Buying a Home is One of the Best Investments You Can Make
When It Comes to Home Buying, There Is No Better Investment You Can Make With Such Little Up-Front Cost
You might think it’s bold, but buying a home is one of the best investments you can make. Sure, you’ve heard this a few times in your adult life, but there’s a reason for it. It’s true.
Here are all the ways buying a home is a great investment.
Buying a Home is Always Better Than Renting
Buying a home may not always be cheaper than renting, though it is a lot of the time. The New York Times has a great calculator that can actually determine if buying is actually cheaper than renting in your area. In many cases buying a home will be cheaper than renting, but, even if it’s not, buying is still the better option.
When you’re paying rent you’re essentially throwing money away. If you pay rent to your landlord for 30 years straight you’re still going to be paying rent on the 31st year. Even the longest mortgage will be paid off by then. While a large portion of your early mortgage payments are going to go towards interest early on, it’s money that you were going to spend anyway. All things being equal, it’s better to chip away at a mortgage payment than it is to light your money on fire. Money put towards rent is gone forever.
Pulling the Lever
There is no other type of loan that the average person can get that gives as much leverage. In legalese, leverage is the percentage of capital used against the amount borrowed. Whether it’s 20% or only 3.5%, the lending institution puts up the remaining amount.
You pay a fee in the way of interest for the “privilege” to use the money, but you’re using other people’s money to purchase something 5 times more valuable than the money you put in. For a relatively small initial investment, you are in control of a very large asset. There is no other investment strategy that puts you in charge of something so valuable.
There are risks, of course. Home values can decline. Interest rates can go up. But you can mitigate a large portion of those by sticking with a fixed interest loan with favorable terms. Also keep in mind that the price of existing homes has grown an average of 5.4% annually since the 1960s. So while it’s not a sure bet (as many people discovered in the mid 2000s), it’s still one of the safest investments you can make.
Building Equity is a Real Thing
Equity is simply the difference between what you owe and what your home is worth.
When you buy a home you can build equity in three ways. The first is through your mortgage payment which reduces the amount borrowed over time. The second happens when the market value of your home goes up. The third is when you do any major renovations or meaningful updates. You’ll need an appraiser from your bank to come and verify that what you did was worthwhile, but that’s easy enough to do.
If you spend $200,000 on your home and it appreciates 3.2% (which is lower than the current annual rate), in three years your total return on investment would be close to 10%— meaning you will have accrued $20,000 in equity in your home.
CNN Money has a nifty calculator that will show you the return on investment with your home. $20,000 is a pretty good deal considering that your personal initial investment was probably no more than $7,000 if you used an FHA loan.
Try getting that kind of return in the stock market. It’s not going to happen.
Capital Gains are Yours to Keep
While we’re specifically talking about the benefits of investing in a home, there is also one significant benefit once you sell. Once you’ve built all this equity in your home you may decide it’s time to use that to buy a larger home. Or you may choose to cash out and swim around in all your heaps of cash Scrooge McDuck fashion.
But wait, you say. Uncle Sam is going to swoop down and peck away at all of your earnings like a vulture feasting on roadkill. Nope! Thankfully, we have the Taxpayer Relief Act of 1997. Yes, usually you would have to pay capital gains tax when you sell your home, but if you’ve lived in the home for two out of the last five years then you can probably keep most, if not all of it.
If you’re single that amount is up to $250,000 and you can double that if you’re a couple. Considering capital gains tax is typically 15% that’s a huge savings on the profit you’ve made off your home. The great thing is that you can use this exemption every two years.
Of course things can go wrong. Markets can stagnate. Values can drop. Things happen. But if you consider that you were just going to throw all this money away on rent anyway you’re still in a better situation than you were before you bought your home. While there are a lot of variables that go into deciding to purchase a home, it’s almost always the smartest use of your money.