Attention America: We Are Terrible Homebuyers

Yesterday, my friend and fellow Fool Morgan Housel got one thing right for sure: I love to disagree with him. That's why it may be surprising that I'm not going to disagree with his views on housing. That may be particularly surprising since I recently took a bullish stance on the investment characteristics of a home.

Fact: It's a crapshoot whether most people make money on the purchase of their home.

OK, so I'm using the word "fact" pretty loosely there, but I'll bet that most people don't end up making money -- or at least worthwhile money -- on their home purchase. Not that they'd know, because I'm sure a fraction of a fraction of a percentage of people actually keep track of all of the financial costs and gains associated with their home, so that they have a full picture of their returns on the day they sell their house.

Which brings me to...

The real reason your home will be a poor investment
Morgan hints at this in his article yesterday, but maybe I'm just a dunce who likes to be beaten over the head with very blatant conclusions. So here it is, spelled out: Americans are terrible at buying homes.

Yes, that's right. As Oprah would say, "You're terrible at buying a home, and you're terrible at buying a home, and you're terrible at buying a home!"

Putting on my exaggeration cap, I'm thinking I could count on one hand the number of people nationwide who sat down with their Realtor and had a serious talk about price-to-rent ratios before doling out the down payment. Those ratios aren't mysterious and hidden (Morgan has a list of major cities in his article). They're not difficult to understand. And it's been a long time since I was knee-high, but I'm pretty sure you learn the required math skills long before leaving elementary school.

And that's not to mention the interesting -- though admittedly anecdotal -- mortgage-interest misunderstanding that Morgan highlighted:

I recently posed a simple question to 10 friends whom I consider fairly smart: If you have a 30-year fixed mortgage at 6% interest, what percentage of your monthly payment goes toward principal in the beginning? Six answered 94%, which is exactly wrong. The correct answer is 16%.

Along with the sad truth of how mortgage amortization works, Morgan points out that the average length of time that homeowners own their home is eight years. Which is great if you're a bank collecting the interest (since most of the payments to that point will have been interest), but terrible if you're an owner who thinks they're building wealth.

And when simple concepts like these are so badly misunderstood -- or simply ignored -- is there any hope at all that potential homebuyers might sit down with some paper and a pencil to plot out all of the future costs and returns of owning a home to determine whether it's really a wise purchase?

Becoming a terrible investor in one simple phrase
But all of that can be kicked to the curb because we can quickly and easily get to the bottom of Americans' problem with buying homes by examining one simple little phrase that's been uttered over and over and over ad nauseum: "The American dream."

Buying a home is part of the American dream. Sure, it sounds good, but what do dreams have to do with investing? Investing can fund dreams. Big dreams can inspire investors. But when the asset you're buying is also a dream ... watch out!

Americans are poor homebuyers simply because they don't think about a home the way a savvy investor approaches an asset purchase. They say, "I'm staking out my piece of the American dream," and assume the rest works itself out.

A wise middle school science teacher once told a younger version of me that when you assume, you make an ass out of you and me.

Change ain't a-comin'
For the nation as a whole, this just isn't going to change. We love our American dream just like apple pie and baseball. Even if cupcakes now trump apple pie and most ADD-riddled Americans prefer the fast pace of football or the bone-jarring brutality of UFC to baseball.

More importantly, though, there is a massive industry built around housing, and it stands to take a hurtin' if consumers get smarter about the way they buy houses. Realtors take massive rips on either side of a home transaction -- the more, the better! -- and homebuilders such as KB Home (NYSE: KBH  ) , Toll Brothers (NYSE: TOL  ) , and Lennar (NYSE: LEN  ) have product to move -- all the better if they can do so at unrealistically high prices.

Banks such as Bank of America (NYSE: BAC  ) , Wells Fargo (NYSE: WFC  ) , and JPMorgan Chase (NYSE: JPM  ) would obviously like to avoid a repeat of the past few years, but even for them, the rapidly churning, price-is-no-issue housing market is peachy, since they collect fees and pawn a lot of the risk off on investors.

I've pulled few punches with this industry, whether it's the sort-of-but-not-quite-advisor Realtors or the let's-take-the-easy-way real estate appraisers. But in all of the post-meltdown rumblings, there doesn't appear to be any big upheaval in the way the industry operates.

So where's the silver lining?
It's simple: You don't have to be bad at buying a home. You can be Foolish about it. We're a nation of terrible homebuyers, yet Fools can decide to step out of the box, look at the numbers, and do the work that 99.9% of homebuyers aren't doing. And you can ditch the delusion that because it's called "the American dream," it will automatically work out in your best financial interest.

Of course you could also ignore everything I've said here and tell me to go climb a tree. That's fine, too. I recognize that people may want to buy a home for the same reason they'd want to buy a big-screen TV. The home may be near good schools, have the backyard-barbeque-party vibe that you yearn for, or have a killer Viking kitchen.

But if that's the focus of your homebuying experience, don't blindly assume that it'll work out from an investment angle.

The Fool owns shares of Bank of America through a Rising Star buy and also holds a short position in the stock in a different Rising Star portfolio. The Fool owns shares of JPMorgan Chase and Wells Fargo. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

Fool contributor Matt Koppenheffer does not have a financial interest in any of the companies mentioned. You can check out what Matt is keeping an eye on by visiting his CAPS portfolio, or you can follow Matt on Twitter @KoppTheFool or on his RSS feed. The Fool's disclosure policy prefers dividends over a sharp stick in the eye.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On May 13, 2011, at 11:23 AM, nmacleod01 wrote:

    I've found these articles on home buying very interesting, I would like to understand a slightly different scenario better.

    If you buy an apartment building, rent out the apartments, and live in one, what would a scenario that would be beat the market from an investment point of view?

    What would be the main points to consider?

  • Report this Comment On May 13, 2011, at 11:32 AM, frankinCA wrote:

    Is a duplex or triplex or quadplex a foolish thing if you occupy one?

  • Report this Comment On May 13, 2011, at 11:54 AM, pointsplat wrote:

    I think this article is great and I am glad to see someone finally coming to realize and comment on something I have felt strongly about forever. Everyone seems to ignoring any other money you put into the home forget about mortgage interest and when they sell a home for more then what they paid for it jump for joy and look at it as a profit neglecting to count interest paid when they state how much they made.

    Real estate truely is a long term investment and its easier to get a realistic idea of what you are "making" in the scenarios above regarding multi-unit buildings because you are more inclined to include your debt obligations and other costs involved in your calculations to determine if you are on a monthly or annual basis seeing a profit and having those costs covered.

    If your income from the property exceeds your mortgage and other debt obligations on the property from day 1 of ownership through the sale of the property then you know that whatever you make ontop of your initial purchase price you are truely making that money on because your other debts were taken care of throughout your ownership. This of course doesn't factor in closing costs on either end and they seem to get looked over as well so its important to factor these in on both sides of the transaction.

  • Report this Comment On May 13, 2011, at 12:14 PM, aviator365 wrote:

    Wish this article was printed few years back...to help people

  • Report this Comment On May 13, 2011, at 12:21 PM, craigrow wrote:

    This article is JUNK. Where is the rent vs. buy analysis? If you're going to tell people they should do the analysis, give them a formula for that analysis. At least show and example of that analysis.

    The article is so devoid of analysis I can't even refute it. It fails to make a prima facia case.

    JUNK!

  • Report this Comment On May 13, 2011, at 12:27 PM, AquaSpearo wrote:

    Aren't these bearish articles on housing starting to get a bit old by now? Ultimately home ownership is a life style choice, regardless of its prospects for appreciation. A unique property ( that kind that would rarely be available for rent, if ever) provides life dividends ( like owning a nice car.. also a terrible "investment"). The percentage of renter's who actually invest the savings effectively, and stock away enough cash to account for future rental inflation in retirement cannot be that high. I decided to buy a home in the neighborhood where the many of the execs in my industry reside..plenty of indirect benefit there that will never be seen on paper.

  • Report this Comment On May 13, 2011, at 12:29 PM, BxBruce007 wrote:

    Agree with craigrow. If you're going to make a point, make a damn point! Show us what we should be doing instead of just telling us we're not doing it.

  • Report this Comment On May 13, 2011, at 12:37 PM, mm5525 wrote:

    As a former mortgage broker, I own a few rental properties, and I bought an investment property years ago where I had "two" down payments... One at purchase, and then, two, the first year/year & a half I held the mortgage I paid several thousand extra on every payment to get that ammortization ratio more at a 50-50 level rather than the 85-16 ratio in favor of the banks. I am amazed people have no idea when they make their mortgage payments how little goes toward the principal in the beginning, but since Americans hardly read anything financial in nature I guess I am not that suprised. Still, at closing you get an ammortization table that clearly shows this ratio at the beginning. How people are so ignorant about the biggest investment they make is troubling. Back to me, once I got the ratio close to 50-50 I stopped paying extra. So if you pay extra on a mortgage, do it at the beginning to tilt the balance from the bank to your equity as soon as possible. Even if you put down less on the house. Kind of like buying a stock, take an initial position, and then add to it. Don't use all your cash all at once. Hope that helps people out there.

