Buying a house is often the biggest investment people make in a lifetime. Instead of renting from a landlord or management company, you’ll begin building equity.
According to the Federal Reserve’s Survey of Consumer Finances, homeowners, on average, have a net worth 40 times greater than renters. Although there are benefits to buying a house as an investment, there are also some drawbacks.
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Is buying a house a good investment?
Buying a house can potentially be a good investment. It builds equity over time that you can tap into if you ever need it. If the home is your primary residence, this may not help you save money if you factor in the costs of taxes, insurance and maintenance. Houses purchased as investment properties are usually rented out or flipped, meaning people are buying them for less and selling them for more.
With house-flipping being the exception, buying a home is a long-term investment. It can take years to break even. Experts say you shouldn’t buy a home unless you plan on living in it for at least five years — the average length of time it takes to build enough equity to recoup fees and costs.
When you own a home, you’re tied to the location — for better or worse. The quality of local schools, employment opportunities and proximity to shopping and entertainment are all factors that impact the value of a location.
Although you can choose where you buy, you can’t control what changes happen in the area. If you decide you hate the area or the neighborhood declines fast, you risk losing money if you sell too soon.
Depending on the type of loan, the type of property, the location and other factors, closing costs can range from 2% to more than 6% of the purchase price. On average, closing costs in the U.S. are $5,000 to $12,500, based on the median home price.
These fees are in addition to the amount you paid for the home. These fees can take years to recover and are part of the reason experts recommend following the five-year rule before selling.
Benefits of owning a home
Homeownership is considered the American Dream for a reason, and it offers major benefits.
Although it’s possible for property values to decrease over time, this doesn’t happen often. The majority of housing markets have seen a price increase of 50% to 100% in the last two decades, based on Zillow data. A higher value means you’ll be able to sell the home or rent it out for more money.
Equity is the difference between your home’s value and what you owe on the mortgage. You can tap into this equity by refinancing or taking out a home equity line of credit, also known as HELOC. This typically offers much lower rates than other forms of borrowing, such as credit cards and personal loans.
It typically takes a few years to build equity, but it’s important to remember renting a home from a landlord or management company will never build you any equity. Making larger mortgage payments or even extra payments can help you build equity faster.
There are some tax deductions exclusively for homeowners that can help lower the tax bill. Homeowners can deduct mortgage interest, home equity loan interest, discount points, property taxes, mortgage insurance, necessary home repair costs, capital gains and home office expenses.
Making regular, on-time monthly mortgage payments can raise your credit score. A rising credit score means lower interest rates and better terms for future financing. Credit scoring models want to see a mix of credit. A mortgage adds diversity to the credit profile, which accounts for 10% of your FICO score.
Becomes cheaper than renting with time
In the majority of cities, it’s cheaper to buy than to rent. Monthly rent is subject to changes based on the market, but your mortgage interest rate is locked in for the entire duration of the loan with a fixed mortgage.
With a fixed-rate mortgage, your monthly principal and interest payments won’t change until the loan is paid off. Every time a lease is renewed annually, the rent may go up. Increases in rent are more frequent than changes in monthly payments for homeowners insurance or fluctuating property taxes.
As a homeowner, you can lease or rent the house out if you need the monthly income. You can rent out a room or the entire home. You’ll maintain ownership and keep all the equity but can use the rent to cover the cost of the mortgage.
You own the space so you can do whatever you want. Add your own personal touch to really make it fit your style. You can make changes and renovations to the home as you see fit.
Note: If you have a homeowners association (HOA), it can legally set certain rules on landscaping, painting and decorations, but you can completely customize the inside of your home.
Drawbacks of buying a home
Although homeownership can seem like a great investment, there are drawbacks. You’ll want to carefully consider the cons of buying before committing to a mortgage for 30 years.
Maintenance and other costs
When you own a home, you’re responsible for all the repairs. If there’s an issue, the burden is on you. There’s no landlord to call or property manager. In addition to the unexpected repairs, you’ll need to plan on replacing the roof every 15 to 20 years and your air conditioning system every 10 to 15 years.
Owning a home means you’re tied for the duration of the loan. You can sell or rent out the property if you want to move, but that process takes time. The market can change and even if the prices drop, you’re still obligated to pay back the full loan amount plus interest and fees.
Although you’re building equity, it isn’t liquid. Your asset is tied up and not easily accessible. If you want to refinance or take out a HELOC, you’ll need to meet credit and income requirements set by the lender.
There are significant transaction costs and processing times when buying or selling a home, which might make it difficult for you to close the deal quickly if you decide you need to sell fast.
Lack of diversification
Even if your home increases in value, you won’t see any financial benefit from living there until you sell it. People may lose out on income that could otherwise be generated by investing in a balanced and diversified portfolio because the equity in real estate frequently remains locked inside a home and does not generate regular income.
Renters aren’t always reliable
You run the risk of getting an unreliable or bad tenant if you decide to rent your home out. Unpaid rent and a costly eviction are the most obvious consequences of renting to the wrong person. Tenants can damage or destroy a home, which takes time and money to repair. In some instances, they may even steal different objects like doors, cabinets, appliances and pretty much anything else they can get their hands on.
Weigh the pros and cons of homeownership before buying
Buying a house can be a great investment opportunity for the right person. To get the most out of owning a home, you’ll want to ensure you’re financially stable and plan to stay in the home for at least five years.
Homeownership carries drawbacks with it, which include major expenses and the potential for a decline in value. Before making a decision, carefully weigh the pros and cons taking your individual circumstances into consideration.
Do you pay tax on an investment property?
In addition to paying the property taxes on an investment property, you’ll also need to report the income on your taxes. Rental income is taxable income.
Is it better to buy a house or invest in stocks?
A house is a long-term investment that builds equity over time. Some investors buy homes to flip, but this takes time and money. Stocks are an affordable option, but you can lose money. There is a risk associated with both options, but real estate is typically viewed as a safer long-term investment.
Can I buy a house as an investment and live in it?
You can buy a house as an investment and live in it. You can decide to rent out a portion of the home or the entire property. Your tax breaks will vary based on how long you occupy for the for, however.