Three things to consider about buying a house
A house is a major investment and can be a huge asset when mortgaged properly. Read here to learn more.
Owning a home is not without its challenges. It’s the largest purchase most people will ever make, and it represents major responsibilities in the way of maintenance and other ongoing costs.
Still, a properly mortgaged house is the most important asset with which to establish wealth.
In Thomas Stanley’s “The Millionaire Next Door,” he writes that 97% of millionaires own their own homes, and with good reason: Owning a home, if achieved with the right planning, is a hedge against inflation and a tax-advantaged asset, and it provides a smart use of leverage.
Let’s explore these factors one by one to see how owning a home can be part of an overall financial strategy:
Hedge against inflation
Talk with a neighbor who has recently paid off, or is about to pay off, a 30-year mortgage. Assuming no refinancing, it’s likely that your neighbor’s monthly mortgage payment seems ridiculously cheap compared to current mortgages. That’s because your neighbor is making mortgage payments based upon house prices 30 years ago. It’s like living in a rent-controlled apartment for 30 years, except you pay yourself the whole time, and then your house-related payment (except for insurance and taxes) goes away.
Favorable tax treatment
Tax advantages are some of the best reasons for owning a home. As a homeowner, you can deduct mortgage interest payments and property taxes on your income tax return. If you have a home office, you have the option to depreciate the part of your house that’s allocated to office use on your tax return. When you sell your primary home, you can exclude up to $250,000 ($500,000 if married) under Section 121 of the Internal Revenue Code, if you have lived in the home for two of the previous five years.
Use of leverage
No other investment class allows you to finance 80% of its cost over a 30-year period. With a mortgage, your interest rate gets locked in — you can refinance whenever interest rates go down, but otherwise your rates will stay the same for the life of your mortgage as long as you have a fixed loan. Financing 80% of your house at a fixed rate provides great financial predictability and allows you to keep investing in retirement accounts while paying your mortgage.
Only buy a home if it’s right for you
These benefits don’t mean you should buy a house at all costs. You’ll want to make sure that you’re not buying “too much house,”for example.
Three good rules of thumb: You should be able to make a 20% down payment and have enough money for repairs or maintenance that need immediate attention; you should keep your monthly payments (including taxes and insurance) under 25% of your monthly expenses; and you should budget 1% of your purchase price for annual repairs and maintenance.
Not following these rules could result in payments that are too high and, added to ongoing maintenance costs, might prove too big a hurdle. In that case, it might be better to put off buying a home until you’re more financially prepared.
If purchasing a home is in your ability, however, you should do it. Not only is it the American dream, but it can be the single best wealth-building tool that middle-class Americans have.
This article first appeared at NerdWallet.