A simple fact: the wealth of most individuals is the equity in their homes.
Plus, for most, a sense of security and control comes with living in a property that you hold title to. But for some, a sense of burden plus nagging problems and costs comes with owning a home. When the horrors in the housing markets from 2008 to 2011 are added to this normal dichotomy of views, thus arises many myths and half-truths. Below we discuss those most commonly encountered.
Navigate this article:
- #1 – Over the long-term, a home is always a great investment
- #2 – Renting is always a financial mistake.
- #3 – Remodeling baths and kitchens is a good financial investment.
- #4 – Using a Realtor® to buy or sell is a waste of money.
- #5 – Buying as soon as possible is better than later.
- #6 – Home buyers with bad credit needing a loan need not apply.
- #7 – A bigger down payment is always better.
- #8 – A 30-year fix-rate loan is best if you have the cash.
- #9 – The best loan? Simple! It’s the one with the lowest APR.
- #10 – You get more house for your money in the suburbs.
- #11 – My home is a great ATM.
#1 – Over the long-term, a home is always a great investment
Truth – nearly always true when “long-term” means 15+ years … otherwise, as we all know … not always.
But for an exception, consider downtown Detroit. Any real estate investment made there a few decades ago was an obvious mistake.
But long-term academic analysis by Wall Street “experts” that renting a home and investing in stocks is better than buying a home ignores some fundamental issues … (1) Which stock? Or index? Or mutual fund? The individual has a much better sense of home values than stock values. (2) A home located where? In Detroit, stocks win for sure. In most cities west and southwest, stocks likely lose. And (3) Which home? A reasonably sized and appointed, well-designed, solidly-built, well-located home in a city having long-term in-migration is going to enjoy solid appreciation for a very long time. Stocks have no chance.
And this presumes that there is a rental choice in the particular community, school district, and/or type of home that you want. If such a rental is not available, then renting isn’t even relevant.
I bet that not one of those Wall Street “experts” espousing investment advantages of stocks over homes lives in a rental. What B.S. that is!
Bottom line: If you buy the right home under the right conditions at the right time, you’ve done a very good thing. Go spend your thinking time and money on other issues.
#2 – Renting is always a financial mistake.
Truth – not always!
If you are paying cash for the home, your up-front costs are minimal, so the relative cost of buying versus selling hinges on your alternative uses for the cash,
If you are financing the purchase of a home, the up-front costs are likely to be substantial. If you expect to be in the home less than four years, most likely you should rent. If you expect to be in the home for seven or more years, most likely you should buy. In between, the actual situation could go either way depending on events.
#3 – Remodeling baths and kitchens is a good financial investment.
Truth – usually not!
The National Association of Realtors annually publishes the results of a study of remodeling costs verses the resulting increase in the sales price. Almost no remodeling returns 100% of the cost. Remodeling baths and kitchens in older homes, 30+ years, in average-plus communities return the most, possibly even over 100% when very judiciously and carefully done.
Maintenance is an entirely different issue. Making all things functional, cleaning, painting, repairing, etc., almost always does repay 100% of the cost, even when you add a cost for your time. More to the point, these activities sometimes make the difference for a not-salable property at anything close to “market”.
#4 – Using a Realtor® to buy or sell is a waste of money.
Truth – exactly backwards!
Not using a Realtor® is almost a guarantee of wasting money.
In nearly all transactions, the Realtor’s commission is paid as a reduction in the net cash to the seller. The buyer pays nothing in terms of commissions, but gets the advantage of his/her agent’s expertise, knowledge and time to find the home and manage the transaction to a successful close – often a lot of time. A buyer would be nuts not to engage a Realtor®. And, obviously, the agent’s negotiating skills and experience is likely to produce a lower price than the buyer could get dealing directly with the seller, or seller’s agent.
A FSBO (for sale by owner) seller has exactly the same advantages going the other way. The exact percentage varies by study, but, for sure, more than 50% of FSBO’s sell under market by more than the real estate commission. In fact, nearly every offer to a FSBO starts by deducting 6% from the market value of the property. So, most FSBO sellers get less while taking on the risks, liabilities, stress and frustrations of managing the transactions themselves. I have heard FSBO sellers brag about their success. Fact is, those FSBOs are likely just ignorant of the money left on the table, and certainly ignorant of the liabilities still lurking out there like icebergs in the dark.
#5 – Buying as soon as possible is better than later.
Truth – not always.
Buying real estate in most places in the USA in 2008 was a very bad financial idea. Over the long term, with very rare exception, real estate prices are going up. So, usually, the sooner you buy, the lower the price.
