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Home Ownership Investment: Risks and Benefits

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Homeownership has always been part of the American Dream. Because of that, many people accept owning a home as the right, even obligatory, thing to do without considering the benefits and the risks.

If you are contemplating buying a home, you should know and review the pros and cons of the investment you are about to make—as you would any investment decision—before signing on the dotted line.

Key Takeaways

Be aware of and review the advantages along with any potential risks before you buy a home.The benefits of investing in a home include appreciation, home equity, tax deductions, and deductible expenses.Risks of investing in a home can include high upfront costs, depreciation, and illiquidity.A home can be a good long-term investment but building equity is key.Real estate appreciates not just because of the home itself, but the property it sits on.

Attractive Long-Term Investment

Appreciation represents the increase in home values over time. Real estate prices are cyclical, and homeowners shouldn’t expect the property’s value to increase drastically in the short term. But if you stay in your home long enough, there’s an excellent likelihood you will be able to sell your home for a profit because of appreciation later.

Buying a home is one of the best long-term investments you can make. Despite dramatic dips such as the 2008 Housing Crash, residential real estate tends to rise in value. Median home prices in the U.S. rose from $298,900 in the fourth quarter of 2014 to $346,800 in the fourth quarter of 2020—a more than 16% increase in value in six years. Go back a decade, when the median sales price was $219,000 (Q4 2009), with a 42.7% increase. That’s not a bad return on an investment (ROI) that provides you with a place to live.

Consider Property Value

Real estate appreciates primarily because of the land on which the home sits, while the actual structure depreciates as time goes by. So the expression “location, location, location” is not just a real estate catch-phrase but a critical consideration when buying a home. The neighborhood with the amenities it brings—school districts, parks, condition of roads, etc.—and the city where the home is located all factor into the property’s appreciation.

Consider a rundown home, neglected to the point that it’s uninhabitable. The land underneath the home may still be worth a significant amount of money—more than the residence, in this case. A seller may consider selling it as is (with the structure still intact) or spending a little extra to demolish the home and sell the land at a higher price on its own.

Appreciation is the change in the value of your home over time, while home equity is the difference between the balance on your mortgage and your home’s market value.

Building Equity

Home equityrepresents the difference between how much you still owe on your mortgage and your home’s market price or value. Home equity and appreciation may be considered together. As noted above, your home likely would grow in market value over time. Your equity also grows as you pay down your mortgage, with less of your payment going toward interest and more toward lowering the balance on your loan.

Building equity does take some time because it takes time to lower the principal balance owing on the mortgage loan—unless, of course, you make a large down payment or regular prepayments. Keep in mind that the length of time you have your home is a significant factor in how much equity you build and the appreciation you can realize. The longer you keep it, the more equity you obtain.

Home and Equity Appreciation

As you pay down your mortgage and reduce the amount you owe, without realizing it, you are saving as the value of your home is increasing—just as the value of your savings account increases with interest. You likely would get back every dollar you paid out and more when you sell, assuming you stay in your house long enough. Over time, the average 6% return (interest rate) on your savings should more than cover your outlay.

Another plus is that home equity provides flexibility to get a loan tied to the amount of your home equity. Many investors follow their home equity and home appreciation simultaneously. If an investor believes their home value is greatly appreciating, they may put off a home equity loan to have a better opportunity to realize a seller’s appreciation. 

Mortgage lending discrimination is illegal. If you think you’ve been discriminated against based on race, religion, sex, marital status, use of public assistance, national origin, disability, or age, there are steps you can take. One such step is to file a report to the Consumer Financial Protection Bureau or with the U.S. Department of Housing and Urban Development (HUD).

Location, Location, Location

While paying down your mortgage works the same no matter where you live, market-value growth varies with location. According to the Federal Housing Finance Agency (FHFA) House Price Index (HPI), real estate prices rose an average of 51.85% over the five-year period ending Sept. 30, 2021, in the U.S. overall. However, prices in the Middle Atlantic census division rose by 43.73%, and prices in the Pacific census division climbed by an average of 55.45%.

To see how this might affect prices where you plan to buy, check out the full FHFA chart below:

Percent Change in U.S. Home Prices, Period Ended Sept. 30, 2021
 
Division
 
Division Ranking
 
One-Year
 
Quarter
 
Five-Year
 
Since Q1 1991

USA
 
 

18.49

4.21

51.85%

246.92%

Mountain

1

25.01% 

5.83%

73.74%

411.59%

Pacific

2

20.90%

5.51%

55.45%

255.75%

South Atlantic

3

20.14%

1.02%

36.39%

177.94%

New England

4

19.39%

3.71%

50.37%

224.04%

East South Central

5

18.25%

4.81%

51.17%

217.35%

West South Central

6

17.51%

4.47%

44.96%

255.957%

Middle Atlantic

7

15.93%

2.92%

43.73%

205.10%

East North Central

8

15.37%

3.12%

47.47%

180.70%

West North Central

9

14.82%

2.83%

44.17%

231.53%

Source: FHFA U.S. House Price Index – 3Q 2021.

Capital Gains Exclusion

Eventually, you will sell your home. When you do, the law allows you to keep the profits and pay no capital gains taxes. Well, not necessarily all the profits. The Internal Revenue Service (IRS) allows a tax-free profit of as much as $250,000 for single homeowners and $500,000 for married couples—for your main residence only, not for a second home or vacation property.

