One of the biggest mistakes Millennials make is purchasing a home before it really makes sense. There is nothing inherently wrong with buying a home, but you might want to reconsider if you are buying your first home for any of the following reasons.
1. Building Home Equity Beats Paying Rent
This is probably the most common reason I hear from someone buying their first home, but it is also the most misguided. Yes, it’s frustrating to pay rent every month and seemingly “throw money away." The conclusion many Millennials reach is that it would be better for some of those monthly payments to go towards building equity.
However, your payment on a typical 30-year mortgage is mostly going to interest instead of building equity in the early years. In addition to mortgage costs, you pour an enormous amount of money into a new home purchase through the transaction itself (closing costs, agent fees, etc) and initial home expenses (furnishings, repairs, improvements, etc).
If you plan to live in a home for less ten years, you should taper your expectations of building equity. You may also grow your net worth more by renting and investing any money that would have been spent on a home purchase.
2. Housing Is A Good Investment
For most of us that own and live in a single home – as opposed to professional real estate investors – our real estate success will boil down to good timing and luck. As a result, housing should be viewed as a place to live rather than an investment.
Unlike a traditional portfolio of stocks and bonds, a home is an indivisible asset (you can’t slice off a piece of your kitchen and sell it for cash) and extremely undiversified (a single bet on one neighborhood). In addition, homes offer very little long-term price appreciation after adjusting for inflation. According to historical data from Nobel Laureate Robert Shiller, home prices have only risen 0.37% per year after adjusting for inflation over the past 125 years.
Many people don't realize the gains in housing prices mostly come from inflation. When adjusting for inflation, a home depreciates in value over time except to the extent you spend additional capital on maintenance and improvements - not exactly something you like to see in an investment.
3. Owning A Home Will Lower My Taxes
People hate paying taxes. Consequently, tax avoidance causes people to make decisions they wouldn’t otherwise make.
Have you ever gotten a coupon from a retailer offering $50 off purchases of $200 or more? I call these “spend to save" promotions, which are really just a tricky way of getting you to spend money you wouldn’t have otherwise. Buying a home for the tax deductions isn’t all that different with the US government creating several tax incentives to promote home ownership.
Even if the after-tax monthly payment on mortgage is lower than monthly rent on a similar living space, you still will have realized an abundance of additional costs associated with owning a house (as discussed above).
4. Buying A Home Is The American Dream
Buying a home has long been a part of The American Dream that has emotional benefits that are difficult to quantify. From a strictly financial standpoint, the decision to buy a home ought to be made within the context of maximizing your net worth.
We don’t live in a spreadsheet and not all decisions should be made as if we do. However, your house and mortgage will likely be the biggest items on your balance sheet, so the math does need to be taken seriously. The longer you live in your home, the more likely you will benefit financially.
The most common mistakes Millennials make is underestimating the overall cost of home ownership and not living in their home long enough for the finances to work out in their favor. Getting married, having a family, moving to a new city or changing careers are all common life events for Millennials that can turn that once ideal home purchase into a bad financial decision by simply shortening your time horizon in the property.
There is no one-size-fits all piece of advice for when a home purchase makes sense. My advice would be to hold off a purchase if there is a good chance you will have to move in five years or less. It's hard to project life events out much further than five years, but aim to live in a home at least ten years to give yourself the best chance of winning the finance side of it. Finally, write out every conceivable expense that you will incur during your tenure at a prospective home and think about how a house may impact you financially if life turns out different than expected.
Peter Lazaroff is the Director of Investment Research at Plancorp. With $3.03 billion in AUM (12/31/15), Plancorp gets your entire financial house in order by engaging in comprehensive financial planning.