Owning a house, the American dream

We call it the American dream, the dream of being a homeowner. But is it a dream or is it a nightmare?

When I ask people to share with me their financial goals, they generally say:

1. To save for retirement
2. To buy a house
3. To provide education to my kids

Is buying a house a good financial objective?

We heard the same anecdotal evidence all the time:

“My grandmother bought a house 4 decades ago and now she made 10 times her money back.”

But did she really?

Did she take in consideration:

• All the repairs done in the house?
• All the property taxes?
• All the time invested to keep the property functional?
• All the insurance expenses?
• All the worries that come with being a property owner?
• Did she account for the change of the roof?
• And the improvement of the plumbing?
• The mowing of the lawn?
• The snow removal?
• All the time invested in finding a house?
• The lack of liquidity by having her money tied up for decades?
• The interest expenses?
• The broker’s commission and title fees?
• The change of the hot water tank?
• And all the other expenses I can not imagine right now?

Probably not.

And did she compare the return of her house by putting all that amount of money and energy into investing in a broad-based index fund generating about 8% return and having liquidity all the time?

Probably not.

We have this misconception that owning a house is a great investment. But it’s not. The real return on homeownership is similar to the rate of inflation, and this is only if a person decides to stay in their house for over 10 years.

Only 37% of North Americans stay in their houses for more than 10 years. The media stay in a home is 5.9 years. This means that for 63% of North American, owning a house is a money-losing activity.

If we take into account that the commission to sell a house is about 6% and that inflation is about 2% per year, we need to sell a house for 18% more than we bought it for at the end of 6 years, just to break even, without considering all the other cost of taxes, notaries, attorneys, so on and so forth.

But, let’s say that you drank the kool-aid. Let’s say that you are determined to buy a house because that’s the script (go to school, get a job, buy a house, and retire at 65), how much house can you afford?

These are the two main things to consider:

1. Don’t buy a house unless you have a 20% down payment. If you don’t have a 20% down payment, you are not ready to buy a house.
2. Your housing expenses should not be more than 25% of your monthly income. If you make $4,000 per month, your housing expenses should not be more than $1,000.

Things to consider when borrowing money to buy a porperty

We are at a time period in history where mortgage interest rates are at an all-time low. I got my mortgage for 2.5%. This means that I can borrow a lot of money to buy a house and still make low mortgage payments. But what will happen when interest rates go up? Fortunately for me, I can afford bigger mortgage payments, but some people can not. You should stress test your purchase. Imagine that the mortgage rate was 2% above your present mortgage rate. Could you still afford a house?

Location, location, location

One of the biggest factors to consider when buying a house is the location. Here are some average prices in some of North America’s most popular cities.

• Vancouver: $1.5 million CAN
• Toronto: $1.3 millon CAN
• San Francisco: $1.29 US

These are outliers, but can you imagine how putting so much of your net worth in a piece of real estate only because you have been told that everyone should own a house? It doesn’t make sense. So, you must ask yourself why live in Roswell, NM (or wherever you’re deciding), and if your heart is set on that specific location, go for it!

When does it make sense to buy a house

1. When you have 20% to give as a down payment
2. When you are planning to stay in the same place for more than 10 years
3. When your mortgage payments are lower than rent payments for a similar property
4. When you can withstand a 2% interest rate increase without fall into financial difficulty.

Related Posts

1. The banks #1 loyalty is towards its shareholders
2. Kids: How to talk to them about money
3. What is an RRIF (Registered Retirement Income Fund)