The Worst Investment You Can Make: Buying a Home

Dreams die hard. None of us want to give up the belief that we could be a rock star, a billionaire or even the president of the United States. Right now, nearly every 40-something man in this country believes, somewhere deep in the recesses of his mind, that given the chance, he could still play pro ball (some form of ball) -- no matter how much the unvarnished facts would say otherwise.

But perhaps the most quintessential of American dreams is the dream of home ownership. We are taught, generation after generation, to work hard, save up and put down roots by buying a house. And just like those armchair ballplayers, when we buy into that dream, we're deluding ourselves.

In his article, "Five Things Your Need to Know Before Buying a House," author, pundit and successful Wall Street guy James Altucher rejects the home ownership mantra. Among his reasons: "The stress is unbearable when you need to sell. And you have no money when you need it."

Altucher lists various ways in which owning a home can drain one's mental well-being and can become a financial nightmare as well.

Mathematically, it doesn't make sense

When you do the math on home ownership, it's plain that it is one of the worst investments you can make. Consider the purchase of a $350,000 house, which is slightly over the current average U.S. sales price.

In most cases, you will be required to have a 20 percent down payment, or $70,000. This leaves you with a loan balance of $280,000, which at the current interest rate of 4.5 percent for a 30-year fixed mortgage will give you a monthly payment of $1,853.10.

At the end of that mortgage, you will have paid $667,166 in principal and interest –- or $387,116 more than the original loan amount. During that same period, assuming a 1.5 percent rate, you will also have to pay another $126,000 in property taxes. (And there are plenty of places where the tax rate is higher.)

But wait, there's more. Using a 1 percent maintenance rate -- for upkeep, maintenance, and repairs -- you can add another $3,500 per year in costs, bringing the total out-of-pocket costs over 30-years to $898,166.

What Could You Have Done With That Money?

But the dream really fails when you factor in the lost opportunity costs associated with all that money.

Since you have to live somewhere, let's assume you could find a similar rental home for 75 percent of your monthly mortgage payment, or roughly $1,400 per month. Then say that you invested that $70,000 down payment in the stock market, which has averaged a 9.4 percent return over the last 100 years.

Then, each year, you add to your investment the difference between your rent payment and potential mortgage payment, as well as the money you save by not paying for property taxes, maintenance and other costs of home ownership.

After 30 years, you would have nearly $3 million in your portfolio.

Of course there are numerous tweaks you can make to this scenario -– for example, factoring in your home's price appreciation or the tax benefits -– but no matter how you slice it, owning a home doesn't come anywhere close to making financial sense.

20 Ways to Slice and Dice the Inputs

Don't believe me? Check out this super cool interactive calculator that the New York Times created. It allows you to input over 20 variables to try and justify owning vs. renting. See if you can make the math work out in favor of home ownership.

Proponents of owning will tell you that there are certain intangibles associated with purchasing your home that trump mere financial considerations. The sense of community. The feeling of planting roots. The ability to change or redesign your house at will. And all of these points are valid, and may tip the scales for some in this debate.

But facts are facts. You can rationalize whatever reasons you want for owning vs. renting, but numbers don't lie, and it's important to at least go into the process with eyes wide open.

Brian Lund's blog offers more on personal finance, the stock market, investing and the secret to eternal life.

Pending Home Sales Drop Unexpectedly in June

By JOSH BOAK

WASHINGTON -- Fewer Americans signed contracts to buy homes in June, as the real estate market appears to have cooled off this summer.

The National Association of Realtors said Monday that its seasonally adjusted pending home sales index slipped 1.1 percent to 102.7 last month. The index remains 7.3 percent below its level a year ago.

Sales have been slowed by a mix of meager wage growth, rising home prices, and mortgage rates that rose steadily through the end of last year.

Pending sales are a barometer of future purchases. A one- to two-month lag usually exists between a contract and a completed sale.

Signed contracts in June fell in the Northeast and South. They rose slightly in the Midwest and West. Pending sales in all four U.S. regions are below last year's pace.

Home sales had been improving through the middle of 2013, only to stumble over the past 12 months. Buying has decelerated despite a recent decline in mortgage rates and home prices increasing at a slower rate than last year.

Sales were initially disrupted by harsh winter weather, but the summer slowdown suggests that financial pressures are now keeping would-be buyers on the sidelines.

"The latest decline raises questions about the housing market strength after the weather-related rebound is behind us," said Yelena Shulyatyeva, an analyst at BNP Paribas. "Housing will remain an area of concern" for Federal Reserve Chair Janet Yellen.

