Is your home a good investment?

In our fall 2016 survey of homeowners only 24% said that they bought their home because it was a “good investment.” 75% said that they bought their home “just to live in.” But, you can make your home a good investment.

As homeowners, we tend to do a financial deep dive into the benefits of renting versus buying before buying a home, weighing the benefits of things like building equity vs. not paying for household repairs.

For every story of someone making a lot of money by buying a home, there seems to be another of a homeowner experience gone awry.

How do you know if your home is going to be a good investment?

Let’s break down the research.

The alternative to buying a home is, of course, renting. Which is better over the long term? This debate hinges on the assumption that renters are putting what they would have spent on their down payment and cost differences between homeownership and renting, like home maintenance, into investment accounts.

Using this comparison – buying a home vs putting the equivalent money into investment while renting – here’s how it shakes out.

From a national average, homes appreciate about 0.8% a year on average, after taking into consideration inflation. One study calculated that investments outpace the future payoff from buying a home, a more recent analysis, however, minimizes the difference. When compared to other investments based purely on growth, homes may be slightly below returns on stocks.

So, is it better to put your money into stocks and rent? Not so fast!

According to research, there is no practical substitute for homeownership in building wealth. Here are four ways that your home can be a good investment.

1. Forced Savings

By getting a mortgage, through amortization, you gradually pay down the principal over time. While principal payments are lower in the beginning, if you keep the home for a while, you will build up a sizable nest egg by regularly making your payments.

Many of us simply won’t continuously and religiously put the money we might save in home maintenance or property tax into an investment account as renters, whereas homeownership increases your equity in your property simply by paying your mortgage.

2. Outsized benefits of home appreciation

Since home appreciation is estimated to be about 0.8% per year, including inflationary effects, it generates a 26% increase in value over 30 years. That’s based on the national average. The financing of a home can leverage the affects of home appreciation. Even if you are a homeowner who doesn’t put much money down, you will still get the benefit of home appreciation. That’s assuming that you are in an area where homes are appreciating higher than inflation. More on that later.

3. Tax benefits

If you can utilize the mortgage interest deduction (and not everyone can), a homeowner can realize between a 15% and 35% deduction on interest paid. Also, capital gains tax is exempt for single homeowners up to $250,000 and couples up to $500,000 on the sale of a property.

4. Hedge against rising rents

Recent rent increases in major cities have been as high as 15% per year in the hottest markets. Buying a home locks you in to today’s home value, avoiding annual increases in rent. If you are in an area where rents have historically risen faster than average, you could see some even larger benefits as a homeowner in the future.

What can make your home a bad investment?

Of course, not everyone has a rosy story with homeownership. There are many factors that contribute to a home not being a good investment. Here are a few that can impact how good an investment your home is in the long run.

1. House prices can be volatile

Housing prices fluctuate a lot. Take a look at this interactive chart and you’ll see that housing price charts look a lot like a roller coasters. A 10% reduction in home value has a big effect on your home equity, while a 20% drop can erase your entire down payment from your net worth. But, there are ways to minimize the effects of housing price drops. We’ll get to that in a minute.

2. Home values not keeping pace with inflation

In certain parts of the country, home prices may be depressed and not keep pace with inflation giving you a decrease in value, even if your home slowly appreciates. In general, the two coasts have held up well in terms of home appreciation, but a lot of what determines whether houses in any particular area appreciate and to what degree can be tied to local market dynamics. The area that you buy in can determine, of course, how good an investment your home is.

3. Wealth tied up in an illiquid asset

Most homeowners have about two-thirds of their net worth in their homes. This means that most of their worth is tied up in an asset vulnerable to swings in value. Unlike investments, you can’t move any of that wealth to another type of asset, which means the whole investment is subject to the same market swings.

4. High transaction costs

When you buy or sell a property, there are many costs associated with it – paying taxes, brokers, lawyers, government fees, processing charges – which add up. Depending on how often you buy and sell houses, realizing these transaction costs, and how much your home is appreciating, these transaction costs can impact how good your investment is.

5. Large home maintenance charges

Unexpected and large home repairs can turn what might be a good investment to a not so good one. When you buy a home, you don’t necessarily know what type of repairs you’ll end up having. It’s a homeowner’s nightmare to budget for a reasonable amount of home repairs and then find out that your home is in fact, a money pit. Home inspections can’t always catch structural issues that require the most money to fix.

6. Risk of default

If, for some reason, you find yourself in a position where you fall behind on your mortgage, you can be at risk of losing your entire investment.

What makes a home a good investment?

Here are four ways to ensure that your home is a good investment.

1. Buy in the right place in the housing price cycle

Certainly, if you can buy on the upswing, you’ll naturally do better. But if you don’t, holding onto the home for longer can sometimes turn what would be a bad investment into a good one.

2. Geographic region

Mostly along the coasts, homes have been appreciating 1% or more in recent years. However, areas in the Midwest and South have seen little or no gains. That’s a huge generalization as appreciation often comes down to local market dynamics. Some areas have also seen negative appreciation. Also, within these regions, homes in a desirable area vs. a declining area are also factors.

3. Low interest rates

We’ve been blessed in recent years with historically low interest rates. Lower interest rates ensure that a larger portion of your mortgage payment goes to paying off the loan rather than just to interest.

4. Refinancing choices

The way and frequency that you refinance can dramatically affect wealth accumulation. Taking advantage of declines interest rates can reduce costs, but not at the expense of resetting the mortgage back to the beginning which makes interest payments higher, and reduces the benefits of forced savings.

Taking cash out of the property for buying things that won’t help you financially erodes wealth, however, the flip side of that is that taking money out of your home can be an effective buffer against income shocks.

5. Quality of home

Buying a home that is a quality home, that doesn’t have a lot of maintenance issues, in an area that is desirable and has desirable features will most certainly appreciate faster than lesser homes.

6. Time

Time is perhaps the biggest factor in whether a home is a good investment. The big wins of homeownership: forced savings, appreciation and other benefits compound over time and even out the ups and downs of the real estate market.

Learn more

Home equity is the largest consumer financial pool in the United States at $12 trillion. Homeowners on average have 61% of their net worth in their homes. On average, homeowners have a net worth of $194,500 while renters have a net worth of $5,400.

If most of a homeowner’s net worth is in their home, doesn’t it make sense that you should be in control it? That’s why this book was written: Avoid the Money Pit, Turn Your Home into a Financial Powerhouse. It’s available in both digital and print versions. Buying the book gives you access to many other resources, cheat sheets and videos to help you as a homeowner to save money and control your net worth in your home.