This is only the second house my wife and I have purchased in our adult lives. Our first one was back when I was 24 years old.
With our first house for sale on the market at almost the same price we paid for it back 11 years ago, this got me thinking:
What if we hadn’t bought a house when we first got married, and did something else with our money? Would we be better off financially?
Although this is a fun little question to ponder, it’s actually a very real and tough choice for lots of young working professionals today. Many of them are faced with the decision of whether to find a place to rent or settle down with a good starter home.
Well, even though getting your first home can be very exciting, I’m going to show you that perhaps waiting a few years to become a home-owner might make better financial sense.
Let’s first take a closer look at some of the myths that push us to buy a home as soon as possible.
Do Houses Really Appreciate in Value?
There are so many things in our lives telling us that buying our first home is a good idea:
- Our parents tell us it’s a great investment. (Back in their day, it probably was!)
- We know we’re doing a smart thing by no longer throwing away money on rent for a place that we’ll never be able to call our own.
- You’re finally somewhat accepted as a responsible grown adult who is capable enough to manage a mortgage.
- Best of all – it feels great to be the king of your own castle!
From a financial perspective, let’s zero in on that first point. Folks from the baby-boomer generation (and older) love to tell you that “buying a house is an investment”.
Like I mentioned, my wife and I are currently putting that theory to the test. We’re trying to sell our house of 11 years at approximately the same asking price that we paid for it originally. The sad reality is that more than likely, by the time it finally sells, we’re probably going to end up with slightly less than that amount.
Now factor in all the numerous upgrades and investments we’ve put into our house over the years, and we’re surely not going to be make any of our money back.
Dr. Robert Shiller of Yale has pointed out this sort of phenomenon with house prices before. According to his research, the average real rate of appreciation of home values was only 0.2% between 1900 and 2000.
We say “real rate” because that’s adjusting for inflation. So in reality when your parents bought a house for $100,000 and later on sold it years later for $150,000, it wasn’t really because the house increased in market value. It was more likely due to the economic forces of inflation.
No matter how you slice it, 0.2% is a pretty crumby rate of return. If I told you I had an investment opportunity for you at that rate, you’d tell me to get lost!
So then what else could we do with our money that would be better? Is there something else that would have made me richer if I had waited 10 years later until age 34 to buy a home?
Absolutely there is!
Saving for Retirement vs Buying a House:
- You started saving a certain amount for retirement right away at age 24, stopped saving that amount at age 34 so you’d have more money to buy a house, and then never saved any more money for retirement ever again.
- You bought a house at age 24, did not start saving for retirement until 10 years later starting at age 34, and then continued to save that certain amount for the next 30 years until you reached the age of retirement.
(I say set “certain amount” because I’m not insinuating that you wouldn’t save anything for retirement in either of these situations; only that this amount would be in addition to what you plan to save. Glad to clear that up.)
To keep things consistent, let’s assume we’re working with the same figures in both situations. If you’re not living in a house and paying a mortgage, then you’re likely renting a place to stay. So here are our assumptions:
- Rent per month: $500
- Mortgage per month: $1,000
- Difference per month to save for retirement: $1,000 – $500 = $500
Scenario A – Delaying the House Purchase and Saving Right Away:
In our first situation, you start saving for retirement right away. That means at age 24 you’re stashing $500 per month into a tax-sheltered savings account (like a 401(k)).
By the end of 10 years at a compounded rate of 10% per year, your 401(k) would be worth $95,625.
Then at that point you decide to stop saving this $500 and instead use it to help finance your new mortgage and home purchase. So you stop contributing this amount to your 401(k).
That $95,625 stays in your 401(k) and continues to grow and compound for the next 30 years until it reaches a balance of $1,668,591 by the time you’re ready to retire at 64.
Not bad for only 10 years of making contributions!
Scenario B – Buying a House Right Away and Waiting to Save:
Now let’s play out the other scenario.
At age 24, you buy a house right away and no money to set aside for retirement. However, 10 years in to your career (now at age 34), you decide to start setting aside $500 per month for retirement. And you continue to save for the next 30 years until you’re ready to retire at age 64.
Surely after 30 years of contributions, you’d have a higher 401(k) balance, right?
… Wrong!
It Matters A LOT When You Start Saving for Retirement:
So effectively, scenario 1 is the winner with a balance of $681,627 more by the time you’re ready to retire.
How is this possible??
Saving Early is the Key:
This whole phenomenon is due in thanks to the power of compounding returns. And the fuel that feeds compounding returns is “time”.
Because you started saving and building up your retirement account 10 years earlier in scenario A, you had far more money to compound and grow by the time you hit age 34. In fact, you had so much money saved that it was able to outpace any additional savings over the next 30 years. This is very similar to a situation I illustrated in an earlier post where at some point you could literally stop saving your money (if you wanted to) and still end up hitting your retirement goals.
Obviously, I’m NOT ever recommending that you stop saving for retirement; we just did that here to illustrate an interesting point. Can you imagine how much money you’d really have in scenario A if you had continued to save more retirement for the next 30 years? Your nest egg would be incredible!
This is why I always recommend to people to start saving as early and as big as possible.
Stocks Return More Than a House:
The other thing that really helped was the return rate of your investments.
Stocks, the things that make up most of our retirement accounts, have an annualized rate of return at about 10% according to NYU. Even adjusting for inflation, that’s still a decent 7% year over year return.
Combining this fact with the recent phenomenon of low interest rates is also the reason why I choose to invest my money rather than pay off my mortgage early.
Houses Aren’t Really Investments, They Are a Place to Live:
Now I know supporters of the house will claim that the house rose in value over the course of 40 years too.
But did it?