New home sales fell 8.1 percent last month to a seasonally adjusted annual rate of 406,000, the Commerce Department said last week.

The Realtors recently reported that sales of existing homes increased 2.6 percent in June to a seasonally adjusted annual rate of 5.04 million homes. It marked the first time that sales have been above the 5 million-mark since October, yet the pace of buying remained below last year's level of 5.1 million.

Economists generally consider annual home sales of 5.5 million to be consistent with a healthy housing market.

Still, there are indications that sales could pick up.

Along with the arrival of spring, average mortgage rates have dropped to 4.13 percent, down from a 52-week high of 4.58 percent, according to Freddie Mac.

The rate of average price gains has slowed to 4.3 percent year-over-year, according to the Realtors. That's down from gains in the double digits. But wage growth has barely kept pace with inflation, eating into how much income people have to spend and save for down payments.

Is Renting or Buying a Home the Better Way to Wealth?

In 2007 and 2008, property values nationwide dropped dramatically in sympathy with the banking crisis, mortgage crisis and the stock market crash. Never before had values of residential real estate fallen so far, so fast and in so many places. It seemed that one of the staples of American wealth was a lousy place to invest money. 

During those brutal times, many investment advisers started suggesting renting a home was the way to wealth. Their theory was that if you invest your down payment money in equities, you would have piles of money in 20 years. Rubbish! These recommendations always come from people who broker your money into equities and are backed up by dubious math.

Some Simple Arithmetic

Let's look at buying a $175,000 home -- and renting one of comparable value. In most areas of the country, due to the down market (although values have had a nice rebound over the last seven years) and very low interest rates, your payment to own will be less than the rent for a comparable home.

If you bought a $175,000 home and put $8,750 down and negotiated the seller to pay most of your closing costs, you could get into this home for around $10,000 total investment. Your 30-year mortgage for $166,250, at 5 percent, would produce an $892 monthly payment. Taxes of $200 and insurance for $70 gives you subtotal payment of $1,162. Because you put less than 20 percent down, you will also pay mortgage insurance until you hit that 20 percent equity. This will give you a total payment of about $1,232.

Rental markets vary (look at www.rentometer.com), but in most areas of the country a $175,000 home will rent for $1,300 to $1,600. Let's use $1,400 -- or annual payments of $16,800 -- with nothing to show for it but receipts. If you lease homes for 20 years and rents increase even a little, you will pay approximately $360,000 in rent and have nothing but rent receipts.

Consider These Variations

If you bought the home with the numbers described above, what might your situation look like? In 20 years you will have paid $295,680. You will owe $88,000 on your mortgage balance. But what if you had used the $1,400 that a home like that would rent for and paid down your mortgage balance by an extra $168 per month? In 20 years, your mortgage balance is only $18,500 -- so your payments have created equity and wealth.

What about the increase in value of the home? I never try to predict the ups and downs of any market, but even with a modest appreciation rate of 4 percent, your $175,000 home is valued 20 years later at $389,000. The house is almost paid off (if you used that $1,400 rental payment) and is worth $389,000.

But what if the value increases less, stays the same or falls? Who cares? You had to pay to live somewhere. Whatever the value is, you own it free and clear and have only the taxes and insurance in your later years. Almost all successful retirees own their properties free and clear. If you are always renting, you create wealth for the landlord.

But Wait, There's More

I didn't forget the theory about putting your down payment money into equities. If that $10,000 grows at a strong 8 percent, it would grow to just under $50,000 in those same 20 years. This is a far cry from financial stability -- or the equity in your home that you can access in several ways.

Even if you factor in the additional expenses of owning a home -- say $50,000 for repairs and updates -- most of that will be offset by your tax write-offs of your interest and property taxes.

According to the Federal Reserve, the average net worth of a homeowner is over $174,000 and average net worth of a tenant is $5,100. This is where financial theory collides with the realities of human nature. Home ownership is a natural forced savings and possible investment account that requires nothing but you to make your payment and enjoy your home. You also have the ability to alter the home as you see fit and are in charge of how long you stay. A home is where you will create memories for you and your family. The investment part is a bonus.

Jul 29th 2014 10:11AM

Updated Jul 29th 2014 10:13AM

John Jamieson is the best-selling author of "The Perpetual Wealth System." If you are interested in pure investment and cash flow real estate, visit Perpetual Real Estate Machine.