  • Report this Comment On May 13, 2011, at 12:40 PM, VoiceintheCrowd wrote:

    People, especially first-time homebuyers, have a tendency to underestimate the costs of homeownership. The costs that go to expenses that do not build equity (whatever other services they might pay for)--interest, condo/association fees, property taxes, and maintenance--are generally significant. When I crunched the numbers for my current situation, I found that owning a home would actually cost me nearly as much just in those sunk costs than my current rent payment, before I even started building any equity.

    It's true that I can't live in my stock portfolio. However, the nominal returns on that portfolio have been handily in excess of 3% per year, I pay no annual property tax on it and minimal other costs of ownership, and it is portable.

  • Report this Comment On May 13, 2011, at 1:27 PM, TMFKopp wrote:

    @craigrow

    Tell me how you really feel!

    And I think you may have had a point if I had instead titled this "The Only Thing You Ever Need to Read Before Buying a Home".

    In simple terms though, the analysis I'm talking about is looking at all of the costs associated with owning a home (mortgage interest, insurance, repairs, taxes, real estate fees, etc) set that against gains (asset appreciation, the rent you'd otherwise be paying) and compare that with the cost of renting (possibly assuming that any cost differential gets invested with associated returns).

    And, of course, it pays to be realistic about the amount of time you'll likely spend in the home because you get much different results running the numbers over a five year period than you do assuming that you live in the same place for 40 years.

    It's not terribly unlike doing the financial portion of a business plan -- costs versus income while taking into account your opportunity costs. And considering that somebody putting 20% down on a $200k house is shelling out $40k, the comparison may be fairly apt.

    Matt

  • Report this Comment On May 13, 2011, at 1:43 PM, TMFKopp wrote:

    @nmacleod01 and @franklinCA

    See my response above. It'd be similar work involved to determine whether either of those is a good idea. Most investments can end up being a great or terrible based on the price that you pay. Owning a four-plex, for instance, and renting out three of the units could be great. But if you pay a ridiculous price for the four-plex, you're going to have a tough time making good on that investment.

    Matt

  • Report this Comment On May 13, 2011, at 1:49 PM, TMFKopp wrote:

    @AquaSpearo

    "Ultimately home ownership is a life style choice, regardless of its prospects for appreciation."

    As I note at the end of the article, there are many people that look at it that way. But there are a *great* many that don't -- or at least don't look at it solely that way. They look at it as a way of building long-term wealth and owning an investment as well as a place to live.

    Matt

  • Report this Comment On May 13, 2011, at 4:23 PM, ionthemarket wrote:

    Good work mm5025. I am glad to see someone offering good solid advice. I have seen both sides of this. I have built a couple of very nice homes, but life changes and unlike my parents time it seems people don't live out there lives in one place. Certainly I haven't, and I lived in paradise. Miss it sometimes. There is something to say about how do you put a monetary value on the experience side of the equation.

    Unfortunately I think the financial world we live in revolving around debt and the banking cartels is out of control and fundamentally flawed. The system is rebooting no matter if we want it to or not. It just isn't sustainable in the classic sense of the word. Right now, the way things are, I'm renting. Meanwhile people continue to write columns like this one below discussing the merits of when one should be investing in banks and which ones to avoid. No thanks, they got enough of mine already. I'll pass on those investments.

    http://blogs.forbes.com/tomaspray/2011/05/13/4-worst-bank-st...

  • Report this Comment On May 13, 2011, at 4:25 PM, mstan65 wrote:

    The ultimate interactive rent vs. buy calculator is right here: http://www.nytimes.com/interactive/business/buy-rent-calcula...

  • Report this Comment On May 13, 2011, at 4:56 PM, TMFKopp wrote:

    @mstan65

    Ah ha! Great resource, thanks for posting!

    That's exactly the kind of work potential home buyers should be doing. I ran through a few scenarios quickly and a major point to emphasize is for buyers to really think about how long they plan to be in a house. Obviously this is easier said than done, but I know quite a few (to understate) buyers in the previous frothy market bought houses that they specifically planned to be in only a few years.

    In the rent/buy calculation, you can make upfront "mistakes" in terms of how much you pay and still do OK if you own over a long period. If you only own for a short period of time it can be much more difficult to justify ownership.

    Matt

  • Report this Comment On May 13, 2011, at 5:10 PM, EnigmaDude wrote:

    That is a fantastic calculator! Thanks mstan65.

    I already figured that I would need to own my new home for at least 5 years to make it a worthwhile investment even though I did not decide to buy purely as an investment decision. The calculator confirms that 5 years is the break-even point for my situation. Now I feel even better about my decision!

  • Report this Comment On May 13, 2011, at 6:30 PM, GregLoire wrote:

    I rented for several years before I considered buying a home. I had a lot of charts, graphs, calculations, etc., and my general conclusion was that renting and home buying, in the long run, were pretty much the same... but only if you're investing everything you save in the stock market while renting (theoretically, rent should be cheaper than mortgage payments). It's the opportunity cost on stock investing that really gets you more than anything else.

    For me, this information was a wash because I really do invest 100% of my savings straight into the stock market. So I waited nearly a full year (after finding a great house at a good price) before making my purchase.

    But here's the thing -- most people DON'T invest in the stock market. Most of us here do, so we're biased. The reality of our country is that when people have a few thousand dollars sitting in their bank account, they buy a new TV.

    It's true that your beginning payments won't pay off much principal, but on average the value of the home will increase, and at least SOME money is being paid toward the principal. Without these two factors, most people simply wouldn't do any investing at all.

    So the paradox here is that the people who are most ignorant about home-buying finances and investing are actually the people served the best with home ownership because it's likely that any money they would've saved from renting would have either been spent or left to sit in a ~0% interest saving account.

  • Report this Comment On May 13, 2011, at 7:08 PM, TMFKopp wrote:

    @GregLoire

    Interesting points... though:

    "at least SOME money is being paid toward the principal."

    While principal may be fixed, the value of the home isn't. Obviously the past few years have been, shall we say, unusual, but it just shows that it's very possible to buy a home and find yourself owing a lot more in principal than you'd get back in a sale.

    In more extreme cases, renting and buying a TV may be a better way to go -- at least in that case you have a TV...

    To some extent I do agree with you, but I think we broadly need much better financial education for everyone. And perhaps that reveals that I have my head in the clouds.

    Matt

  • Report this Comment On May 13, 2011, at 8:24 PM, ffbj wrote:

    It's all about timing, luck, and yes, thought. My own situation is very good compared to most, and mostly based on timing, luck, and a little thought.

    I bought a home for 60k, 20 years ago. Now having almost paid it off, and having it appreciate about 2.5 times I don't think of that as a poor economic decision. Now if I had rented in the mean time what would I have? Pretty much nothing, as rents have continued to rise, and even the lowest rents in my area are higher than my house payment including taxes and insurance.

    So bottom line buy when the prices go down and don't by when they are high, and you will be fine.

    Of course that's easy to say but hard to do.

  • Report this Comment On May 13, 2011, at 8:34 PM, ffbj wrote:

    Oh and I payed down the pricipal with every little extra nickle I could find and planned on living in the house a long time. So I turned my 30 year into a 20 year, and though I never re-financed my 6.1% mortgage even when rates hit 4% I did ok.

    Calculating that it was a wash to pay for the refi costs at my point in paying the whole thing off.

    So general rule: refinance if rates fall 2% below your current mortgage rates and only once.

  • Report this Comment On May 13, 2011, at 8:50 PM, GregLoire wrote:

    @TMFKopp

    "While principal may be fixed, the value of the home isn't. Obviously the past few years have been, shall we say, unusual, but it just shows that it's very possible to buy a home and find yourself owing a lot more in principal than you'd get back in a sale."

    If you owe more in principal than you get back from a sale, the lender (bank) has to eat the difference in the short sale. On average, home values go up. Lately they crashed, yes. But the same is true of stocks. On average, they go up. But lately they crashed. In both cases, you can't go below 0. And in both cases, you're going to go up on average. Investing is all about average expected returns. Home values go up less than stocks do, but you can live in the home while you're making payments, which means that you're probably not paying rent as an additional cost.

    "In more extreme cases, renting and buying a TV may be a better way to go -- at least in that case you have a TV..."

    Yes, extreme cases. But investing isn't about extreme hypotheticals. It's about what we can reasonably expect. It's not reasonable to expect the value of a home or stocks to lose value at the same rate as a new television, even if this sometimes happens.

    "To some extent I do agree with you, but I think we broadly need much better financial education for everyone. And perhaps that reveals that I have my head in the clouds."

    I completely agree that people would be better off with better education. But it is constantly mind-blowing to me how apathetic people are about investing. I talk about it all the time with friends and family members. They either just don't care or they have illogical perceptions of risk. These are the sorts of people who really should buy a home -- they lack both education and discipline, and they often have little interest in improving either one. At least building equity is forced on them if they buy a home.

  • Report this Comment On May 13, 2011, at 9:11 PM, TMFKopp wrote:

    @GregLoire

    Again, on balance, I agree, but a few nits:

    "If you owe more in principal than you get back from a sale, the lender (bank) has to eat the difference in the short sale."

    That's a very big assumption because the bank is absolutely not obligated to accept a short sale. And, though state laws vary, they can come after you for the difference.

    And even in cases where a bank does accept a short sale, they'll often require that the seller come up with something. Generally not the entire shortfall, but if it's, say, $50k, they might want $5k to approve the sale. (or at least that's happening here in Vegas)

    "On average, home values go up. "

    This gets to the idea behind the article above. When this blanket assumption is too widely held, it creates problems. People start to be willing to pay anything for a home because they think "on average, home values go up." But it's important to run the numbers and make sure you're not paying an absurd price because that's a good way -- whether we're talking stocks or houses -- to ensure that your purchase won't work out well.

