $16,400, and double that for 20%, means $32,400 downpayment, plus let’s estimate 3%, or $5K, for closing costs (all the costs of processing the transaction)….to buy this $164K house, you’d essentially put down $37,400. What’s that??? I can have an asset that gains 37% in value, by only paying for 23% of it up front?? Brilliant! Hard to find!
Now assuming you used your mortgage calculator accurately, the cost of your monthly mortgage + insurance + tax should be the same that you would have spent in rent. (You also get a tax benefit of buying, writing off interest on your mortgage, most online calculators include that, so keep it in mind). So again, we put down $37,400 (only 23% of the price), and after 5 years you sell it for $225,000. You pay off the remaining mortgage debt on the original $164K, and get your $37,400 back, AND THEN you make a profit of $61,000 ($225,000 less $164,000 = $61,000) .
So you invested $37K, and you made $61K in profit, after recouping the $37K!! That’s more than double your money – 2.63x to be exact – compounded annually, you’re making 21.3% on that $37K. That’s almost crazy talk – well beyond savings accounts, or mutual funds, or stocks or bonds in a typical year. All this WHILE you have a place to live with your own front door, amazing flooring, great countertops, and the pride of home ownership. Again, we’re assuming you will pay monthly housing costs on rent or a mortgage anyway, so I’m just talking about the profit compared to the down payment.
Again, this isn’t a simple transaction, you do have to get a mortgage loan from a bank, which means a good credit score, and you have to have the down payment saved, and you are responsible for every cost that may arise with the house – no landlord handling plumbing issues. But for over a 20% compounding annual return, I will deal with the challenges of buying. Look at the incredible returns!
Most of my friends do say the biggest challenge in buying a house is having that down payment to begin with. In Los Angeles, where I live for example, zillow tells me the average price is $690,000 right now. So having 20% down, plus closing costs is about $150K. That’s not small. But if you get that $$ together, and you do that same math over 5 years, the profit is that much bigger – your $150K investment means you walk away with $245K in profit! Think what you can do with that money. (Ideally put PART of it into another new home, not all of it, and put the rest in your IRA, or invest it in stocks/bonds/other fun stuff, or buy a rental property! We can discuss all that fun later.)
Once you start in the real estate game, and get together that first down payment, you will always be reaping benefits. Now of course, annual returns are never guaranteed! There are down years in real estate, when you can’t assume that value is up, so you may have to wait to reap the benefit. But since 1940, the data shows that with enough time, your investment will pay off. People always need homes!! In my experience, real estate is quite simply one of the most advantageous investment choices, AND you get to live in it.