“It Ain’t What You Don’t Know That Gets You into Trouble. It’s What You Know for Sure That Just Ain’t So” – Anonymous (sometimes attributed to Mark Twain)
I love a great debate, and personal finance is a most fertile ground for those.
It’s why they call it personal finance. Because the right answer almost always starts with, “That depends…”
My most recent debate was with Jason Clendenen, about whether your home should be counted as an asset or a liability. In short, I hold that it’s an asset, while Mr. Clendenen insists that it’s a liability. Read on, and decide for yourself.
Clendenen’s Position and Proof
Clendenen argues that you should “beware of mainstream financial advice,” arguing that your home is a liability by citing Robert Kiyosaki (of Rich Dad Poor Dad fame), “One of the most important is a new definition for assets and liabilities: Assets put money in your pocket. Liabilities take money out of your pocket.”
I’ll set aside the fact that Mr. Kiyosaki is considered by many to be a fraud (e.g., read this excellent and comprehensive review of Kiyosaki by John T. Reed). After all, what’s important in a debate is not who said something but rather whether their argument is factual and compelling.
Instead, I’ll concentrate on Mr. Clendenen’s argument and show why I hold that he is suffering from a case of partial knowledge that leads him (and any reader who accepts his position) astray.
Clendenen sets up an example of your buying a $250,000 home. He proceeds to show that assuming a 3% annual appreciation of the value of the home, and accounting for your down payment, mortgage payments, property taxes, and insurance your overall 20-year return is a negative 1%. This, he claims, proves his assertion that your home is a liability rather than an asset (and for the sake of this debate, I’m willing to accept his modified definitions of assets and liabilities).
What Clendenen Misses
Mr. Clendenen would be 100% right, if you were to buy the house, and proceed to make 20 years’ worth of payments while leaving it unoccupied. This would clearly be the height of folly.
What would really happen in this example is that you’d obviously be living in the house for 20 years. Otherwise, you’d have to rent another house to live in.
Since we can assume that the hypothetical landlord of this other house has at least some business savvy, your rent payments would cover all of his costs, plus a bit extra. If we assume this hypothetical house you’d be renting is similar in all respects to the one you bought and left unoccupied, you’d likely be paying over $28,000/year or about $2360/month for a place to live:
- $17,600/year to cover the landlord’s mortgage payments including taxes and insurance
- $1250/year to cover expected repairs (0.5% of the value of the house)
- $1468/year to cover property management fees (one month’s rent per year is typical)
- $8000/year for positive cashflow for the landlord
If you were to buy into the idea that a home is a liability, you’d have to assume that you should rent instead of buying, and invest the difference. The problem is that the difference is negative, since instead of paying $17,600/year, you’d be paying $28,000/year!
This means that owning this hypothetical home and living in it saves you $10,400/year! And this even before accounting for the fact that the landlord would most likely increase your rent periodically, increasing your savings even further.
Further, none of this takes into account the tax benefits of the mortgage interest deduction or how inflation eats away at the value of the money you owe, such that you might even end up making money off your mortgage loan! To see how that can play out, read this.
What the Full Data Prove
Since I already ran the math for an example of a $500,000 home here, I won’t repeat the whole thing. Feel free to go read that if you’d like, I’ll wait for you here :).
Whether you read that other piece or are willing to take my word for it, what the analysis showed using plausible assumptions was this:
- If you buy a house and sell it after two years, you’ll end up slightly ahead of renting a similar house for the same period
- If you sell after 10 years (the typical length of time Americans hold a house before selling), you’d come out ahead of renting by about half the initial cost of the house
- Sell after 19 years, and you’d be ahead by more than the appreciated full value of the house.
Does this mean that buying a home and selling it after whatever number of years will leave you with a positive rate of return? No, it does not! This is as posited by Mr. Clendenen.
However, the cost of renting a similar house is so huge that if you account for it, you’d save hundreds of thousands of dollars over the course of 20 years.
At the risk of putting words in Clendenen’s mouth, he might argue that money saved isn’t the same as money earned. I’d agree. However, money saved is actually better than money earned! That’s because you don’t need to pay income tax on the latter!
The Bottom Line
Should you always buy a house? Of course not! Here are 7 examples of when you shouldn’t:
- You can’t afford the down payment
- Your income isn’t stable and/or high enough to afford the mortgage payments
- You’re likely to move within a (very) few years
- Your credit score is so low that you can’t get a mortgage at all, or can only get one with an exorbitant interest rate
- Your local market (temporarily) favors renting over buying
- You’re willing to (temporarily) live in a much cheaper place than you’d be willing to buy
- Your employer will pay your rent, but not mortgage payments
Will typical appreciation of the value of your house outstrip your mortgage payments and other costs? Possibly, but don’t count on it.
Do mainstream financial advice and/or conventional wisdom always steer you right? Not by a long shot!
Should you buy as expensive a home as you can get a mortgage for? Absolutely not! That’s a great way of becoming “house poor,” and stalling your wealth-building efforts.
Having said all that, once you also account for the money saved by not having to pay rent, owning a reasonable for your financial circumstances home will leave you far ahead compared to renting a similar home. To the tune of hundreds of thousands of dollars over your lifetime.
That’s why I assert that Mr. Clendenen misses crucial pieces of the puzzle, causing him to fall prey to “What [he] Know[s] for Sure That Just Ain’t So.”
Financial strategy is all about setting financial goals, crafting a plan to reach them, and doing what's needed to start implementing that plan in both your business and personal life. This includes figuring out whether buying a home or renting is more appropriate in your specific situation. If you'd like to learn what financial strategy can help you accomplish, email me and we'll coordinate a free, no-strings-attached phone call to explore that possibility.
This article is intended for informational purposes only, and should not be considered financial or legal advice. You should consult a relevant professional before making any major decisions.