Originally, this was to be a two-part series discussing the pros and cons of buying a home as opposed to investing. The purpose wasn’t to pick a winner or loser, per se. (After all, one of the main tenets of Get Rich Slowly is that you really should do what works for you.) Instead, the purpose was to highlight the strengths and weaknesses of both options in case you were faced with a choice for some reason.
Holly Johnson’s article should you buy a home or (invest?) was first; and she said that, if she had to make that choice, she “would invest for the future and forgo the house in a New York minute.” I intended to explain the benefits of the opposite side of the hypothetical.
But you stole my thunder! So many people made great comments in response to Holly’s post that I thought it would be better to explain what was left over or unclear for some reason. We both started by looking at the past.
The (more common) way to build wealth
Two activities have stood the test of time throughout history as the best ways to make money:
- Real estate investing
If you look at America’s list of millionaires and what they did to get there, you will observe the most common path to millionaire status in America has been real estate.
Sure, you have the Warren Buffetts who did it by investing in stock, and you have the Zuckerbergs and Gateses who did it by starting new companies and riding them to fortune. But most of the lower profile millionaires built their wealth with real estate.
There is a reason for that. As my dad always used to say: “Everyone has to live somewhere.” The world’s population is expanding, but Mother Earth isn’t. So it isn’t hard to see the math of supply and demand working in favor of real estate investing.
Limiting the price for shelter
Consider the precept that, if you want to build wealth, one surefire thing you can do is to limit your expenses. Look at your budget. What is your largest expense? Housing. Whether it’s your rent or a mortgage payment, unless your house is fully paid off, chances are there is nothing you spend more money on than that. (Well, okay, if you’re leasing two Ferraris and a Mercedes, your cars may cost you more, but then you admit you’re not typical.)
Jeff nailed this concept in the comments of Holly’s article:
My mortgage will end while rent never does. When I buy, I am locking in my price. Housing can go up and down in value but my mortgage doesn’t change based on that, what I owe is what I owe, even when prices rise 20% or crash 20%.
When you think about your future, what offers you better security than having a shelter of your own choice … with no rent or mortgage payment?
Look around you at retired people who are living comfortably, and look at their finances. Nine out of 10 will have a paid-for home. Not only have they locked down the price of housing for the term of their mortgage, they effectively brought the expense down to zero as compared to rent once the mortgage is fully paid.
You can’t get there if you don’t buy a home.
To me, one of the biggest reasons to buy a home first is that it puts an (inevitable) expense on a track to become an asset. Like all investments, that difference usually starts out quite small, because in the beginning most of your monthly payment to the mortgage bank is interest. However, as time passes, more and more of that monthly amount transitions from expense to an asset, i.e., the equity in your home.
That, to me, is nothing short of a thing of beauty; and to my mind, it’s the biggest single reason people who are secure in retirement got there.
The concept of leverage
Ec was one of the few that mentioned leverage as an advantage to buying a home over investing your money:
Secondly, the other big advantage of owning your own home is leverage. If you had 30k to invest in 1940, based on a typical ltv ratio of 80/20 you could buy a home worth 600k. Would you rather have 600k growing at a slightly lower rate or 30k growing at a higher rate?
But judging from the fact that only three comments mentioned it, I thought it would be good to explain the concept.
Most of us know that debt is more evil than good … except, of course, when it comes to buying a home. One of the big things that makes buying a home the first step in most people’s financial security is that debt. Home mortgages are usually the cheapest loans out there, so the burden imposed by paying interest is relatively minimal. More here.
How leverage works
Here is where the math becomes compelling, and it’s rooted in (of all things) inflation. Home prices over the long haul have gone up in most places. That is something we love, isn’t it? That appreciation is also called inflation … but it’s the kind of inflation that works for us.
And leverage is how we make inflation work for us. Here’s the math: