A Home as an Investment
Buying a house is a good investment for most people. It can offer very good returns with low or moderate risk, and you get to live there while your money grows.
How to Measure Your Investment:
With stocks or bank accounts, the way to see how your money is doing is to check the rate of return. For buying a home, it’s called your Equity.
Your equity is basically how much of the house you own. So if you make a 3% down payment when you buy your house, your starting equity is 3%.
|
Price of House |
Down payment Amount |
Your Equity |
|
$ 100,000 |
3% or $3,000 |
$3,000 |
Your home equity increases when:
- You pay off some of the principal of the mortgage
- The property appreciates in value
Mortgage payments and equity
You will make a monthly mortgage payment that is divided into two parts: the principal and the interest. (Unless you get an Interest-Only loan in which case you don’t pay any principal.)
- Principal is the part that repays the loan and increases your equity
- Interest is the cost of the loan for that month, and for the first years of your loan, most of your payment will go to paying off the interest.
Appreciation and equity
So while you will build equity slowly through your mortgage payments, most people will see larger, faster gains through appreciation of the home value (houses like yours are selling for more this year than they did last year).
As your home increases in value, your equity rises as well. This is because the mortgage is now a smaller percentage of the house's worth. So, if your $100,000 house appreciates by 5 percent and is now worth $105,000 you would now have $8,000, or 7.6%, in equity.
|
Original Price of House |
Down payment Amount |
Appreciation |
New Value of House |
Your Equity |
|
$100,000 |
3% or $3,000 |
5% or $5,000 |
$105,000 |
$8,000 or 7.6% |
Appreciation isn't guaranteed, but if you buy a property where the neighborhood is improving, you will usually see an increase in value over time.
Investment Issues to Consider:
It may make more financial sense to continue renting and put whatever money you have saved up into a stock or mutual fund if you will need to either spend it soon, or need a quick gain.
Not a short-term investment
When you buy a house, there are a lot of costs and fees that you pay as part of the transfer of ownership (as much as 10% of the selling price). These costs mean that it will take a while, often years, to make money on the purchase. Most people stay in their homes between 7 and 10 years, and the increase in equity is what allows them to make a good return on their house.
If you think you’ll need to sell the home within 3 years of buying, it may not make sense to buy. So if you think you might end up moving to take care of ailing family members, or a job transfer, consider how much appreciation you would need to see to cover the costs of selling (these are often between 2-5% of the price) and moving to the new location.
Liquidity
This is a big word for how long it takes to get your money out. If you sell your house, it usually takes weeks, and sometimes months before the money shows up in your account. If you need to get to your money quickly, buying a home is not the right investment.
Capital gains taxes
Under most circumstances, the profits you make on a home when you sell it can either be deducted or deferred on your taxes. For many people, their home is their largest single asset and this capital gains benefit is a major reason to make the investment.
Opportunity Costs
One of the issues to consider is what you could do with the money if you didn’t buy and continued to rent. If the amount of monthly mortgage payment would be greater than your rent, that’s A. There are also the amounts for your down payment (B) and your closing costs (C). A+B+C = the amount of money you could be spending on some other investment.
So if your down payment is $3,000 (B), and your closing costs are $2,000 (C) and your mortgage payment is $200 per month more than your rent (A), that’s $5,200 you could use to buy stock, or lend to your family, or otherwise spend and maybe get a bigger gain from than if you invest it in a house.