    "In both cases, you can't go below 0."

    Well, not really and this goes back to the negative-equity, short-sale issue above. Since you're (typically) borrowing significant money to buy a home, the value of your investment can go below zero, and there is an alarming percentage of Americans in this position right now.

    It's certainly not the norm, but it's when we forget that it can happen that prices can escalate to the point where it's likely to happen.

    Matt

  • Report this Comment On May 13, 2011, at 9:13 PM, TMFKopp wrote:

    Of course, to be fair, a lot of these issues are far lesser concerns than they were a few years ago. Just as with stocks, as prices fall, the investment case often gets better. So as the housing market has crashed, the investment case of buying a home has gotten stronger.

    It's very much a location-by-location thing though, as Morgan's chart shows that some geographies are still pretty pricey.

    Matt

  • Report this Comment On May 14, 2011, at 11:57 AM, meatmann50 wrote:

    Bearish article on housing,however for investors this housing market is anything but bearish....There is plenty of cash flow to be made in this housing market.I live in Cali and have purchased 2 homes in the last 14 months and am cash flow positive,in less than 4 yrs I will have recouped my down payment and all loan costs and all the while NETTING almost 1000.00$ a month in cash flow.The rental market is hot...these forclosure people have to live somewhere,they want a house not an apartment.

  • Report this Comment On May 14, 2011, at 1:58 PM, ansu wrote:

    Only a FOOL rents if you plan to live in it over 2 years. Buy now as you won't get this chance again. I just bought 2 more houses.

  • Report this Comment On May 14, 2011, at 2:48 PM, 5000monkey wrote:

    I live in a 4-plex and my other three units pay about 300 a month more than my mortgage payment. I've been very happy with it.

  • Report this Comment On May 14, 2011, at 5:46 PM, hachmujt wrote:

    Thanks for the great discussion. I am an aggressive LTBH stock market investor.

    I also own one investment property which I made a onetime payment on to bring the mortgage balance to below 50% of the initial loan. I have had it for 5 years. It cash flows now and will be paid off in 3 years. At the time I did not realize how important this was. The discussions and links here help me wrap my mind around it.

    Remember that as a rule of thumb you are going to still pay out about 20% of your rents AFTER the mortgage is paid off. This is on vacancies, repairs, taxes and insurance. One of the posters above who was a mortgage broker also supports this thinking. I completely agree with the NYT article linked above, do not pay more than 150 x how much you can rent a place for. William Bernstein talks about this in The Investors Manifesto.

    I also have to point this out. Principle is how much my investment is worth less how much I owe on it. Principal is the owner of the desk that I sat on the wrong side of during school. 

  • Report this Comment On May 14, 2011, at 7:02 PM, slowpick wrote:

    hachmujt -

    As long as we're picking nits, both of your examples should be "principal", not "principle". A "principle" is a philosophical guideline or an ethical rule or similar. For example, it is a principle of mine to never touch the principal in my investment accounts.

  • Report this Comment On May 14, 2011, at 10:15 PM, dcorley wrote:

    Interesting article when housing prices have crashed. I am currently buying a house that has a mortgage approximately 1/2 of the rental rate.

    If you want a loan to pay 50% toward principal from the first payment, get a 15 year loan. (Actually, about 17 years.)

  • Report this Comment On May 15, 2011, at 1:59 AM, firstguy wrote:

    I would presume that most of the people buying a house today are saving money or money savers and know, at leasst in the short run, that they do not want to pay twice the amount in rent as they would to own a house. Regardless, it's just the idea of it.

    Once the average person starts renting, you are stuck renting. Once you say carte blanche that buying a home is a bad idea-you wouldn't just buy any old stock would you? You have to pick them just like you pick a stock. Does a stock always go up after you pick it? Or do you justify it when it goes down?

  • Report this Comment On May 15, 2011, at 2:27 AM, kdohert wrote:

    I have bought 5 houses in the last 30 years and have followed various strategies.

    My first purchase was for $60K on a of salary $18K. My calculations showed that after a 10 % down payment, I could afford about a $45K mortgage. However, after looking at the tax deduction effect from the mortgage deduction, I raised my withholding exemptions to 4 which put enough extra money in my pocket to make the higher payments and break even on income tax.

    BTW principal in year one of a 30 year fixed is 1% under the rule of 84, not 16%. It doesn't even reach 5% until year 5.

    House number two was a $ 90,000 purchase (marginal profit on the first sale because I paid too much). I followed the same strategy and salary had gone up and interest down below 9%. Once again, this play cost me no extra OOP net money.

