Many financial gurus cite a house as the biggest investment most people make. In fact, a home that someone has paid off is often the basis of a comfortable retirement. This is even more true if the person downsizes, thereby realizing a significant income. However while your home may come to represent a large part of your net worth, it’s not necessarily a good investment.
Starting from the wrong point
The problem people have when looking at a house and trying to determine their profit is they often take the price they paid for the house and use it to compare to the selling price. However, think about costs associated with home ownership. You have closing costs when you purchase, people normally make changes to their house when they move in, and you must pay taxes and insurance every year.
Additionally, consider how a mortgage works. If you purchased a house costing $300,000 (assuming a 30-year fixed-rate mortgage at 4%) and paid 20% down, your monthly payment would be $1,146 (not including insurance and taxes). Over the life of the loan, you would have paid $412,560 for your house. That’s the number you should start with, then add in the renovations, closing costs, and taxes/insurance mentioned above. Compare that to your sale price for a truer return on investment.
If you haven’t paid off your house, determine the starting number by adding up the monthly payments you’ve made since you moved in along with the other variables, then add in the outstanding principal (often on your statement) to get a good estimate.
Inflation may be the reason for your profits
Historically, homes have appreciated at a rate of 1% to 3%. This may not seem like much, but if your grandmother bought a house in 1984 for $90,000, it could be worth a little over $290,000 today. That seems like a great deal, but again if you add in the costs of purchasing the house, mortgage, maintenance, taxes, insurance, renovations, and costs to sell the house, you could have a rate even less than 3%.
Recent purchase
Given the recent double digit returns in house prices, you may wonder if you purchased recently would you show outsized profits? Let’s say you purchased a house in 2016 for $295,000, paid 20% down, and got a 30-year fixed-rate loan at 3.5%. Your payments would be $1,059.75, not including taxes and insurance. You’ve lived there, making minor changes – maybe a new HVAC or added insulation – and are ready to sell. A conservative value of your house is $400,000.
In a little over five years, you’ve made approximately $70,000 in payments. Add in another $18,000 in taxes and insurance, $8,500 in home improvements, and a 6% commission to sell. Then grab your latest statement – the outstanding balance is approximately $210,000 which of course would be paid off at closing. Drum roll: your average return is -0.23%. Yes, even with the house increasing in value by more than 1/3 over five years, you still didn’t make money.
Note: These examples do not consider using a home as a tax deduction. With the 2018 tax overhaul, many previous homeowners who itemized their deductions have instead gone with the standard deduction. If you still itemize your returns would be different.
Houses are more than investments
A house isn’t just a money exchange though. It’s your home. This has been made more real to me as we’ve been selling my mother’s house. She lived there for almost 40 years and had it paid off before she retired. We had so many celebrations there: Christmases, Thanksgivings, random birthdays. It became a safe place, a place that was warm and inviting.
With that said, if she had invested her $18,400 down payment in the S&P 500 she could have had $1.2 million. Her house sold for $375,000. Adding in a monthly rental (she would have needed a place to live) still puts the S&P investment at twice what the house sold for.
Would you invest that money?
Here’s the hard part. If you decided back in 1984 that you wanted to rent, would you have invested that down payment in the markets? Some might, but many others would find reasons to use the money for a vacation or car or just whatever. Perhaps the biggest financial benefit to home ownership is a house is a forced savings plan. The key here is to be educated about what you can expect monetarily from your home and take a true look at the numbers.
Photo by Milivoj Kuhar