Your Primary Residence: Asset or Liability?
For years the advice on the best way to build wealth was to buy a home. Every month you pay down the loan, and as the years go by the value increases. A home was your greatest asset. Is that still true?
It depends on who you ask - and what you’re actually asking.
Short answer: Your home is an asset and should be included in your net worth. Your home’s equity should not be included in your FI number unless you plan on selling it when you retire (Read more about you FI number here).
Long answer: It depends on what you prioritize, and how you handle buying (or not buying) a home.
You should also plan on certain housing expenses every year, regardless of if you still owe money on the mortgage or not.
“Rent is the maximum you’ll pay, and a mortgage is the minimum you’ll pay.”
When you buy a home, you become responsible for paying property taxes on the home. You are also responsible for homeowner’s insurance. If you took out a loan to pay for the home, you’re responsible for paying that loan back plus the interest on the loan. What this means is that if your monthly mortgage payment is $1,000/month - you aren’t gaining $1,000/month in equity. Depending on how recently you purchased and what interest rate you have, you may be gaining only about $100 a month in equity.
The counterpoint to the above is this: If you rent and you pay $1,000/month, each month you gain $0 in equity.
Considerations when deciding to buy a home
When you are budgeting for housing costs, consider Ramit Sethi’s quote above. Don’t buy a house where the monthly mortgage maxes out your budget. Leave yourself some wiggle room for when you inevitably have to call the plumber.
Quick story: We bought a house and within the first year had a plumber come to our house on three separate occasions. The third visit cost us $2,500. In this case, our house was acting like a liability because it was costing us money.
If the monthly payment will max out your budget, consider continuing to rent until you can save up for a larger down payment or keep shopping for a more affordable home. You may have to look at smaller, or older, homes to bring down the cost. Improving your credit can also help reduce the rate on the loan, and that can significantly lower your monthly cost.
Let’s also remember 2008. The housing market crashed. Home values are not guaranteed to increase, though historically they have. If things go well, you can pay down the loan and increase the equity in your home, thereby increasing your net worth.
The problem with equity? It can only be accessed by taking out a loan or opening a line of credit and using your home as collateral (which costs interest), or by selling the home. There are also costs associated with buying and selling a home. Zillow estimates closing costs to be as high as 5% for buyers and up to 10% for sellers.
So yes, owning your own home can build wealth, and 94% of millionaires own their own home, but it isn’t always the best answer when you consider return on investment. I know real estate investors, who own rental homes, who still rent because it makes more sense financially. If you want to maximize return on investment, owning your primary residence might not make sense unless you can add value to the home while you live there via a remodel or addition. Most likely, return on investment is not your priority. You may just want a comfortable place to live that provides stability.
If you buy a home in your 30’s, and you don’t move or refinance, you can have it paid off by the time you hit traditional retirement age. All your equity is there for when you need it, whenever that may be.
To conclude: Your primary residence is an asset in the sense that it is a thing of value that you own. It’s a liability in the sense that you may have to keep putting money into it to keep it well-maintained and valuable.
Personally? I recommend buying. I also recommend getting a good real estate agent who will talk you out of buying the wrong house.