Buying a home creates many advantages, so many that one article will probably not be enough to list them. Buying a home using a home mortgage also creates many advantages if done correctly, and since there is a lot of negative feeling out there about mortgages let’s address this first.
Personal land ownership and home ownership are our government’s bread and butter. They want us to own homes and land because they collect taxes on these. For this simple reason, they have created a structure which makes borrowing against land or developed property one of the best leveraged investments available. What does that mean?
Typically banks lend money on property at anywhere up to 90% LTV, or loan to value. This means if a home is worth $100,000, a bank may lend you anywhere up to $90,000 to buy it. In some cases banks will even lend more. This is a huge amount of leverage. If you tried to borrow the same amount of money to buy stock, the bank would laugh at you, even if it was the bank’s own stock!
Now, most people understand this concept already, but they don’t understand when borrowing this much is the right thing to do. I’m talking about using debt responsibly, not just borrowing because you can. Let’s take an average household, who according to the US Census Bureau has an average income of just over $60,000. Let’s also say that they spend approximately a third of their income ($20,000) on housing, which is what most experts say is the maximum you should be spending in this area. Let’s say the household uses this money to rent or buy a house for the next 5 years. Now that we have our starting numbers, let’s compare renting to owning.
Renting: The $20,000 per year is used to rent a lovely 2 bedroom cottage, with all utilities included. The landlord (if they are good) takes care of repairs, and at the end of 5 years there is no money, but also no debt and the household is free to stay or rent somewhere else.
Owning: $30,000 is put down (I’ll tell you where this came from in a moment) on the same lovely 2 bedroom cottage, with a total of $150,000 owed as a mortgage. The $20,000 a year covers the mortgage, taxes, insurance, and maintenance on the property. At the end of 5 years, there are several financial benefits to the owners.
1. Tax benefits - Almost all of that $30,000 put up as a down payment comes back to the owners, because the interest on your primary home loan is tax deductible. Closing costs, property taxes, and upgrades to your home can all be deducted from your taxes depending on the various laws in your state and "promotions" that the federal government runs at different times to provide incentives to taxpayers and landowners. Remember, if you rent, there is no deduction and your income is taxed normally.
2. Principal reduction - In early years this won’t mean much, but even over those first 5 years of paying off your mortgage, you’ll have paid off almost $2,500 a year of the principal amount on your loan just by spending the same amount you would have if you were renting. This means even if you resell your house for the same exact amount 5 years later you’ll be $12,500 ahead.
3. Appreciation - Listen carefully, this is nothing to depend on, especially in the short term. But over the long term (15-30 years), property appreciates in a similar fashion to stock market appreciation. Only with property its much better, because you could have been 90% leveraged to begin with, but your appreciation goes 100% to you, not the bank.
There are a lot of caveats (the most obvious being, if you can’t buy a house for similar money to what you pay in rent as in the example I’ve shown) that if not watched out for debt can be your enemy, not your friend. Treat debt like fire. Use it right, it can warm you up, use it wrong, you’ll get burned. Too many people out there are burned right now, but the answer is not that fire is bad…its that we need to learn to use it more carefully.
A last word: Saving money is generally good. Accumulating debt is generally bad. But when it comes to housing, save your money for the down payment because mortgage debt is some of the best debt you can get. It’s still debt, and just like fire it can burn you, but not if you use it wisely.
P.S. These numbers are simplified for easy understanding, but they are good approximations of real costs. For anyone who wants more detail on these numbers, feel free to contact me directly.
