I am moving into a new apartment in about three weeks. Every year when my apartment lease is up, I have a decision to make: I can renew my lease, I can end my lease and rent a new apartment, or I can end my lease and buy a house.
The “American Dream” part of me wants to buy a house, but the “Smart Personal Finance” part of me knows better. Home ownership is definitely right for some people, but not for me. There are a lot of things about owning a home that scare the crap out of me. For example, did you know that homes and new cars are very similar in that both lose an incredible amount of value as soon as your purchase is complete?
Your gut reaction might be to think I’m stupid to compare buying a home to buying a new car, but the comparison works for the first few years of home ownership. Just take a look at the data and see for yourself.
Buying a $100,000 Home
Pretend you are about to take out a mortgage on a $100,000 home. When you take out a loan for a house, you have to pay closing costs. These are usually 3-5% of the total value of the loan. If you put 20% down on your house, that means the closing costs on an $80,000 home loan will be between $2,400 and $4,000. Let’s take a number in the middle and pretend closing costs are $3,000. So to get into a $100,000 home, it’s going to cost you $20k of a down payment plus another $3k in closing costs.
Initial Investment: $23,000
Total Cost of Home: $103,000
We need to keep this $23k number in mind, because this is our investment and we would like to get this back when we sell the house. Now let’s look at how long it will take to get that initial investment back if we sell.
Selling a Home is Expensive
Have you ever wondered how those real estate agents make money? They have to be making money somewhere Each agent (the buyer’s and seller’s agent) gets 3% of the final purchase price of the home, which means it is going to cost you 6% of the value of your home just to sell it.
You could try to sell your house without a realtor, but that is a complicated mess when you consider all the paperwork and legal things that go with buying a house. I’m no expert so I don’t know the specifics, but I know it is pretty complicated and getting a realtor is the way most people go.
In the following calculations, we will assume that the amount of your mortgage (after accounting for taxes, insurance, and mortgage interest tax benefits) is the same as what you would have paid in rent if you had rented a place to live. In reality, owning a home is almost always more expensive than renting, but this assumption makes calculations easier and is, in general, a pretty fair assumption.
What If You Sell Immediately?
Let’s pretend that you bought your house today, and tomorrow you get a new job out of state and want to sell your house, or you find out you’re having a baby and want a bigger house, or you lose your job and can’t afford your house, or any number of reasons why you’d want to move.
Usually it takes three to six months to get someone to pay you fair market value for your house, so to unload it right away you would probably have to sell at a discount. Let’s say you can get $90,000 to sell quickly. Then we have to take out 6% to pay the realtors and you barely have enough left to pay off the mortgage.
$90,000 Sale Price – $5,400 Realtor Commission – $80,000 Loan Balance = $4,600, Loss of $18,400 or 80%
Holy baloney! You just got boned! You basically lost your entire initial investment. The obvious lesson here is don’t buy a house for a day, but the real lesson is that you have to be prepared to sit on a home 3-12 months if you want fair market value when you sell. Otherwise, you are going to have to discount the price and lose money.
Sell After A Few Years
For a more realistic situation let’s say you live in your house and pay your mortgage for some period of time, and then some life situation requires that you move. You have enough time to plan ahead and leave your house on the market for 6 months to get fair market value of $100,000. Let’s look at how many years it will take to get to our breakeven number of $23,000.
Let’s use a 30 year mortgage with a 5% fixed APR. We will also assume a 1,000 annual appreciation of home value, which I think is generous in today’s market.
$101,000 Sale Price – $6,060 Realtor Commission – $78,820 Loan Balance = $16,180, Loss of $6,820 or 29.7%
$102,000 Sale Price – $6,120 Realtor Commission – $77,579 Loan Balance = $18,301, Loss of $4,699 or 20.4%
$103,000 Sale Price – $6,180 Realtor Commission – $76,275 Loan Balance = $20,545, Loss of $2,455 or 10.7%
$104,000 Sale Price – $6,240 Realtor Commission – $74,904 Loan Balance = $22,856, Loss of $144 or essentially breakeven
Homes Only Make Sense When You Hold For Years
There are so many variables when you buy a home that it’s pretty much impossible to come up with any concrete rules about home ownership, but in general you have to hold for a minimum of 3-5 years before you can break even on your investment. That can be much longer or shorter depending on how much the home appreciates or depreciates, how much money you put down, how much work you do on fixing the house, etc.
The bottom line for the average home buyer is that you better be damn sure you are going to stay in that house for at least three years. If you aren’t sure of that, then you have no business buying a house unless you are looking to lose a lot of money.