    However, I made about 15 % profit upon sale.

    I put 100% equity into the next home which I bought at a lower price. I got an ARM mortgage because I didn't think rates would get any higher, but also reduced the term to 10 years. The rate went quickly to 4.5% from 9%. I doubled my payments against principal and was within a year of payoff when I sold it for a 20% profit.

    Next move was to a much higher cost community, but I had so much equity built up, that I was able to purchase a home at three times the cost, but was able to handle a 15 year mortgage (10s were not available). Sold this home with a 20% profit.

    Current home was about 20% less in cost, but larger and more modern. 10 year mortgage was modest and allowed me to pay for 2 new cars, including wifie's big Lexus and pay college tuition with no stretch on the budget.

    Ultimately you have to watch your markets, do your tax planning and take advantage of tax breaks and your real estate markets.

    Apologies for typos and spelling. No spell check and eight incapable fingers.

  • Report this Comment On May 15, 2011, at 1:21 PM, ikkyu2 wrote:

    Here's some things this article spectacularly fails to address:

    a) Much of the money you "put in" to the home, including qualified repairs and upgrades, increase your cost basis in the home and therefore reduce the amount of capital gains booked at sale time (if any).

    b) Although the value of a home may not increase, or may not increase much, in real terms; no one disputes that interest rates and inflation are set to rise from here. This means the value of the house can increase in nominal terms. Meanwhile, a purchase now locks in a very low interest rate (I am paying 5 1/8%.) How's that going to look in a few years when the cost of capital is 9%?

    c) If one is in a high income tax bracket, a huge amount of that interest payment (equal in percentage to one's marginal tax rate) is effectively rebated by Uncle Sam. My true interest payment on my mortgage, considering the tax benefit, is below 3%. How's *that* going to look in a few years when the cost of capital is 9%? Sweet, that's how.

    d) I enjoy owning a home. The official CPI calculations include "hedonics" - the amount of extra pleasure a buyer gets from, say, a flat screen as opposed to an old curved-screen TV - so why shouldn't my pride of homeownership be taken into account? Or, for example: the low neighborhood crime rate I enjoy in my community of proud homeowners who participate in a neighborhood watch program? These benefits don't come with a visible price tag but they are not worthless either.

  • Report this Comment On May 15, 2011, at 1:28 PM, ikkyu2 wrote:

    Then again, you do make a good point: if a person really doesn't understand what an amortization schedule is, or how it works, that person really has no business trying to do the math associated with their home-buying decision. I imagine that's probably true of a lot of folks.

  • Report this Comment On May 16, 2011, at 1:49 AM, LennyLenard wrote:

    I bought my first house 4 years ago. If you subtract the cost of renting from what I've put towards the house so far, I would be close to being able to buy my house outright today. If I invested that money I would be able to, provided I got a modest return on my investments.

  • Report this Comment On May 16, 2011, at 3:50 AM, splicketylick wrote:

    When we bought this place, the mortgage, including taxes and insurance, was a couple of hundred dollars less than the rent we would pay for a similar house. But now, nine years later, it would rent for about $700 per month more than our mortgage payment. The properties that I could rent today for the same price as my mortgage, I wouldn't want to live in.

    In my opinion, the notion that you will invest any 'difference between rent and mortgage cost' is a pie-in-the-sky concept for most people. It's just not going to happen. So for a lot of middle class Americans who are not sophisticated about investing, owning a home for the long term is an indirect way of saving toward retirement. If they can get that mortgage paid off, there will be a certain level of comfort after retirement, and something to leave the kids. But I"ll admit, that is a plan from my grandparents' time, and not really relevant now.

    Bottom line, though, is now that I've 'owned' a house, it would be awfully hard to go back to the restrictions of renting. No thanks. I happily pay my mortgage payment each month, because I feel like I'm getting a benefit every day from that money.

  • Report this Comment On May 16, 2011, at 4:38 PM, Darwood11 wrote:

    I agree, I love that NYT calculator! Thanks mstan65.

    I used the older version when I decided to purchase some years ago, and have periodically recommended it to my kids and to others.

    The issue with home buying is it is such a long term purchase, and with real estate currently out of vogue, one must think twice before making such a long term commitment.

    However, rents are creeping up, and some think there will be a spike this year with about a 15% increase for some. It wouldn't take long if that were the case to give people some pause. On the other hand, if we can't do the math, it becomes a simply emotional or fear/greed driven event. In that case, even if it makes a lot of sense, many will avoid real estate, just as they were recently diving into the bubble.

    Some people, possibly many of us, will never learn.

    I suggest serious financial planning begins in grade school.

