Express-News columnist Michael Taylor is seen Aug. 11, 2016 in the Express-News photo studio,
If you can be satisfied with merely getting rich, instead of getting rich quick, then buying a home is one of the most important financial moves you’ll make in your lifetime.
It’s right up there in the top five, along with steering clear of credit cards that charge high interest rates, enrolling in automatic savings plans, putting your money in high-risk, high-return investments and doing it for more than five years.
So why is homeownership so important? And can it go wrong?
Oh yes, it can go very wrong.
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It’s been less than a decade since homeownership went terribly, horribly wrong for many, so even while I want to extol ownership, it’s worth reviewing painful lessons too.
In 2014, the last time the Federal Reserve published their Survey of Consumer Finances, reporting the median net worth for homeowners at $195,000, compared with $5,000 for renters. Homeowners have nearly 40 times the net worth of renters.
Of course, scientists will point out that correlation doesn’t automatically mean that buying a house will make you wealthy. People own a house because they have wealth, and people have wealth because they own a house.
Homeownership works to build wealth because of (my favorite savings tool) automated investing, tax advantages and leverage.
By automation, I really mean to highlight the way in which paying a mortgage over 30, or even better, 15 years steadily builds, month after month, year after year, your ownership in a valuable asset. And it does so without much pain to your monthly budget since you would have to pay about the same in rent anyway.
Your monthly mortgage payment is a combination of interest and principal, and every bit of principal you pay adds a steady drip into your bucket of positive net worth. Sleep like Rip Van Winkle and then wake up 30 (or even better, 15) years later, and boom! You own a valuable asset free and clear of debt.
The biggest tax advantage to owning a home isn’t the mortgage interest deduction everyone already knows about (and that I don’t like). It’s the exclusion from capital gains taxes when you sell: $250,000 for individuals and $500,000 for married couples.
Homeownership doesn’t work like other investments. It works better. If you buy a house for $200,000, and then manage to get $450,000 after fees when you sell it many years later, you have a $250,000 capital gain. Normally, Uncle Sam takes a cut of a big gain like that, like 20 percent, or $50,000.
But as long as certain conditions are met – you lived there two out of the last five years – then that entire $250,000 gain is yours to keep, tax free.
In the bad old days – before 1997 – Congress only let you do this tax trick once in a lifetime. Since then, however, you can do it over and over as much as you like. Doesn’t that make you love Congress more?
Congress is way better than cockroaches, traffic jams and Nickelback, even if it consistently polls worse.
The leverage is key too. It allows middle class consumers to use someone else’s money (the bank’s) to borrow four times their down payment to buy a valuable asset. That juices your return on investment in an extraordinary way.
Wall Street uses leverage like this all the time, why shouldn’t you?
Please forgive the oversimplified math I’ll use as an illustration of leverage: If you invest $50,000 as a down payment and borrow $200,000 for a home, and then the home goes up in value by 10 percent, what’s the immediate return on your investment? Hint: The answer isn’t 10 percent.
If you sell your $250,000 house for $275,000 (a 10 percent gain), you’d clear a profit of $25,000. That’s a 50 percent return on investment. That’s the power of leverage.
When you combine automated investing, the tax advantages and leverage, you have a powerful wealth-building cocktail from buying a house, which, by the way, provides something you need anyway.
Ready for the cold water? Homeownership as an investment can also go terribly wrong.
I was thinking of this recently because I checked a personal finance book out from the library that has aged very badly, David Bach’s “The Automatic Millionaire Homeowner.”
Published in 2005, a few years before the 2008 crisis, Bach’s book is a combination of good advice, like I reviewed previously, and terrible advice.
Bach urges people with weak credit scores to check with their banks about alternative mortgages specifically tailored to them. Bach also describes in detail the opportunities for prospective homeowners to purchase with just 5 percent or 10 percent down, or even “no money down,” rather than seek the conventional 20 percent down-payment mortgage.
Bach describes, without apology, the idea that your house could increase in value by 6 percent per year, every year for 30 years, turning your $200,000 starter home into something worth $1.1 million. In fact much of the book reads, in retrospect, like an excited exhortation to flip one’s way from a starter home to a millionaire mansion through risky mortgages, low money down and price appreciation as far as the eye can see. Needless to say, that isn’t the way to do it.
I’m not saying low down payments or buying with weak credit will always go wrong and should be forbidden.
I’m just saying that, given what we experienced a few years later, we know it will lead to tears for many.
And I’m not saying your house won’t appreciate, I’m just saying that a more normal annual price increase like 2 percent, in line with inflation, is a much better bet.
Good personal finance books are evergreen, and that one isn’t. If you want a good one, however, may I suggest Bach’s readable and important “The Automatic Millionaire,” in which he extols the concept of automating savings and investments, a key for most middle-class people to build wealth over a lifetime.