This post began with a snarky reply I sent to blog advertiser and mortgage lender Josh Mettle. He did a refinance for me a few years ago and I've been on his email and mailing list since. He sends out a nice newsletter every so often. My snarky reply was mostly just pointing out that everything he sends me is always unabashedly pro-home buying. It didn't help that his email showed up while I was still licking the wounds of losing money on the place I bought in 2006 and had sold a couple of weeks prior to getting the email. But it caused me to reflect a bit on The American Dream. Wikipedia says this about the topic:
The American Dream is a national ethos of the United States, the set of ideals (Democracy, Rights, Liberty, Opportunity, and Equality) in which freedom includes the opportunity for prosperity and success, and an upward social mobility for the family and children, achieved through hard work in a society with few barriers….The meaning of the “American Dream” has changed over the course of history, and includes both personal components (such as home ownership and upward mobility) and a global vision.
The American Dream
I got to wondering about how homeownership ever became connected to the American Dream, but at some point, it certainly did. In fact, some have argued that homeownership is what separates the poor from the middle class. Merrill Lynch says 84% of Americans agree homeownership is part of the American Dream. However, a more recent survey by the American Institute of CPAs says homeownership was the top indicator of financial success for only 11%. 28% felt enough money to retire was most important, and 23% said providing their children with debt-free college was most important. Home ownership is now at a 20 year low, while rental rates have risen to a 30 year high.
I'm 40 years and have been married for nearly 17 years. We have bought three homes and sold two in that time period. Using the retrospectoscope, only with this third one have we been better off owning instead of renting (and the jury is still out since we haven't yet sold it.) I'm having a hard time squaring this idea of homeownership being this awesome American Dream when it has treated us so poorly. I mean, take a look at this graphic Josh sent me in his newsletter:
The message is pretty clear- if you just owned your home you'd be rich and be spending way less of your income on housing. Of course, correlation is not causation. In reality, homeowners have more money and spend less of it on housing because they make and save more money, not because they own a home.
Better Off Owning Or Renting?
The real question, which neither this graphic nor any newsletter I've ever received from a lender or realtor has answered, is what percentage of home purchasers would have been better off if they had rented instead. A quick Google search finds this article, which states the percentage is 50%. That seems about right to me. I mean, think about all the people who would have been better off renting:
- People whose houses depreciated
- People whose houses didn't appreciate at a rate sufficient to overcome the transaction costs
- People who expect to move in less than 3-5 years or so
- People who end up moving unexpectedly in less than 3-5 years or so due to:
- Lost job
- Ill parent
- Bad job
- People whose alternative investments would have made more money than their home equity did during the period of home ownership
- People who have a hard time selling their house (how many months of extra mortgage payments will it take to eat up all the benefits you saw in 5 years of homeownership?)
Unfortunately, there are several entire industries who continue to push the idea of homeownership- banks/lenders, title companies, realtors etc. I don't blame them; they're only pursuing their own self-interest like the rest of us. But there is no counterbalancing message out there. And most first-time (and second-time, and maybe even third-time) buyers are swallowing the message hook, line, and sinker. There's a lot of money behind the message. I mean, just consider the realtor industry. The average home buyer stays 13 years. The average home is about $280K. There are 123 Million households in the US and something like 62% of them own. The typical realtor commission is 6%. So, 123M*0.62*280000*.06/13= about $100 Billion dollars per year in realtor commissions. How much money is that? Well, it's about 1/6th of the national defense budget. It's about 7 times my state government's budget. And we're not even talking about the other industries promoting homeownership. Or the government. Homeownership might be good for society, but that doesn't necessarily mean it is good for your finances.
