<disclaimer: I’ve never bought a house. But I’m a financial reporter and I get seasoned financial experts to answer reader’s questions, and someone wrote in just last month with almost the same question. Here’s what I learned and can pass on.>
Well, I take it you’re buying this house to LIVE in, rather than as an investment property. That takes a lot of the risk out of the equation, because you don’t have to worry about not being able to rent it out, and you don’t have to worry about the trash you rent it to tearing up the place.
So if you have money to either put down on a home or keep in stocks, here are some ways to look at it, from a purely financial perspective.
Historically, according to Freddie Mac, the prices of single family homes have appreciated between 5% and 6% per year. Stocks have appreciated at around 16% per year since 1975, using the S&P 500 as a proxy.
(I think that’s excessive, and wouldn’t plan on more than 10%, but that’s what the Q1 1975 to Q4 1999 numbers are telling me. That’s measuring from a trough to a mania, though.)
Point stocks.
BUT–we’ve left out the most important part of the equation: rental income on property. Now, if you live in the house, that doesn’t mean there’s no rental income. You can pretty much figure you’re paying it to yourself. So although you’re SAVING rent rather than recieveing it from a tenant, the net effect on your bank account is the same.
Generally, you have had to be able to realize a rental income (or savings) of about 10% of the house per year over 25 years in order to match the return of stocks, AFTER your expenses in insurance, upkeep, property taxes, etc, assuming the rental value of the property increases along with the value of the house. (No locking in 5 year leases, etc.)
See how that works? The 10 spread between the historical returns on houses and on stocks = the amount you’d have to take in or save on rent money.
So in order to be a better investment than stocks over the last 25 years, a 240,000 house would have had to rent for 24,000 per year, or 2,000 per month. Capice?
(If you think the spread between property values and stocks will be closer to 7%, then a house will have to provide rental income or rental savings of 7% of the value of the home.)
Generally, you can do that. Point house.
Also, keep in mind the effect of leverage. If you put a 20k down payment on a 200k house and it goes up 10%, although you only have 20,000 of your own money in it, you potentially benefit from the appreciation of 100% of the house.
Don’t buy a house for the home mortgage deduction, though. Never let the tax tail wag the investment dog, as the saying goes.
Also keep in mind that you’ll have to deduct the interest rate from the equation. And the amortization tables only work for you down the road. In the beginning, almost everything you pay with each house payment is interest. Only a few dollars apply to the principal.
(See, banks know that you’ll only stay in the house for about 7 years, just when you’re starting to pay more principal down with each mortgage payment than interest. Then they know you’ll go to a bigger house and take a bigger loan. That’s why bank stockholders get rich faster than homes appreciate. <g>)
To minimize that effect, suck up the extra few bucks a month and get a 15 year mortgage rather than a 30 year. The difference in monthly payments is small, and it will save you 100,000 or more over the life of the loan. And give them a good, chunky down payment. Zero down sucks, babe.
And make payments every 2 weeks rather than every month. That translates into an extra month’s worth of payments every year. Good policy, and it pays off principle much, much faster.
Now, if you can make the numbers work–REALLY make them work, and not have to fudge it or force them to work or pretend that they work, then by all means do so. The home you live in is a great investment, according to no less an investor than Peter Lynch. (Saw him say that on TV last week.
)
If not, then wait, and keep shopping. Don’t try to time the market. You won’t outguess it. And right now interest rates are relatively low. Sure, they can get lower, but so what?
And make sure you own the house–it doesn’t own you. Too many people are house rich and cash poor because they bought a house they couldn’t afford, and the payment became a stressor rather than a blessing.
Make sure you have some good, knowledgeable people on your team. The real estate agent is NOT on your team. Have a lawyer and a good trusted and experienced financial advisor on your team, and pay them generously for their advice. It’ll be worth it many times over.
I’d consider David Yeske (Yeske & Company, Inc.) from Marina Del Rey, CA as an advisor, he’s the guy who related most of this stuff to me (which I then had to compress into about 60 words. <grrrrrr> ) He can help you or recommend someone who can.
David Bergmann, also in the San Francisco area, is very good, too.
Hope this helps!