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Welcome to the 32nd edition of the Tech Financial Planning (TFP) newsletter.
Is buying a house a good financial decision?
People often say buying a house was the best financial decision they’ve ever made.
Or people say that they need to buy a house so they “stop throwing away money in rent.”
In this newsletter we will dive into the true math on home ownership, the many “hidden costs,” and what the different outcomes are.
TL;DR
Many people view home ownership as one of the best financial decisions you can make
Unfortunately, when they calculate the costs, they vastly underestimate the costs of owning a home, therefore overestimating the gains
Renting can make more financial sense
Is A House A Good Financial Decision
As I mentioned before, you hear many people say that their house is the best decision they’ve made financially.
Another advisor (can’t remember who) pointed out that might be the case because it’s the only investment they’ve held on to for 30 years.
But even in that, it’s not telling the full story.
When people talk about the money they made on their house, they only look at two points:
What they paid
What they sold it for (or what it’s worth today)
Unfortunately, that doesn’t even come close to telling the whole story.
Let’s dive into an example and see the actual costs and gains.
A quick note: If you want to find something wrong with this analysis, I’m confident you can.
You can find a house that was bought for less and sold for more.
You can find a different market.
You can find a different time frame.
This isn’t perfect by any stretch.
I literally picked a house in Santa Barbara that’s currently on the market (so we could get Zillow information) that wasn’t bought / sold in the last couple years so we had some history to go off of.
It isn’t perfect.
There’s probably an error with the math somewhere.
Just go with it.
The House
The house at 4537 Carriage Hill Dr was bought in 2003 for $720,000 and they are looking to sell it for $1,695,000.
Yes I chose a house in Santa Barbara - I live here!
And yes, housing prices are going to be inflated to most of the rest of the country
On paper, this is a gain of nearly a million dollars - not bad!
A gain of 4.37% is ok - but it would have underperformed both the S&P 500 AND the aggregate bond index over 20 years
Unfortunately, that doesn’t count all the costs.
For argument’s sake, let’s say they put down 20% of $720,000, which is $144,000.
They got a 30 year fixed loan at 5.9% interest (yes, it’s likely that they would have refinanced at some point, but just go with it).
They still have a mortgage balance of $309,129 that they have to pay back
They paid $553,079 in interest and $266,867 in principal.
They paid almost double in interest - It’s fascinating that it wasn’t until year 19 that they started paying more to principal than interest.
They paid ~$145,000 in property taxes! Note: this is an estimate because we only have historical information through 2014, but I believe it’s close
We don’t have any information on maintenance costs, remodels, etc, but let’s be extremely conservative and say they spent $20,000 ($1,000 / year).
This number is likely much higher.
I didn’t include insurance and HOA fees because I didn’t have enough historical information, but obviously both of these increase the cost of ownership!
This property has a $860 / month HOA fee.
Insurance is probably around $600 / month currently
That’s just what they spent while owning the property.
Now when they sell:
Closing costs will be around $50,850 (again, going low here at 3% of closing price)
Capital gains tax of $148,917 (even after the primary home exclusion
So all in, they spent over $750,000 in expenses (interest, property taxes, maintenance, and closing costs).
Plus nearly $150,000 in capital gains taxes.
And, they have to pay back the $309,129 mortgage balance.
Pretty quickly, our “gain” of $975,000 is gone.
When you compare this to the gain of $975,000, over 20 years they actually “lost” over $250,000
For an annual return of -0.69%
PS: Even if they didn’t sell and held it until it was paid off - there’s still a lot of ongoing monthly expenses: HOA, insurance, property tax, maintenance, etc.
The Counter: What If They Rented
We can’t look at this in a vacuum.
We have to live somewhere, so lets look at what would have happened if they rented over the past 20 years.
Average rent in Santa Barbara 2003 was around ~$1,200 / month but that is probably low,
We will bump it up to $2,300 / month
Today a 3 bedroom apartment is is $4,310
Note: (I’m positive the quality of the apartment won’t be as nice or as big as the house. Just go with it).
If we say rent increased by $100 / month from 2003 to 2023, the total rent payments over that time were $831,720.00.
If you stop renting today, you get $0
Buying a house saved over $580,000.
House savings = Rent + House gain
House savings = $831,720 + (-$250,000)
House savings = $581,720
Or did it?
Let’s say you rented and invested the money you didn’t spend on housing.
Housing payments (principal plus interest) were $819,952.89
Property taxes were ~$145,000
Maintenance costs were ~$20,000
So we will invest the $144,000 down payment, plus housing costs - rent (we will round it to $150,000
So we will do the $144,000 up front, plus $625 / month.
As of March 2023, that portfolio would be worth $1,060,919.79 after taxes.
From a math perspective, renting + investing comes out ahead.
Putting It All Together
There’s one glaring issue with this whole analysis.
We don’t make decisions solely based on the math.
Because math can’t account for having and raising your kids.
For having friends over for dinner.
For shooting hoops in the driveway.
For the pride and joy (and sometimes frustration) of ownership.
For making it your own.
Buying a house is a personal decision as much as it’s a financial one.
We don’t make decisions on spreadsheets
But while it’s not without its flaws, I hope this analysis at least made you think a bit.
Do you want to buy a house because “it’s a good financial decision” or because you want to plant roots, raise a family, and create a home?
Sometimes the answers are both yes.
But don’t be surprised if the financial side isn’t as clear cut.
And that’s ok.
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