Buying A House. Is this a Good Idea?
by Ndubuisi Chibuogwu
Introduction
It is the dream for most people to own a home. For them, it embodies a sense of pride and stability. In most developing countries, home ownership bestows status on its owner and is used for appreciating the net worth of an individual. This project will show how much progress I have made in the use of BibTeX for describing and processing lists of references, and LaTeX to produce technical and scientific documentation. It showcases the potential misfortune that can be experienced by the individual that consistently fails to follow strict financial management choices. I will elucidate my thoughts with the use of pros and cons to answer the question; which is better: To lease a property or to own a mortgaged property?
Disclaimer: There is nothing wrong with an individual wanting to own a home as a means of keeping a roof over one’s head. It is one of the three incessant needs for human existence and should be enjoyed by all if possible
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Background
Many homeowners take up mortgage loans that leave them broke or in many instances: outlives them. This paper shows us reasons why it is more beneficial to lease a property until the individual is financially able to afford one, and not be in debt afterwards. In the following paragraphs, we shall by see how leveraging on the power of compound interest can help in attaining financial independence, hence being able to purchase real estate.
Pros and Cons
In the case of a lease, the landlord can opt to not renew your lease before the current one expires but if you have a family and need to move then renting becomes more desirably than owning a home because it increases your level of flexibility significantly. In the situation where the mover is the home owner, it becomes more difficult for the owner to get rid of the property or at best find a good tenant.
The next reasons favors leasing to ownership because, outside of your rent and some minor expenses around the house, every other cost must be borne by the landlord. For example, if a windstorm or a hurricane were to damage your roof; that is your landlord’s cost to bear (yeah you might need to make some expenses assuming you rented an unfurnished apartment). Yes, some will say that a homeowner’s insurance can take care of some if not all the expenses, but not everyone insures their homes. On the flip side, owning a home is preferred to renting one because of the small matter of minor and major re-modification of the property. For a tenant to make certain changes to the house without the approval of the landlord. It might be as little as changing the color of the walls, furniture rearrangement, cutting down trees to create a garden or even installing a koi pond for my fish aficionados. This serves as a big factor for some choosing home ownership over renting.
Let us hazard another example in favor of home ownership: If you buy a house for $100,000 and after 3 years, the house is valued at $250,000. That additional $150,000 is the equity that you have on that house, which really is a tangible asset because you can use the equity to leverage on other investments. Equity is important but be aware that the interest on every mortgage is weighted to the front so in hindsight, you may not be building equity as fast as you thought. Now when you rent, you are not building equity but enriching your landlord who is taking your rent and paying the mortgage assuming they have a mortgage. Hmm, there is a way around this. With all that is been said above, let’s analyze some scenarios on why owning a home is a bad idea or bad investment.
Unexpected Expenses
The first reason for not having a home is because of all the unexpected expenses. When you think of a standard portfolio investment you can be sure about what your principal cost will be and all the expenses associated with that investment. With a house there are a ton of things that you just cannot anticipate but are needed for you to purchase the house. Some of these things are not predictable, some are based on what is in the market and some of them, for example like paying for a valuation will differ significantly depending on who you hire to do it. Another expense can come from the damage to your property, and this can escalate significantly and be very unpredictable. In the case of an investment, you don’t have such unpredictability. Again, the longer you own a home, the more expenses come over time and your maintenance bill keeps increasing because if you leave it then the property will devalue and you will not be able to make back your money if you choose to sell. Other expenses range from 3% to 10% of the value of the property. Fees like application fee (mortgage), attorney fees (for managing sales agreement), some times closing fees depending on where you live, a credit report fee (because the bank that you’re borrowing from will need to verify you are able to pay back your loan), mortgage insurance premium (applicable in some situations), if the property is located in a planned area this will attract home owner’s association fees (HOA), and an HOA transfer fee which is charged for the transfer of property to you the buyer, there is also home owner’s insurance fee, origination fees, pest inspection fee in some instances, property appraisal fee, property tax, stamp duty, transfer tax, commitment fees, loan fees, registration fees, survey ID, QS report and the list goes on and on. Who would have thought that procuring a property would have so many fees. For me, this alone is a huge deterrent.
Other expenses range from 3% to 10% of the value of the property. Fees like application fee (mortgage), attorney fees (for managing sales agreement), some times closing fees depending on where you live, a credit report fee (because the bank that you’re borrowing from will need to verify you are able to pay back your loan), mortgage insurance premium (applicable in some situations), if the property is located in a planned area this will attract home owner’s association fees (HOA), and an HOA transfer fee which is charged for the transfer of property to you the buyer, there is also home owner’s insurance fee, origination fees, pest inspection fee in some instances, property appraisal fee, property tax, stamp duty, transfer tax, commitment fees, loan fees, registration fees, survey ID, QS report and the list goes on and on. Who would have thought that procuring a property would have so many fees. For me, this alone is a huge deterrent.
