What is your single largest investment? According to many experts the largest investment for most Americans is their house. While there is some truth to this, is it really an investment?
After all, an investment should put money in your pocket, right? Does your house put money in your pocket or take it out? If your house puts money in your pocket please let me know what I am doing wrong. My point is that it is very difficult to call a home an investment.
Most people plan to live in their house for a few years and then sell it for a higher price than they initially paid. With the exception of the last five years this was definitely how things worked.
In their minds, they are making an investment with the expectation of making a profit. Is it really a profit though?
Yes you may be getting more than the purchase price of the house, but did the home increase more in value than you paid in interest, repairs, additions, maintenance, insurance, taxes…?
For example: If you took out a 30-year mortgage at 6% and the home increased in value at 6% per year you actually didn’t make any money, with the exception of the minimal principal you have paid. You essentially saved the money at the current rate of inflation for the length of time you stayed in the home.
This only takes into account the amount you paid for the mortgage in principal and interest payments, not maintenance and insurance.
If you were to rent you would be throwing the money away because you don’t have anything but a place to stay for the period that you have paid for, but this is the best option for many (especially military families that move every few years).
After you include all of the property maintenance, taxes and insurance is it really an investment or is it an expense? Ideally we always plan to sell our home for more than we paid for it and until 2008 that was expected.
I have come to the conclusion that our home is not going to be an investment. Your house will not pay your utilities or put food on your table when you decide to retire or if you lose your job!
The point is that an investment will provide income to pay for living expenses at either of these points in your life. Real Estate Agents always want people to think of purchasing a house as an investment, because people allow their emotions to influence their decisions when purchasing a house and that is compounded when they feel that it is an investment.
So instead of buying a house for $250,000 that is within your $300,000 budget (approved by a lender), you will pay something more like $325,000 for a house that is over your budget.
Because real estate agents like to push the envelope by getting you to fall in love with a house that is more expensive and justify it by convincing you that this is an investment in your future.
While I am not suggesting that purchasing a house is a bad idea, it is important to be an informed consumer.
Getting a Mortgage
Keep in mind that just because a bank or mortgage company is willing to lend you the money does not mean that you can actually afford to pay for it. A mortgage is something that will be there until it is paid in full or until you sell the home.
The lenders estimate that you will spend between 55-60% of your income on living expenses and taxes, allowing you to have 40-45% to pay for your debts. This is based on your gross income, not your take home pay.
Even though your house is an expense you still get to determine how much you would like to spend on it. It is important to understand home prices in your target area and to choose a great Real Estate Agent and lender to help you or you can check out Zillow to help you access home values in your area.
Zillow has great resources, including free, no-obligation mortgage quotes.
Always do enough research to make sure you don’t overpay for your home. This can cost you in the long run, especially if you are buying on the high end of your budget.
The last thing you want to do is to purchase your dream home only to realize a year or two down the road that your dream is now a nightmare because you are housebroke!
Real Estate as an Investment
Although your personal residence isn’t an investment, I believe owning real estate can still be an investment. Owning residential or commercial rental property can be a great investment if you are willing to deal with the “hassle factor” tenants.
Many people shy away from rental property partly because they don’t want to deal with tenants every month. This can be a great investment for those who want to invest in real estate.