062 Should You Buy A House?

(Complete Show Notes Below)

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In the 62nd episode of the Financial Procast:

For so many years, home ownership has been a rite of passage for Americans.  It's all part of the American Dream.  Now, before I get all sorts of hate mail and nasty comments on this topic, we're not against buying a house or investing in real estate for that matter.

However…

We would like to have an honest conversation about it.  Can you really consider your house to be a great investment?

There are certainly a number of good reasons to buy a house but I'm not sure that any of them are necessarily great financial reasons.  For most people, buying a house and signing up for a mortgage is the largest financial commitment they'll ever make.

Is that a sad commentary on the financial well-being of our country?  Is it a good thing if you are planning on your home being a “path to prosperity?

What's My Problem?

Liquidity or lack thereof.

If you've been around The Insurance Pro Blog for any length of time and/or listened to the Financial Procast (a la Cash is King) you will undoubtedly be familiar with our somewhat obsessive tendency toward maintaining liquidity.  Brandon and I have often discussed the fact that it probably stems for our business experience more than anything. Let's just say we've both experienced some fairly lean times in regards to cashflow, that's the nature of business.

So, the thought of having a ton of equity tied up in your home doesn't make us warm and fuzzy.  Many people will argue that you can always access your equity via an equity loan or a home equity line of credit (HELOC), however, if you get into a situation where you really need the money, you'll likely have a hard time getting it.

Huh?  If you become disabled and can't work, you lose your paycheck.  The key ingredient when qualifying for a loan of any kind is your ability to repay the loan.  If you aren't working and your income has taken a hit, you'll find lenders not too keen on loaning to you.  Not to mention, that qualifying for any type of equity loan has become much more difficult since the financial crisis of 2008.

Is it Really A Path to Prosperity?

We think that most attitudes surrounding home ownership aren't rooted in logic.  Again we find like so many other things in personal finance, that we have general rules of thumb or axioms that everyone has accepted as truth and applied universally without questioning if it really makes sense in their particular circumstance.

Now, there are certainly numbers that seek to prove a correlation between greater net worth and home ownership but does that really tell us anything useful?

Realistically, if the value of your house increases by $100,000 your life won't be any different.

Over long periods of time your house will likely prove to be an asset–in that it will appreciate in value.  However, it's the ability to tap into that value and the opportunity cost that you sacrifice along the way that gives us a bit a of heartburn.

An Alternative Philosophy

Buy the house but don't make an oversized down payment.  If you need to make a 20% down payment to receive favorable terms on your loan, that's fine but don't make a 50% down payment just because you have the cash available.

It really makes more sense to employ your assets in other ways, outside of your house, that will be effective for you at retirement.  When you plow tons of money into a house, you are giving up the opportunity to grow a significant net worth outside of your house.

It's really a matter of risk management and we've all been led to believe that owing less on your mortgage is a way to lower risk.  We'd contend that while it appears to be true on the surface but that's a little too simplistic when it comes to really evaluating risk.

The truth is that having a large equity position in your house can place you in a precarious position.  What?

Follow me for minute.

Let's go back to our discussion of a disability that takes you out of income earning mode.  Your house is worth $400,000, you have a mortgage of $50,000 as a result of making a sizeable down payment, paying extra principal every month and a couple of well timed refi's.  The balance is a fifteen year mortgage and your required monthly payment is $1,000.  You fall behind because you've exhausted your savings and your monthly cashflow isn't enough to make the payments anymore.

Unfortunately, the bank will likely place your pending foreclosure to the top of the list.  If they're looking at all their foreclosures, your property is very attractive to them because they're likely to profit from it.  On the other hand, the guy who has a house that's worth $400,00 and owes $425,000 will likely have a much more prolonged foreclosure because they'll take a bath on his house.

Risk always tilts toward you or away from you. And we'd suggest that keep it tilted away from you as much as possible.


One Response to “062 Should You Buy A House?”

  1. Jeff Hexter says:

    While I think this is good explanation, or at least introduction, to some of the financial risks associated with home ownership (namely: the opportunity cost of the money tied up in the down payment, the additional lack of liquidity of the asset, the time-risk associated with the ups-and-downs of the real estate market, and the [potential] low actual CAGR relative to other investments), I think you undervalued the risk associated with the mortgage.

    Part of the risk I am referring to is the tendency of debt to enhance the dangers of ones mistakes and miscalculations. If you lose your money, you are out just your money. If you lose borrowed money, you are out the money but still owe it to someone else. The loss is enhanced (well, worsened) by the terms of the loan.

    And this of course totally ignores the fact (that you touched upon) that you still pay rent (property taxes) even after you are done paying off the mortgage. You never really own it – I read somewhere that the “Real” in “Real Estate” refers to “Royal”, as in “Owned by the Crown”. A change in zoning or tax rates and you can be screwed. Can you buy insurance against acts of government?

    I learn so much listening to you guys. Thanks for all you do!

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