Buying a house is a rite of passage for many Americans, but the conventional wisdom behind the decision is -- in my humble opinion -- backwards. In fact, I think purchasing a house for the wrong reasons is one of the most financially and emotionally disastrous decisions young people can make.
My wife and I are both in our mid-30s -- with a two-year-old daughter -- and have yet to buy a house. The day may soon come where we are homeowners. But in the interim, we've had plenty of friends tell us that we're making a mistake by renting. When we asked them why they bought their house, we've heard some doozies.
Here are the three most flagrant -- be sure they don't factor into your decision-making process.
"Real estate is a great investment"
Lots of people look at their parents' situation with envy. For instance, my parents bought their house in the mid-1980s for $100,000 and it's now worth about $250,000. If they ever choose to leave, they'll realize a 150% return on their investment, and it will largely be tax-free.
That's great for them, but anyone making this argument clearly misunderstands the power of compounding returns from the stock market. Consider that between the summer of 1984 (when they bought the house) and today, the S&P 500 has returned 1,250% including dividends. In other words, stocks have appreciated in value at over eight times the rate of this house.
Furthermore, how much have they really gained? If we factor in inflation, $100,000 in 1984 is worth the equivalent of roughly $230,000 today. So in real terms, they're only looking at a gain of about 9% over 30 years.
And this isn't an anomaly; Nobel laureate Robert Shiller has shown that real estate is simply a terrible investment, appreciating at a rate that barely keeps pace with inflation.
What this table actually shows is that between 1871 and 2015, a house worth $100 is only worth $170 today -- after accounting for inflation. In other words, it averages a return of 0.37% per year in real terms.
The next time someone tells you buying a house to live in is a great financial investment, kindly tell them that CDs often offer a better return.
"I'm tired of throwing away money on rent"
Many young homebuyers believe that once they buy a house, they own it. They conveniently forget about an occurrence that became commonplace over the past decade: defaults, leading to foreclosures, leading to repossession.
That's because even if you put 20% down on your purchase, the bank still owns the other 80%.
And if you want to argue that at today's rates, you're paying off a huge portion of your principal every month after you buy, you need to get a handle on how amortization schedules work. In essence, during the first six years of home ownership, a whopping two-thirds of your mortgage payment goes to paying down interest.
It isn't until year 13 that more of your mortgage payment goes toward principal than interest.
And why did I point out that two-thirds of your money goes in the bank's pocket during the first six years of homeownership? That's because this is roughly the median length that a homeowner stays in her house.
So the next time someone tells you they aren't throwing their money away on rent, just remind them that for the next 15 years, they've just shifted from a traditional landlord to a bank.
"We're living the American Dream"
There are different ways this type of reasoning can be interpreted. And from certain perspectives, I actually think this could be a valid reason for buying a home. But in talking to lots of people, I think they believe that owning a home will automatically make them happier with life.
In the end, every ounce of proof (both by psychologists and from anyone who anecdotally sits down to think about their own lives) goes to show that happiness is the result of four key things, as earlier highlighted by fellow Fool Morgan Housel:
1. Control over what you're doing -- which means that it's likely meaningful to you.
2. Progress in what you're pursuing -- or proof of personal growth.
3. Connections to people.
4. Having purpose and meaning -- which often comes from the first two above.
It could be argued that owning a house could help meet these goals. But for far too many Americans, homeownership is financially fragilizing. You become locked into jobs that you may eventually lose interest in, and you need to spend your time focused on making ends meet -- instead of letting those pursuits that are meaningful and enjoyable dictate your actions.
While being able to make rent payments could present the same dilemma, such contracts are usually for more flexible and -- in the short and medium terms -- much less expensive.
Don't be (small f) fooled, however. I think there are great reasons to be a homeowner, which I'll discuss in a future article. But the next time someone tries to convince you to buy a house for one of these three reasons, please tell them that you know better than to fall for such myths.