Economic commentators spent the last several years lamenting the fact that Millennial homeownership is lower now than ownership rates among young adults of past generations. They attributed the trend to factors including large student debts, the fact that young adults today marry and have kids later in life, and the desire among many Millennials to live in urban areas (where the cost of homeownership keeps them renting).
But we may see the homeownership trend shift soon. The oldest Millennials are in their mid-30s, which may mean they could start enjoying more financial stability.
That doesn’t mean homeownership automatically makes sense (even after paying down student debt and hitting other life milestones like marriage). While there’s nothing inherently bad about buying a home, there are bad reasons for doing so.
If you’re considering buying for any of the following reasons, it might be time to pause and reconsider.
You Think Building Home Equity Beats Paying Rent
This is probably the most common reason I hear from someone buying their first home, but it’s also the most misguided rationale.
Yes, it’s frustrating to pay rent every month and feel like you’re “throwing money away.” But that doesn’t mean you should conclude it would be better if those monthly payments went toward building equity in your very own home.
Why? Your payment on a typical 30-year mortgage goes mostly to interest in the early years of making payments.
In addition to mortgage costs, you also pour an enormous amount of money into a new home purchase through the transaction itself. That includes closing costs, agent fees, and more. Then there are the initial expenses of homeownership, like furnishings, repairs, and regular maintenance.
If you plan to live in a home for less than ten years, lower your expectations of building equity– and know you might grow your net worth more by renting and investing any money that would have been spent on a home purchase.
You Believe Housing Is a Good Investment
For most of us that own and live in a single home – as opposed to professional real estate investors – our real estate success will boil down to good timing and luck. As a result, housing should be viewed as a place to live rather than an investment.
Unlike a traditional portfolio of stocks and bonds, a home is an illiquid, indivisible asset (you can’t slice off a piece of your kitchen and sell it for cash) and extremely undiversified (a single bet on one neighborhood).
Home also offer very little long-term price appreciation after adjusting for inflation. According to historical data from Nobel Laureate Robert Shiller, home prices have only risen 0.37% per year after adjusting for inflation over the past 125 years.
Many people don’t realize the gains in housing prices mostly come from inflation. When adjusting for inflation, a home depreciates in value over time.
The exception is to the extent you spend additional capital on maintenance and improvements, but that’s not exactly something you want to see in an investment.
You Expect Owning a Home to Lower Your Taxes
People hate paying taxes. Consequently, tax avoidance causes people to make decisions they wouldn’t otherwise make.
Have you ever gotten a coupon from a retailer offering $50 off purchases of $200 or more? I call these “spend to save” promotions, which are really just a tricky way of getting you to spend money you wouldn’t have otherwise.
You’re not saving anything if you still spent $150 when you initially didn’t plan to spend anything at all. Buying a home for the tax deductions isn’t all that different, with the US government creating several tax incentives to promote homeownership.
Even if the after-tax monthly payment on mortgage is lower than monthly rent on a similar living space, you’ll still realize an abundance of additional costs associated with owning a house (as mentioned above).
You Feel Buying a Home Is the American Dream
From a strictly financial standpoint, the decision to buy a home ought to be made within the context of maximizing your net worth.
But we don’t live in a spreadsheet and not all decisions should be made as if we do. Buying a home has long been a part of the American Dream, and that comes with emotional benefits that are difficult to quantify.
That doesn’t change the fact that your house and mortgage will likely be the biggest items on your balance sheet, though. In this case, the math does need to be taken seriously. Know that the longer you live in your home, the more likely you will benefit financially.
How to Avoid Common Home Buying Mistakes
The most common mistakes Millennials make include underestimating the overall cost of homeownership and not living in the home long enough for the finances to work out in their favor.
Getting married, having a family, moving to a new city, or changing careers are all common life events for Millennials that can turn a once-ideal home purchase into a bad financial decision by simply shortening the time horizon in the property.
There is no one-size-fits all piece of advice for when a home purchase makes sense. But you can put some general best practices into place to help guide you.
First, write out every conceivable expense that you will incur during your tenure at a prospective home. Then think about how a house may impact you financially if life turns out different than expected.
My advice would be to hold off a purchase if there is a good chance you will have to move in five years or less. It’s hard to project life events out much further than five years, but a good rule of thumb is to wait to buy until you reasonably expect to be in that home for at least ten years (assuming you are taking out a 30-year mortgage).
Doing so means giving yourself the best chance of winning the financial side of homeownership.