Sell Home To Capitalize
Here is the thing, you may not capitalize on your home investment unless you sell; but you know what? You may never sell, and as a matter of fact most people don’t. In many people’s eyes their home is a forever home, something that they will or will pass on to the next generation. I am sorry to have to break it to you but if you are not in it to sell it, or rent parts of your house or lease it out to do something then it is really not a real estate investment. It is only considered as an investment if when you buy it , it appreciates in value and you sell it and make a return on your investment (ROI) because all the costs and fees are taken out and you still make a profit or when you rent your house, whether all of it or parts of it and collect money that helps to offset your mortgage or you rent your property for things like weddings, parties and so on to be able to offset that mortgage.
Appreciation Is Not Guaranteed
When the market is hot, it will make home ownership seem like an excellent investment. Housing prices are always going up for the most part but this is not usually the case for the most part everywhere across the world. Let us draw an example from recent history and go back to 2008 during the housing bubble bust. When you look at the market crash and the conditions that followed; home prices hit rock bottom and that left a lot of home owners struggling to pay their mortgage. It was especially difficult for those who were either typical home owners or people who thought they could use home ownership successfully as real estate investment and bought into that “Anyone Can Start Investing in Real Estate” fad, that was trending back then. Now when this happens, not only will your property not appreciate in value, but it will actually devalue to the point where you lose all or most of your money.
Money Not Well Spent
It is not money well spent. Why? If you purchase a home with the intention to make it your primary residence, things like your mortgage, your monthly payments will eventually kill your cash flow. What do I mean? A mortgage (fixed one) remains unchanging for the life of the mortgage and puts tremendous strain on one’s finances. Think of it, what is your biggest line item on your budget? I am sure you will say it is your mortgage. This takes up to (20 to 30) % of your income and unless you acquire the property for rent, if you are smart you will charge more for the rent and use the returns to pay for the mortgage while having a positive cash flow or surplus. Now back to the question of why it is not money well spent. Let us say rather than buying a property to live in but instead you decide to invest in a portfolio income like a bond, index fund or mutual fund. If the house that you would have bought costs $150,000 or the equivalent based on where you live. You would have to make the following payments:
- Down Payment: 10% of $150,000 = $15,000.
- Closing cost: 10% of $150,000 = $15,000 made up of loan fees, stamp duty, registration, commitment fees.
- Incidental cost: $3,000 which is made up of valuation fee, survey ID, and QS report.
The above ($33,000) is what is required as upfront for buying the house. In addition to that we have the upfront costs which comprises of insurance, property tax, and repair costs totaling $300 annually. The final cost is based on a rule which states that a property costs about 1% of what it cost at purchase to maintain it, making the maintenance cost $1,500. Adding the upfront and maintenance costs we get about $1,800 per annum. If our mortgage is $1,200 per month, then our monthly cost owning the property will be:
\[ Monthly \ Cost = \frac{Mortgage + (Maintenance + Upfront \ cost)}{12} \] which gives us about $1350 per month.
Now let’s say instead of buying a home you chose to invest the money in a diversified index fund with an 8% per anum interest rate over a 30-year period. The $33,000 that was required as down payment for our house in the first scenario will now serve as the principal for your investment. Out of the $1,350 used in the first scenario as monthly cost, take out $850 and use as payment for a lease (yes $850) and now have a surplus of $500.
Investment breakdown:
Principal = $33,000.
Less Rent = $850.
Investment After Rent = $500.
Compound interest formula:
\(A\) = final amount
\(P\) = initial principal balance
\(R\) = interest rate
\(n\) = number of times interest applied per time period
\(t\) = number of time periods elapsed
\[ A = P(1 + \frac{R}{N})^{N*t}\]
At the end of the 30 year term, our principal would have yielded $360879
By leveraging on the power of compound interest the total amount accrued is the compound interest on the $33,000 principal at an 8% rate per year, compounded 12 times annually over a 30-year period. Having only contributed out of pocket $180,000. So instead of buying a property and sinking all that money into it, you invested it into an index fund, took the excess or surplus and invested it on a monthly basis and with over $360,000 you can now buy your dream home. Hopefully you are strong enough to enjoy this privilege. Now with over $360,000 you can buy a home of $150,000 cash down (even though it took you 30-years) and still have over $210,000 left. Now you are a cash home owner with $210,000 sitting in the bank.
Dream Home
Conclusion
In conclusion, a house is an asset based on accounting; that costs you money to buy and maintain, which quite frankly in my humble opinion is really a liability. The issue though is that even if you choose to sell your house there is absolutely no guarantee that you will make a profit at the end of the day. It is important to note that most people on average only keep their house for about 13 years, which is barely enough time to make back their principal.
When I was in my second year in college I came across this book Rich Dad Poor Dad by Robert Kiyosaki (Kiyosaki and Lechter 2000) and I would like to recommend it to teenagers. The book should be included. this book