  • Report this Comment On May 16, 2011, at 6:16 PM, chaz572 wrote:

    I hear a common thread in the homebuyers refrain... The mortgage payment at the beginning was more than I could rent something comparable for, but by 5 to 10 years down the road, it was less as rents had risen to surpass it.

    Which is *KEY* in any buy-vs.-rent calculation. By buying, and locking in a long-term mortgage, you fix your payment for the entire life of the mortgage. And then when it's paid off, your payment goes down drastically (not to zero, as I'm still counting property taxes and insurance). When you rent, you lock in your payment for typically only a year, but almost certainly three years or less, after which it goes up. And when that lease expires, it goes up again. And again.

    So your buy-vs.-rent calculation should include a forecast of how long you realistically plan to stay living where you are, and factor in the long-term average yearly percentage increase in rents in the area to the cost of renting over that period of time.

    Even if you're not going to stay living in the house long enough to build a lot of equity in it, as long as you stay long enough that rents have risen to parity with your mortgage payment (a bit higher to account for taxes and maintenance), then you'll have the option to keep the house and rent it out when you move out, and you'll be able to do so at near break-even. Eventually that will become a source of cash flow while you continue to build equity.

  • Report this Comment On May 17, 2011, at 8:08 PM, martianrealist wrote:

    You note that some people may not see a house as an investment and for them buying a house works fine. My opinion is that everyone who buys a house thinking that it is an investment or thinking that it is a combination of investment and a place to live are kidding no one but themselves.

    It is neither of these. House is a place to live, to call it home; that's it. Nothing more, nothing less. If you turn a profit by ever selling it, that's just a byproduct of your decision to buy and eventually sell the house.

    I don't think it should be considered any different than buying a car. If I buy a BMW or Merc, I am not buying it hoping to turn a profit when I sell it. I buy it to enjoy driving it, for the sheer pleasure of owning it, to enjoy the comfort that I won't get in a Yaris, and of course in a lot of cases, the pride of showing it off to my friends :-) If I ever buy a BMW hoping to sell it at a profit, I am doomed. Owning a house is no different. Or dare I say owning a house MUST be no different. Houses were packaged as investments and we got royally screwed :-(

  • Report this Comment On May 19, 2011, at 2:39 AM, hbofbyu wrote:

    The mortgage interest deduction is sinking our country. This tax deduction makes no sense, drives up housing prices and keeps the feds running deficits forever. It's not like America needs to encourage homesteading in this day and age.

  • Report this Comment On May 19, 2011, at 2:33 PM, theHedgehog wrote:

    If you can rent just as nice a place in just as nice of a neighborhood for lower net cost, then of course you shouldn't own. Is that likely to happen? Given the demographics of rental houses and apartments, no.

  • Report this Comment On May 19, 2011, at 2:35 PM, theHedgehog wrote:

    @martianrealist, you might want to look up the difference between a declining asset (car) and real property.

  • Report this Comment On May 19, 2011, at 10:08 PM, martianrealist wrote:

    @thehedgehog, a car is a declining asset?! I had no idea :-)

    I sense that you didn't capture the underlying message of my analogy of buying a car and buying a property. My point was; a person buying a house as a primary residence should not be driven by a profit motive. Property values most likely will go up in the long run or in the less likely scenario it won't. But for the buyer who purchased it with only one intention- namely living in it- wouldn't be bothered too much either way.

  • Report this Comment On May 20, 2011, at 12:10 PM, jett96 wrote:

    The foolishness has exceeded the usefulness sadly. There are times when renting vs buying make sense for a certain period of time and in certain situations. Some reasons are sheer preference and some are entirely due to buyer discipline and intelligence. There's a ton of people in foreclosure who have their leased BMWs in repossession having leased them using their HELOC. I feel bad for their families but not much. Too many irresponsible types out there creating problems for the rest of us. This FOOL article is just more pop fizzz and enlightenment is minimal. Key to success is save money, be disciplined, invest in a low cost index fund, and buy a home you can afford with a mortgage that makes sense. Toys are nice but they can be much more fun when affordable. FOOL isn't adressing this since the focus is -duh- on buying stocks and paying commissions and fees. Amateurville.

  • Report this Comment On May 20, 2011, at 12:50 PM, DJDynamicNC wrote:

    THANK YOU MATT. This article is a pleasant anodyne to the conventional wisdom.

    I can't even count the number of times I've heard "renting is just throwing away money when you could be building equity." Obviously, renting isn't throwing away money - I'm trading money for shelther which is a fairly important transaction - but your article addresses the flaw in the "building equity" argument.

    Further, I AM building equity - and I am building it in a diversified portfolio, instead of putting one critical and extremely non-liquid investment at the center. I'm not paying property taxes, upkeep and maintenance, or homeowners association fees. I'm not paying realtor fees, bank fees or interest. Just a modest monthly stipend in exchange for shelter, which frees up resources to invest in securities or my own business interests.