Brief Side Note
On a side note, if you want to make a lot of money, I suggest you get into an industry where you “handle the money.” Small percentages of huge amounts of money quickly add up to a pretty good income. That means fields like sales, asset management, lending, and real estate. And unlike some entrepreneurial pursuits where you have to come up with a new product and a method of marketing it, these industries are ready made for the entrepreneurial type. You don't have to have anything new to be a real estate investor; just do what other successful investors do. Part of the reason for this blog's financial success is it deals with subjects where there is a universal need and with industries that have a lot of money sloshing around in them. It's not that hard to add a little value and get your piece of the pie. Looked at my ads lately? There's a common theme. Financial advisors, insurance agents, real estate, mortgages etc. Now, back to the subject at hand.
Forced Savings Is A Weak Argument
Some home-buying advocates like to say that a house is a way to force people to save money. They point out that many people won't save any money they aren't forced to save so at the end of the day, at least homeowners will have something. They might have to reverse mortgage it in order to pay their retirement expenses, but at least there is something there. I find that argument just as weak with regards to home buying as when it is used to justify buying whole life insurance. 80% of whole life purchasers surrender their policies prior to death. And plenty of homeowners get foreclosed on, or suck all the home equity out to pay for toys, vacations, and living expenses. At any rate, it's a particularly weak argument for anyone reading this site. Hopefully, you all will retire with many multiples of the value of your home.
Cost of Housing Goes Down With Time?
One of the reasons I've always liked the idea of homeownership is that over time inflation rises (along with rents) but your mortgage payment stays the same. However, the more I think about that, the weaker I think it is. First, all of your costs except your mortgage (taxes, repairs, maintenance, insurance etc) rise over time right along with inflation. Second, there is an opportunity cost to having that money tied up in home equity. Imagine a paid off home. Let's say it is worth $600K and can be rented for $3000 per month. It has non-mortgage expenses of $1000 per month. So the real benefit of having your $600K tied up in that home is to save you $2000 a month, or $24K a year. What kind of a return do you need on that money to get $24K a year? About 4%. Reasonable, but certainly nothing special. Certainly the expected returns on riskier, long-term investments like stocks and real estate investments are higher than that. In reality, as the value of that home goes up, the cost of your housing doesn't go down. It keeps going up due to the opportunity cost.
Homeownership Still The Right Move Lots of the Time
Of course, homeownership is still the right move much of the time. The last thing I want to happen is for readers to think I always think homeownership is a bad idea. If you're in a stable job and a stable living situation, then buy a home and you'll likely come out ahead. There are also non-financial benefits. You can't be evicted by your landlord. You can paint the walls any color you like. You get the “pride of homeownership” and a piece of the “American Dream.” Your cash flow situation is better, at least once the mortgage is paid off, but probably even before. And, of course, real estate investors aren't losing money. If they are going to be successful, they have to charge more in rent than they are paying in expenses over the long term. But at least take a few minutes, run the numbers, and think long and hard before committing to such a huge purchase. The transaction costs are huge (round trip is ~15% of the value of the home, i.e. 75% of your 20% downpayment “investment.”) The opportunity costs of the home equity are also not insignificant. Finally, the risk that something happens in your life that will cause you to sell before you thought you would is almost surely higher than you think.
You can consider yourself financially successful even if you don't own your home. In fact, there are probably even times when you would be better off using your downpayment to buy an investment property instead of the home you're living in! Sometimes it is easier to hold an investment property for a longer-term than your residence. Plus, you're much more likely to look at it from an investment perspective when there isn't the emotional aspects of “home” tied up in the decision. There is also the natural tendency to buy more home than you would rent, simply because you envision it as being a much more permanent situation, even though many times, it isn't. The end result being that you consume more of your income with housing.
Maybe the American Dream should be owning a business. Why not? It's just as much a symbol of wealth and status as homeownership. I don't care if that business is shares of publicly traded businesses (i.e. stocks), a privately owned business, or even a real estate business. That's all your home really is anyway. You just get to be your own landlord. At least you know the tenants won't destroy the place.
If after all that, you decide that buying a home is right for you, check out these WCI partners:
What do you think? What percentage of homebuyers do you think would have been better off renting over the time period they own their home? How do you decide whether to buy or to rent at any given time? What do you think about homeownership being part of the “American Dream?” Comment below!