Home ownership has long been touted as a foundational element of building personal wealth. Rather than rent, the theory often goes, by taking on a mortgage you are avoiding “throwing away money”, as a portion of your payment goes toward principal, and you obtain tax deductions as well. Plus, it feels better for many to own than rent, as you have a sense of possession and pride with your own home. The emotional component of this is important to note. Overall, home ownership seems like a great deal, especially for those aspiring to buy their first place.
I am very positive toward home ownership, as long as the market is stable (a topic for another day). If your hope does appreciate at a modest rate – say 2% per year – you can amplify the return through leverage. This means that if you have a $300,000 home with 20% down ($60,000), your 2% increase ($6,000) can appear to be a 10% return on investment. Very good, indeed.
The only thing is – those same people looking to buy their first home tend to overlook the true costs of home ownership. I will make the following two suggestions here:
1. It is more expensive to own a home than many first-time buyers realize
2. You don’t ever truly own your home
It is more expensive to own a home than many first-time buyers realize
Taxes: When people rent, they typically pay the rent, plus renters insurance, and that’s about it. With homeownership, there is the mortgage payment, plus insurance, plus property taxes. That last component can be significant. The national average in the US has hovered around 1.0% of market value, but many counties have average rates well over 2.0% of market value. Thus – with that $300,000 home I mentioned, taxes at 2.0% would be $6,000. Sure, there is a tax break, but if you end up paying a net $4,000 of taxes after deductions, it comes out to around an extra $333 per month. That’s not small change.
Association Fees: This isn’t applicable to all homeowners, but most condominium or townhouse complexes will require association fees. The fees typically cover things such as common area costs (roofing, siding, landscaping, etc). These fees vary by complex or building, due to each one’s unique needs, but these fees can be relatively significant. For a $300,000 home, you could be looking at $100 or more per month – perhaps in the $500 or more range for a high rise building. With single family homes, this is less prevalent, but some newer ones do have neighborhood association fees.
Maintenance: When you rent, it’s a matter of calling the landlord to have him come fix the problems. When you own, you’re on your own (so to speak)! If the roof leaks, you have to fix it. It there is a plumbing problem, you have to handle it. Either you personally fix problems or you pay someone else to do it, which will be expensive. Plus, you have to account for the periodic replacement of certain things – the aforementioned roof, sump pump, appliances, etc. It is a wise idea, I believe, to budget at least 1.5% of your home value for such expenses. Thus, for the $300,000 house, you put away $4,500 annually for such expenses. It might not all be spent up each year – some years less, some more. But the money should be regularly set aside. Problems will happen, and shouldn’t be entirely unexpected.
Updating: If you buy a pre-owned home, you may be tempted to update a room in the house – perhaps the kitchen, maybe the master bathroom. You might even want to put new flooring throughout your place. Even if you like the place as is, you might want to change some things after living there for a long period time. All of this takes money, and in some cases it takes significant money. For example, a total remodel of a large kitchen can easily cost over $30,000 (U.S.).
Outdoors: If you are renting, outdoor maintenance is covered. If you own attached housing such as a condo or townhouse, this is likely included in your association dues. With a single family home, you will have to pay for things such as lawn mowing, snow shoveling, landscaping, etc. Even if you do it yourself to save money, you will be spending time on such activities.
You don’t ever truly “own” your home
Lets say you purchase a home and take out a mortgage. What a great feeling, you are a homeowner! Now, if you try to stop making those mortgage payments, you’ll see whether or not you truly own it. Remember – if you have a mortgage, you may have the title, but you’re still paying for it. It’s not yours free and clear.
Speaking of free and clear, what exactly does that mean with respect to home ownership? In most circles, this has come to mean the mortgage is paid off in full. Some people hold little parties for this accomplishment, when their loan is finished and they feel that they own their home outright. And make no mistake, it is a great accomplishment as you no longer owe money to the party that is servicing your mortgage.
Realistically though, your payments are not done. Furthermore, they probably won’t ever be done. In effect, you have rent payments to make on your home, and they go on in perpetuity. These payments are called property taxes. Back to that example above with the $300,000 home – those taxes of $6,000 annually will most likely move higher over time. If you try to stop making those payments, once again you’ll see if you truly “own” the home.
All of this said, should a first time homebuyer be leery of buying a home? After all, its easier to just write the rent check and forget about it. As I said, I’m pro-home ownership. Long-term, it’s a good move financially, and there’s something about having your own home that’s point of deep personal pride for many of us. But the timing has to be right, and it’s a step that can be taken with complete knowledge of the true long-term costs of home ownership – which continue even beyond when the mortgage is paid off.
This article was included in Carnival of Personal Finance #257 at Canadian Finance Blog