    And if any of my investments go south, I don't get evicted.

    If you are going to raise a family and stay in one location for the next 30 years, then by all means, purchase a home. But most of us aren't. The sooner we admit that, the better.

  • Report this Comment On May 20, 2011, at 12:53 PM, DJDynamicNC wrote:

    Further, this penchant for homeownership for investment purposes makes people irrationally fixated on home prices. Everybody needs shelther. In a rational market, the headlines for 2008 would read "Housing becomes wildly more affordable!" and everyone would be celebrating at this increase in general living standards. But because we use our houses as investment vehicles, a drop in price is seen as crippling.

    Completely irrational, which is par for the course when dealing with markets, but still frustrating. Much respect to the Fool for keeping rational analysis at the forefront.

  • Report this Comment On May 20, 2011, at 12:56 PM, NolAloha wrote:

    Any purchase should be looked at in terms of what is important to the purchaser, and those are not necessarily economic values. However ,since this newsletter is primarily looking at economic factors, not quality of life, it should have articles that are grounded in fact, not assumption. The article above was appropriate in a general strategy sort of way, but lacking in specifics. As a real estate investor who NORMALLY makes (nets) over $100,000 on each transaction, keep the following points in mind.

    1. Real Estate ties you down, and if you are not careful, it will limit your career. To protect yourself, ALWAYS buy a place at a price that is less than replacement cost. ALWAYS buy a place that will rent out for more than all your normal costs. NEVER buy a place that you would not be willing to live in, because you might need to.

    2. Real Estate is the biggest tax-advantaged investment you are ever likely to make, and is your best chance at protecting at least part of your earnings that are stolen each year by inflation. Long Term Hyper inflation is already here. Today's dollar is only worth about 2 cents compared to the dollar of 1945, when I was born.

    3. Though the writer expressed concern about people actually making money in real estate, In most cases, following the rules in paragraph 1, you will not lose money, and can preserve some of your earnings.

  • Report this Comment On May 20, 2011, at 2:23 PM, drborst wrote:

    @mstan65, thanks for the link.

    Matt, Not bad. But I'd add this: I look around my house after reading this article and think that when it applies to me, the title is too specific. I'm just a terrible buyer.

    Also, I'm just a little bit surprised that there isn't a single comment about the distorting effects of the Morgage Interest deduction. Maybe that's a topic for a future article.

  • Report this Comment On May 20, 2011, at 2:52 PM, outoffocus wrote:

    I think Americans are terrible homebuyers but for different reasons.

    I think the idea that most Americans buy home for "investment" is a faulty premise. Most Americans don't buy a home for investment, they buy a home to live in. They are the "end user". So for most americans homes are more of a commodity than an asset. These homes do not generate a cash flow. If anything they are a cash drain. When they sell their home, they arent' "withdrawing equity", they are collecting a capital gain.

    I think people who buy homes for investment purposes are the only ones who, well, own a home for investment. Typically these investment homes generate a cash flow. In collecting cash from rents, they may be retaining some of that cash for repairs or improvements, hence generating REAL equity. Not this false equity that banks fooled the average american into believing they had.

    Whats worse is the typical american takes on the highest leverage for these commodities. Most people who get FHA loans only put 3% down. Thats 97% leverage! When someone puts 97% leverage on any business or investment asset brokers and advisors look at them like nuts and say they are being too risky. But somehow its ok for the average joe schmoe.

    As a result Americans habitually overpay for homes (regardless of rent to own ratio) because of this false idea that they are building wealth. But in most cases they are only building wealth to the extent that they pay off their mortgage and have a home to pass on to their heirs. But most Americans dont even do that. As the article stated, most Americans only keep their homes for 8 years. Yet they take on 30 year mortgages (or "interest only" mortgages).

    Sounds to me like the only ones "building wealth" on the "American Dream" are bankers and brokers.

  • Report this Comment On May 23, 2011, at 1:20 PM, mikepriz wrote:

    To someone in New York City, it may be hard to understand, but not everything one buys is an investment. I designed and help build my home. It is a one bedroom, 4500 sq. ft. home. t is exactly what my wife and I want. When I designed it, resale value was not even considered. What is the value of a one bedroom house? I invest money so that I can buy the things that I want. By the way, 5 months ago I went on vacation to Europe and Africa, and last month, I went on vacation to the Caribbean. I did not make any money or either of those two investments. I just bought a new car last month which will likely turn out to be a bad investment, but I really like it. I have done well on my investments. On the things that I buy for the fun of it, my house will bring the best return on my money if I decide to sell it.

  • Report this Comment On May 24, 2011, at 10:58 AM, hachmujt wrote:

    @ slowpick, thanks for the kind correction. You are the best!

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