What is the best financial reason to buy a home? (Hint: it’s not what most think)
Contrary to popular belief, capturing home price appreciation is not the best financial reason to own real estate.
Many people want to own their homes because they believe the property will rapidly go up in value, providing them an endless stream of free money they can spend on anything they want. During the housing mania, lenders allowed anyone to finance up to 100% (or more) of the value of their property, and with “innovations” in mortgage finance, their payments would actually go down! Quite a deal.
Unfortunately, those innovations proved to be less than successful, and most people who availed themselves of that free money lost their homes in foreclosure, or they barely hang on through a loan modification, probably hoping and praying for rising prices and another chance and HELOC riches.
Many people believe home price appreciation is the best reason to own their home rather than rent, but as the housing bust proved, that is not always the case. Even today, many people buy homes because they believe they will make a fortune on appreciation, but with the likelihood of rising rates reducing borrowing power, future home price appreciation will not match what happened over the last 30 years. (See: Housing market impact of 25 years of falling mortgage interest rates)
Financial Reasons to buy
There are several financial reasons to buy a house. People who pay cash or pay off the mortgage actually own the house, and this asset can be passed on to their heirs. Rich people are by definition those who’ve acquired financial assets in excess of their debts. Owning a primary residence can be, and often is, a solid component of a family wealth-building plan.
As all regular readers of this blog know, I am a big proponent of using rental parity to evaluate whether a property is costly or a bargain relative to rent. Saving money each month is a powerful motivation to either buy or rent, depending on which is a better deal. However, this is a point-in-time analysis that ignores some of the long-term benefits of owning versus renting. The longer a person plans to live in a particular property, the more the math favors owning over renting.
Houses tend to go up in resale value over time as workers in a community earn higher wages. The inflation of wages translates into more buying power that allows potential buyers to bid up the price of residential real estate. There is a strong connection between local wages and local house prices. The rising value of real estate serves as a hedge against the ravages of inflation preserving the value of an owner’s investment.
Equity accrues through slow but steady home price appreciation and the retirement of debt used to acquire the property. The mistake people made during the housing bubble was borrowing and spending the rapid appreciation of the mania, squandering wealth rather than allowing wealth to accumulate.
Hedge Against Inflation
Also tied to the growth of wages in a community is the cost of rent. People who chose to rent rather than own face the likelihood of rising rents over time as they compete against other renters for available properties. There is no way for a renter to fix their cost of housing. Sometimes they may find a landlord content to leave their rent alone for years at a time despite the rising rents around them, but once the renter wants to move, they bear the full brunt of increases in local market rents.
Wise homebuyers use fixed-rate amortizing mortgages, and the primary feature of these mortgages is a payment that never changes. This permanently locks in a consistent and affordable cost of housing that doesn’t rise with inflation (except for some increases in property taxes). While renters face a cost of ownership that typically rises with wage inflation, a homeowner does not. This makes home ownership secured by a fixed-rate amortizing mortgage the best reason to own a house.
As an additional benefit, loan amortization serves as a forced savings account. Fixed-rate amortizing mortgages are the best tools for retirement savings available to most Americans — assuming they don’t foolishly raid this savings account with HELOCs and cash-out refinancing. The gradual increase in value and the gradual retirement of mortgage debt combine to create equity for homeowners, another great benefit of long-term home ownership.
Diana Olick, Tuesday, 26 Jan 2016
Renters take note: It’s getting harder to buy a home today, but it may be getting easier to stay right where you are. Home price gains are accelerating, but rents are moderating and could ease substantially in some markets. By the end of this year, rents may actually rise at a slower pace than incomes in many markets, according to a new analysis by Zillow, a real estate listing company.
Home price gains, meanwhile, are accelerating at what the National Association of Realtors’ chief economist Lawrence Yun recently called an “unhealthy and unsustainable” pace. Home prices are rising because of limited listings and rising buyer demand.
Surprisingly candid remarks from Lawrence Yun. realtor economists are supposed to cheer for any price increase, sustainable or not. If he keeps this up, he may actually gain some credibility with someone, somewhere.
“Hot markets are still going to be hot in 2016, but rents won’t rise as quickly as they have been,” said Zillow chief economist Svenja Gudell.
“The slowdown in rental appreciation will provide some relief for renters who’ve been seeing their rents rise dramatically every single year for the past few years. However, the situation remains tough on the ground: Rents are still rising and renters are struggling to keep up.”
If rent growth did moderate, it would be a good thing for the housing market. Potential homebuyers can’t save for down payments with high rents, trapping them in rental housing for life. If they can’t save for a down payment, they will never be able to fix their housing costs and enjoy the best financial benefit of home ownership.
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