You need to meet a few requirements to qualify for this exclusion. You must own the home for at least two years—24 months—within the last five years up to the closing date. The residence requirement dictates that you should have lived in the home for at least two years during the five-year period leading up to the sale.

The final requirement, the look-back requirement, outlines that you didn’t profit from selling another primary residence during the two-year period leading up to the most recent sale.

Tax Deductions

After appreciation, the benefit of homeownership that is cited most often is tax deductions or savings. When you buy a home, you can deduct some of the expenses of owning that home from the taxes you pay to the government. This includes mortgage interest on both your principal residence and a second home, which can amount to thousands of dollars per year.

Interest on home-equity loans, or home-equity lines of credit (HELOC), is also deductible if the funds are used to improve your home substantially. You can also deduct $10,000 in state and local (SALT) taxes, including property taxes.

The Tax Cuts and Jobs Act’s Effect

The Tax Cuts and Jobs Act made substantial changes to the parts of the tax code that have to do with homeownership. Unless a future Congress amends the law, all provisions will expire after December 31, 2025. But for now, changes in that law have reduced the value of owning a home. The law limits mortgage interest deductions to $750,000 of total mortgage debt, including for a first and second home and any home-equity or HELOC loans. However, the higher limitation of $1 million in mortgage debt still applies for indebtedness incurred before December 16, 2017.

The law also set the SALT deduction limit to $10,000. Other new provisions include restrictions on claiming casualty losses except for federally declared disasters. The moving expenses deduction no longer exists, except for the active-duty military moving for work reasons.

All these changes have lowered the value of owning a home—including the fact that, with the near doubling of the standard deduction (another feature of the Act), fewer people will have enough deductions to file Schedule A instead of taking the standard deduction.

So the fact that you are eligible for a tax deduction does not mean that it will be useful to you. The severe limiting of the SALT deduction will be particularly detrimental in lowering available deductions for people who live in highly taxed states.

High Upfront Costs

The cost of investing in a home can be high—there’s more to your expenses than the property’s selling price and the interest rate on your mortgage. You can expect to pay anywhere from 2% to 5% of the purchase price in closing costs, for starters.

Some of the most common closing costs include an application fee, appraisal fee, attorney fees, property taxes, mortgage insurance, home inspection, first-year homeowner’s insurance premium, title search, title insurance, points (prepaid interest), origination fee, recording fees, and survey fee.

Experts say you should plan to stay in your house for at least five years to recover those costs.

Potential Depreciation

Not all homes grow in value. The housing crisis of 2008 resulted in many homeowners being underwater, which means owing more on your mortgage than your home is worth. It doesn’t take a housing crisis to stagnate or drop home prices. Regional or local economic conditions can result in home values that don’t keep up with inflation.

Remember that the actual structure you live in will depreciate over time. This can result from wear and tear on the property or a lack of maintenance and repairs.

Pride and Financial Responsibilities

One often-cited benefit of homeownership is the knowledge that you own your little corner of the world. You can customize your house, remodel, paint, and decorate without the need to get permission from a landlord.

Ownership comes with responsibilities, however. You must pay your mortgage or risk losing your home and the equity you’ve built. Maintenance and upkeep are your responsibility. You can’t call the landlord at 2:00 a.m. to have a leaky water pipe repaired. If the roof is damaged, you must repair it—or have it repaired—yourself. Lawn mowing, snow removal, homeowners insurance, and liability insurance all fall on you.

Illiquidity

Unlike stock, which can be sold within days, homes typically take much longer to unload. The fact that you might have access to $500,000 in tax-free capital gains doesn’t mean that you have ready access. Meanwhile, you still must make mortgage payments and maintain the house until you sell it.

Is Buying a Home a Good Investment?

Buying a home is an investment but whether it is a good investment depends on a few factors. If you need a home to live in, it’s a good investment. Monetarily speaking, there are high upfront and ongoing costs associated with your home. If you build enough equity and sell when the real estate market favors sellers, you will likely make a good return on your investment due to appreciation. But if the market is weak, or you have little equity in the home, or you have to sell too soon, you may lose money.

What Is an Advantage to Owing a Home?

There are many advantages to owning a home. For starters, there are tax benefits granted to homeowners. You can also build equity in your home, which in turn, may act as a long-term savings account. Some landlords have specific rules about how a tenant can renovate their apartment. If you own your home, you have the freedom to renovate. If you have a 30-year or 15-year fixed mortgage, you can anticipate what you will pay for your home year-over-year. A landlord, once a lease is up, could decide to sell your home, or raise the rent higher than you are able to pay.

What Are the Tax Benefits of Buying a Home?

The Tax Cuts and Jobs Act reduced the value of owning a home. So, while there are tax benefits to owning a home, the law limits mortgage interest deductions (up to $750,000 of total mortgage debt). Another hit to homeowners, the SALT deduction limit was capped to $10,000. However, even with these changes, homeowners still do benefit at tax time versus renters, and these laws are set to expire in 2025.

The Bottom Line

A home is an investment that comes with many investment benefits and risks, which makes it an investment that is not for everyone. Weighing the investment benefits against the risks is essential. A rational comparison of pros and cons can help you decide whether to put your money into a home investment or potentially find better returns elsewhere.

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