Home Ownership: Always Worth It?
Regardless of the reasons you may want to own a house, the reality is that home ownership may not always be the best choice.
Common wisdom is that a house is always a good investment. After all, the Seattle metro area saw home price gains of 12% in 2013 (S&P/Case-Schiller Home Index), with another 5% rise expected this year (Zillow.com). Given the likelihood that our historically low mortgage rates will head higher, people are stepping all over each other – and themselves – to buy before rates rise.
Alternatively, quite a few empty nesters with lots of home equity are loath to sell, despite their desire to cash in and downsize. After all, once the family home is sold, so is part of the family’s history. And if the house’s valuation has soared, there are likely to be capital gains taxes (see below).
Worthy of Consideration
Let’s start with those looking to buy. In a seller’s market, such as the Seattle area is now, buyers are often pressured to waive all sorts of clauses and contingencies — house inspection, appraisal, even financing – all designed to protect buyers. And, on top of that, buyers are often asked to provide a substantial amount of earnest money.
So from a financial and legal standpoint, a winning bid isn’t necessarily a good thing.
The upside is limited if you overpay. A house is a fairly illiquid, and often leveraged, investment. The cost of owning, maintaining and eventually selling this asset will definitely eat into returns. Costs include: real estate commissions, closing costs, mortgage interest (70% of home purchases involve a mortgage), renovations, upgrades, regular maintenance, annual taxes and insurance.
Sure, you can deduct mortgage interest and real estate taxes. But only if you itemize, and the interest deduction gets smaller and smaller over time.
Longer term, many economists predict modest housing price increases. Nobel Prize-winning economist Robert Schiller, for one, points out in his book Irrational Exuberance (second edition) that U.S. housing prices were essentially flat for the 114 years ended 2004, adjusted for inflation. Most of the returns in economically vibrant areas such as King County have happened since the 1990s and are being boosted by global money flows. But will the recent annual gains continue? Schiller, for one, predicts U.S. housing price increases are likely to revert to 3% annually in the long run.
Don’t forget opportunity costs. For empty nesters who want to travel or split their time living in different places, owning a house can be a ball and chain. Singles or those with young families give up the flexibility to move easily for a better job, or even to experience life somewhere else in the city.
Overly concentrated portfolio. If most of your money is tied up in your house either as debt or equity, you’re more exposed to a fairly illiquid asset that may not appreciate as much as you expect over time. The money that goes into mortgage payments increases your exposure to that one piece of real estate every month. It might make more sense to invest some of this money in more liquid, financial assets or in yourself – to travel more or to start a new venture.
The tax situation when you sell. If you end up selling your primary residence for less than you bought it, there’s no tax break; realized losses in this case are not tax deductible. It’s a different story when it comes to gains. For couples filing jointly, up to $500,000 in realized gains from the sale of a primary residence is not taxed ($250,000 for singles). And the proceeds from the sale can be used for anything, not necessarily housing. However, house-sale gains higher than the tax-exempt amount are taxed as capital gains. And for higher-income households, the new 3.8% Medicare tax also applies to these gains.
We’re not saying that home ownership is not a good idea. It depends on personal finances and lifestyle, which vary greatly. But if you’re really stretching to buy a house – or you feel like the house you own is becoming a burden — don’t be too afraid of not being a homeowner. You might find it makes more sense to enjoy the freedom and flexibility of being a renter, while still keeping an eye on the market just in case something comes along that really suits you.