Owning a home is – and should be – a goal for many people. It’s a feeling of pride to own a piece of the American dream. It’s more than a place to call home. Birthdays are celebrated, dinners are served and gardens are laid out. If purple walls are the decor of choice, no permit is required, just some paint and sweat likeness. However, too many people associate home ownership with investing. So if extra dollars are found in the budget, “invest” them by paying back the mortgage. That has to stop.
First, consider a few things that a homeowner or home buyer should be doing.
1. Homeowners should have at least 20% equity in their home. For new buyers, this will likely mean a 20% deposit. Meeting this minimum capital target will ensure that owners are never submerged in their home, except in extreme circumstances. It’s not good to be underwater in a purchase, but certainly never one the size of a house. Failure to pay a minimum of 10% deposit can mean that a buyer may not be willing to make a purchase.
2. Buyers should be able to get a minimum of five years’ commitment to a home when purchasing it. Yes, life happens and circumstances change – it’s inevitable. However, if a buyer knows they will be moving across the country in three years, they should rent.
3. Homeowners should have a fixed rate mortgage. One of the main financial benefits of home ownership is the ability to control future housing costs. A home payment of $ 1,400 today will be equal to a fixed rate mortgage 12 years from now. Don’t agree to an ARM or balloon loan with the idea that you have been long gone as it may not be. (My wife and I swore we would only be in our house for five years – that was 16 years ago!)
These recommendations seem like conservative guidance when it comes to home ownership, and that’s fair. However, this cautious approach also supports the earlier recommendation for homeowners to stop prepaying their mortgages. Here are the reasons why.
First, financial decisions are determined by the allocation of valuable resources, and for most, their resource – income – is not unlimited. This writer has seen many people pour extra money into their home payments every month because they thought it was a wise investment. At the same time, they didn’t fully exhaust their retirement plan at work (assuming they even had a retirement plan at work), or they had a car payment or student loan that they were still paying back.
Second, a fixed rate mortgage offers some inflation protection. Inflation has been tame for many years, but in case no one noticed, the government pumped trillions of dollars into the economy last year. Inflation is one of those things that seems to be fine and under control – until it is no longer. Inflation may remain in check, but if it rises for a period of time, borrowers will win if they repay the loan with cheaper dollars.
Finally, a fixed rate mortgage offers positive leverage. When a home is valued at $ 300,000 and gains 3% in value in the first year, the owner’s net worth increased by approximately $ 14,000, including appreciation and principal, although only about $ 72,000 in down payment and mortgage payments in the first year Were “invested”. Tying $ 300,000 into an “investment” that historically brings back a little more than the rate of inflation is not a great investment.
As a consultant, I remind people, “When you retire, you can’t take a piece of your paid gutter to the grocery store and trade it for groceries – they’re going to want money.” So people need to focus on investing in assets, which enable future cash flow. It takes time – usually decades – for these assets to grow, and that time cannot be replaced by future savings. In other words, save and invest as much as you can, but remember that your home is not a piggy bank.
Tim Sullivan is the owner of Clarity Financial LLC, a paid consulting firm in Columbia, CFP practitioner, and a member of the National Association of Personal Financial Advisors. He has been recognized as an Enrolled Agent by the IRS.