A few weeks ago I wrote about 10 purchases that are worth the money, but threw in a caveat about one of them — buying a house:
I think the idea of buying a starter home is one of the worst moves you can make financially as a younger person. Buying a starter home will likely cost you way more money in the end as opposed to waiting until you’re ready for a more high quality home. Around 70% of your mortgage payments in the first 5 years will go towards interest costs on your loan, so you build up very little equity in a starter home by the time you’re ready to move. Then you end up spending a ton of money trying to fix the place up. And when you do decide to trade-up to a nicer place you end up paying closing costs and realtor fees. In the majority of cases it will prove to be a far better move to rent for a few more years and save enough money until you can afford a nicer house. At that point the pros far outweigh the cons because of the sense of community, place to call your own and the psychic income involved.
This one seems to have struck a nerve. I probably got more emails on this one than any post I have ever written. I was asked to do interviews, answer questions, provide caveats and context and expand on these thoughts from some reader push-back.
A few additional thoughts:
- I don’t know everyone’s personal situation, so it’s impossible to make a blanket statement on these things. Buying a home is always situation-dependent. The numbers can change depending on your down payment, geography, local market conditions, rent vs. own comparison, current financial situation and future plans. I just think young people need to put more thought into this decision beyond “I’m sick of paying someone else’s mortgage” or “I’ll just trade up in a few years.” That’s not enough for a decision of this magnitude.
- Owning a home is expensive. Beyond your mortgage and interest payments there’s upkeep, property taxes, furniture & decorations and the cost of home improvements. Then you have the expenses from trading up to a new home — realtor fees, closing costs, taxes, title & insurance, moving costs, purchases for your new place, etc. You should probably bank on 8-10% of your home’s value that gets eaten up by switching costs alone. “Trading up” can be an expensive proposition.
- It’s not so much the condition of the house itself that matters, but the length of time you will live in a starter home. Some people assume that starter homes are always fixer-uppers, but really the costly move is when people try to trade up in a short period of time. The breakeven from a cost perspective could be as high as 5-7 years because of the switching costs involved. Like all investments, time (0r luck) will have a great deal to do with your success. Typically, the longer you stay in your house the better because you don’t incur as many transaction expenses.
- Most of the time housing goes up, but not always. Banking on building up home equity through price appreciation over a short period of time is a tricky proposition, especially in an asset as important as the roof over your head. If you happen to guess wrong because of local or national housing trends, that’s a leveraged bet that’s going against you which can quickly wipe out any down payment or equity you have in your home.
- Opportunity cost is often underestimated when making a big financial decision such as this. Buying a house is a huge responsibility but it can also set you back if you don’t have your finances under control. The great thing about a fixed rate mortgage is that you can always grow into your payment over time. But first you have to ensure that you don’t take on more than you can handle. You don’t want the rest of your finances to suffer just so you can own the home of your dreams. You can’t spend a house in times of need.
- Young people shouldn’t feel pressure to buy a home simply because everyone is telling them it’s the logical next step on their road to adulthood. There’s no shame in renting to give yourself increased flexibility and time to get your financial house or career in order before becoming a homeowner. Buying a house involves much more than simply comparing your current rent payment to the potential monthly mortgage payment on a house. It’s not a decision you should take lightly.
Buying a home doesn’t always have to come down to a cost/benefit analysis on a spreadsheet. There are plenty of non-monetary benefits you can receive from owning a home. But it’s often these non-monetary benefits that cause people to put too much emotion into the house-buying process. This is especially true for young people who most likely don’t have their financial house in order to begin with.
It’s impossible to say whether or not young people should be buying a home. If you do plan on buying a house at an early age, try to consider both the costs and the benefits. And when you buy make sure it’s a house you would be willing to own for a number of years. Otherwise it’s likely to be a losing proposition.
Point/Counterpoint on Real Estate as an Investment Option