#6 – Home buyers with bad credit needing a loan need not apply.
Truth – way wrong!
The real world difficulties for the half-dozen years after 2006 are well known to lenders. Foreclosures, short sales, even bankruptcies are common items on loan applications these days. These will not necessarily prevent you from getting a loan, even with a very low down payment. The critical issues will be (1) how you handled your non-housing financial obligations – did you pay your other bills?, and (2) the situation around your housing issue. If you just “bailed” on an underwater property, that might not be taken so lightly … but it’s better accepted these days, by far, than it would have been in 2009 or prior.
#7 – A bigger down payment is always better.
Truth – definitely not necessarily.
If you put lots of cash into a home purchase, you’ll borrow less, saving tens of thousands of dollars in interest on the loan, and lower your monthly mortgage payments. You won’t need to buy mortgage insurance, which is required if you put less than 20% down. Also, if your home value falls and you want to sell, you have a cushion of equity and less chance you’ll have to contribute extra cash to pay off your mortgage.
Here are some reasons for a small down payment, even considering the added cost of mortgage insurance:
- Borrowers with mortgage insurance may be able to get a lower interest rate than those who put down 20% or even 25%. Some lenders feel safer when loans are insured – the insurance covers the lender if you default.
- A low down payment may help you buy now, while prices are at record lows, if you haven’t yet saved 20%. If you wait to save a bigger chunk, prices could rise beyond your reach.
- Flexibility. Your money is not all tied up in your house, leaving you with little or no cash for home repairs and improvements, an emergency or job loss.
- Diversification. You can diversify your investments, distributing your money more safely among a variety of investment types — stocks, bonds or mutual funds, for example. That way, a real-estate downturn won’t wipe you out.
- Choice. You can always make additional payments, adding to your equity and paying off the loan sooner; you refinance to eliminate mortgage insurance once you have 20% equity in the home.
#8 – A 30-year fix-rate loan is best if you have the cash.
Truth – likely NOT true!
Think about it: (1) how long are you going to be in the home before you sell and move; and (2) what can you afford to pay monthly.
A 30-year fix-rate loan is likely to have the highest interest rate of any of your choices. Over the life of that loan, at any likely interest rate, you would pay far more in interest that you paid for the house itself. And if you are in the home less than 10 years, the bulk of your loan payments would have been for interest, with a small reduction in the principal.
A 15-year fixed rate loan would generate far less than half the interest, plus would likely be available at a lower interest rate for even greater interest savings.
An adjustable rate mortgage(ARM)would start out at the lowest interest rate of all, so, if you sell and move within or close to that low-rate start period, your interest costs would be much less.
When you consider the numbers, that grand ol’ 30-year fixed rate loan may the worst choice on the table … except for the attractiveness of that low payment.
#9 – The best loan? Simple! It’s the one with the lowest APR.
Truth – not necessarily!
The problem with APR is the definition of the “fees” to be included in the calculation. The rules provide some leeway on that issue.
The best way to compare loans is simply the dollar costs, with separate numbers for the up-front costs and full-term interest, but it’s imperative that the loans being compared be for exactly the same original principal.
#10 – You get more house for your money in the suburbs.
Truth – Probably, but travel costs and time need consideration.
A near universal truth … the farther out the home, the more home you get home for the money. And they’re often brand new, or newer, to boot. Plus the more uniform, couples-with-kids environment is a great lifestyle. But that drive, sometimes to most everything, can become a costly bore. Give this a lot of thought, both the money and the time, and maybe even a few test trips.
#11 – My home is a great ATM.
Truth – absolutely worst financial idea anyone ever had!
People used equity lines of credit or mortgage refinances to buy cars and vacations and to put the kids through college. It wasn’t unheard of to finance your ongoing monthly expenses with home equity. Of course, in retrospect, it was an awful idea.
Today, banks are more conservative about lending, even to those with equity, but cash-out refis will be back. When home prices rise enough and lenders forget their pain while focusing on the $2,000 and $3,000 fees they earn from each new loan, you could find yourself thinking, “We need/want ???? and, look, there’s all that equity just sitting there.”
Just be sure to keep a cushion of equity above at least a slight decline in values, and a definite cushion to cash flow. Better yet, forget about the equity – just let it roll!
If you went through a foreclosure or short sale, normally there is income tax attached to the deficiency between what you owed and what the lender got. The Obama administration enacted temporary tax laws to eliminate that tax for normal deficiency amounts. The benefit likely will not apply for any such event in the future.