Since the mortgage meltdown, many people have become wary of the idea that home ownership is a lofty goal that every American should aspire to.
There are obvious pitfalls to buying a home that you can’t afford or that you don’t plan to keep very long. But for most people, owning real estate is still one of the best ways to build long term wealth.
Here are 6 major pros and 6 major cons of owning a home, so you can evaluate whether you should buy a house:
6 Pros of Owning a Home
1. Spend less– Even though owning a home can be expensive, it doesn’t have to cost more than renting. Buying an affordable home with a reasonable mortgage can actually cost less on a monthly basis, depending on where you live. The Rent vs. Buy Index on Trulia.com shows the major cities where homeownership is more affordable than renting. Their study from early 2011 reveals that it’s still cheaper to buy in 72% of America’s 50 largest cities. However, renting is less expensive in a few large cities, such as New York, San Francisco, and Seattle. The best way to make a comparison is to analyze the monthly numbers for comparable properties. Try using a Rent vs. Buy Calculator at sites like dinkytown.com and bankrate.com for help.
2. Build equity– When you have a mortgage that amortizes, you can build equity with each monthly payment. Amortization means that each payment is made up of a principal and interest portion. Principal pays down your original loan amount and interest is the price you pay for having borrowed the money. For a fixed-rate mortgage, the monthly payment stays the same, but the amount of principal and interest changes each month. In the early years of a fixed-rate mortgage, payments are mostly interest—but as your loan balance gets smaller, so does the amount of interest you owe. That’s why the principal portion of your payment increases at the same time that your interest portion decreases. As you build equity in a home, it makes the long-term cost of ownership less expensive than renting a comparable property.
3. Get appreciation– If you sold a home in 2005 or 2006, you probably took advantage of the highest real estate values the U.S. has ever experienced. As you know, values have declined significantly since that time in many areas. However, if you’ve owned a home since 2000 or so, the current market value of your property could still be 20% to 40% higher than your purchase price. Since having a place to live is a basic human need, owning real estate will always be a good long-term investment when handled judiciously. This is especially true when you purchase property in a desirable area that’s close to shopping, amenities, public transportation, or recreation.
4. Hedge against inflation– A fixed-rate mortgage locks in your monthly payment, which means it’s immune to inflation. No matter what happens to the economy or to interest rates, a fixed-rate mortgage payment never changes. (This isn’t true with an adjustable rate or interest-only mortgage, however.) With rates on 30-year fixed loans at about 4% right now, that’s an incredible incentive to refinance an existing loan or to become a first-time home buyer. As a renter, if future inflation pushes rents higher, you’ll be forced to pay more or to move into less expensive digs.
5. Reduce taxes– You can claim a tax deduction for the interest you pay on a mortgage for your first or second home up to a certain amount. This valuable benefit is available regardless of your income as long as you itemize deductions on your tax return. Another unique tax benefit occurs every time you sell your home. As long as you’ve lived there for at least 2 of the 5 years prior to the sale, you get to exclude up to $250,000 (or up to $500,000 if you’re married and file taxes jointly) of capital gains. You can also defer taxes with a 1031 exchange in certain cases, which can help you defer paying taxes on real estate investments. Watch my Mortgage Interest Tax Deduction FAQ Video to learn much more about how this tax benefit works and who’s entitled to claim it.
6. Have flexibility – When you own a home, it comes with lots of flexibility that you might not have if you rent a home or apartment. You can remodel the interior, do landscaping, create a garden, or have pets, for instance. You generally have more room to spread out and store more stuff. You also get a pride of ownership and the ability to put down roots, which many homeowners enjoy.
6 Cons of Owning a Home
1. Spend more– Though spending less is one of the pros of owning a home, it can also be a drain on your finances, depending on your property. When a tree falls in the yard, the roof leaks, or the heating system goes kaput (which are all issues that I’ve had to address in the past couple of years!), you’ve got to come out-of-pocket for those expenses. And unexpected repairs and maintenance always seem to pop up when you can least afford it. Homeowner’s insurance will cover certain repairs, but you typically still have a hefty deductible to pay. Not to mention the cost of your time that it takes to deal with the insurance company, merchants, and repair crews.
2. Experience depreciation– Appreciation is a benefit of being a homeowner when you plan on keeping the home for the long-term. However, selling it when the value is down, means that you might have to bail for less than the original purchase price and lose money. You should never buy a home unless you’re certain you’ll stay there for at least 4 to 5 years – and even then you can lose money on your home when you sell.
3. Make a down payment– A lender will offer you a mortgage only if you make a substantial upfront down payment. You might qualify for a down payment that ranges from 5% to 20% depending on the lender’s guidelines, the type of loan, and your credit score. Additionally, there are more closing costs—such as having to prepay a certain amount of homeowner’s insurance and inspection fees–that you have to shell out at the closing table. Renters only have to come up with a maximum of a month or two of rent plus a security deposit.
4. Credit needed – Having a mortgage can help you build your credit—but you’ll never get a mortgage if you have poor credit! Another problem is that having a credit score that’s average or below average means you’ll pay a higher interest rate than if you have excellent credit.
5. Wait to sell – When you’re ready to put your home on the market due to a great long-distance job opportunity, a divorce, unfriendly neighbors, or to move closer to family, you can’t make a buyer appear overnight. Real estate is an illiquid investment, which means it takes time to convert to cash. Depending on your home and the local market, it could take months or years to sell your home.
6. Have foreclosure risk – If you lose your job or business income and are unable to make timely mortgage payments, you risk losing your home through a foreclosure. A foreclosure is more damaging to your credit than being evicted from a rental property for not paying rent.
Should You Buy a House?
When you consider the pros and cons of owning a home, you can see that there are lifestyle and financial considerations. If you’re only thinking about whether buying a house or condo will be a good investment, remember this:
To cover all the costs of buying and selling a property—such as legal fees, recording fees, real estate commissions, title insurance, and an appraisal—you need some amount of appreciation to break even. To achieve appreciation on residential real estate in most U.S. markets, you have to own it at least 4 or 5 years. So be sure you plan to stay in your new home for the long term before you pull the trigger on a great deal.