Go back to the beginning of this article. Remember that Dr Shiller found housing to produce an inflation adjusted rate of 0.2%. So even though you may be able to sell your house for more (eventually) than what you paid for it, this is likely only due to inflation; not because it was a great investment.
Compare that to the return of the stock market and its unfortunately no contest for the stocks.
What Can We Learn From This?
Really this whole exercise is NOT to dog on anyone buying a house at an early age (or any age really). Like I said, I bought my first house at age 24 and have lots of great memories. I’m all in favor of home ownership.
Like all things on My Money Design, this article was meant to make you “think”. It’s meant to challenge conventional wisdom and really do a deep-dive into the numbers to see which financial opportunity is really the best.
When you crunch the numbers as did and really examine both scenarios, you quickly realize just how powerful saving earlier rather than later can be. In fact you can almost double the size of your nest egg depending on how much you save and how your investments perform.
But does that mean we should all wait until our 30’s to buy our first home?
Of course not! Ultimately, the choice is yours.
There are plenty of “qualitative” reasons why you may want to buy a house. It’s not always about what makes you the most money.
Just remember that a house is a house; not an investment. You should buy a house because you love it and can see yourself being happy there for the next 10 or 20 years. If you want an investment, there are other places you should look.
Readers – Which would you rather tell a young a person in their 20’s: To buy a house or save for retirement? Looking back, which would you have rather done?
Images courtesy of Mark Moz | Flickr and FreeDigitalPhotos.net.
I took care first my investment and retirement fund over a house as I believe that the moment I want to buy a house, it should be the ideal or my dream house. I’d rather put the money into a long-term investment portfolio, so that my investment can double to somehow let’s say $300,000 in 10.5 years.
Probably a very smart move.
Your theory works unless a mortgage payment is equal to or less than renting. We would be paying as much in rent right now for a 3 bedroom house as our mortgage payment is, so it never made sense to rent. If you can save money by renting and diligently invest that amount each month, renting is probably better, especially if you plan to move before 10 years time.
The real problem comes when people become house poor and don’t invest or save at all. Unfortunately, I think that happens all to often.
Very true … obviously some generalizations had to be made for the sake of keeping my point coherent. I do completely agree, though, that way to many people make themselves house poor; often without ever realizing (or caring) that they are doing it. That’s where the danger comes in – making this an “all or nothing” decision of having to choose between the house and retirement. That unfortunately ends up leaving them with nothing to show for in 10 years.
Exactly. Where I live currently, I’m spending around $600-$700 less per month on my mortgage payment (including principal, interest, taxes, and insurance and assessments) than I would on renting a similar place (our last rental place was very similar if not worse and cost about $700 more per month, and rents have only been going up). And that does not even include tax benefits (with a mortgage, we’ll itemize) or any appreciation.
Assuming maintenance costs aren’t outrageous and there isn’t an utter collapse in real estate values (unlikely in the city where I live — this same neighborhood didn’t lose anything in the crisis in terms of value, but hasn’t really appreciated much since the crisis either), we should end up doing far better by owning rather than renting.
I second what Kim said – in the housing markets I’m familiar with, a mortgage payment is way less than renting a similar place, and most people pay less per month when going from renting to buying even with a serious square footage upgrade. Now, perhaps after you factor in other costs normally associated with owning or a crazy HOA, perhaps there is some differential in favor of renting, but i don’t think it would be 100%. The period right before buying might also be tight, having to pay rent and save a down payment – that could delay/reduce your long-term investments as well.
In any case, I’ve been renting for 8 years and there’s no end in sight, and I’ve been aggressively saving into my Roth IRA. I think that would have also been possible as a homeowner – even easier, perhaps, with roommates helping out with the mortgage – but I couldn’t afford to get into a house when it made sense in terms of the amount of time I planned to live in the city. I hope at some point to be able to make a free choice between renting and buying!
Interesting points on the housing markets. Reflecting on my own experience, I went from paying around $600 in renting to $1200 / month when I bought my first house. However I totally get that not every geographic location is the same.
I think in a lot of cases it can be a mistake. A lot of people I see now rush into buying their “forever” home and therefore their mortgage is a lot higher than what renting a smaller place would be. Especially sine they don’t have kids yet. Plus then you figure in PMI, maintenance, upkeep, yard work, taxes, etc. and sometimes it can be a BIG financial mistake at the end of the day. Every location and scenario is different. I just know that I’ll be renting for the foreseeable future, and investing what would have been a down paymet.
Though I have no regrets about buying my first home, when I think back to how much money we could have had saved for a real down payment or purchased in another area, the possibilities are endless.
Interesting post, especially comparing saving for retirement early versus buying a house early. Hubby and I didn’t buy our first house until we were well into our 40’s. However we didn’t get married until I was 40 (he was 42). So buying a house wasn’t a consideration for either one of us until we met and got married. Now to answer the question posed in the headline. I don’t think it is a simple yes or no. I agree with Emily’s point about depending on the housing market in your area. Cheap or affordable rents where I live also tend to be very undesirable areas. We were renting a duplex very cheap (owners were friends and cut us a nice deal) when we first met but the area became increasingly bad as the years went on. I lived there 15 years and it went downhill a lot by the time we moved. We live in a nice neighborhood with decent neighbors and it is much safer than where we were. Don’t discount those memories made in your home. Sometimes there are other things to take in to consideration besides the cold hard numbers.
There is of course no simple yes or no to this question! 🙂
I couldn’t agree more that it goes beyond the numbers. I like to use this blog to crunch the numbers and get some discussion going about these kinds of topics. But at the end of the day there are always so many other factors at play that ultimately make or break your final decision. I know for us part of our reason for the recent move involved where we thought the neighborhood was heading and how many $$ in future repairs / upgrades would be coming up in the next 10 years.
I would have told myself to invest as well as buy a two family house, and have the renter pay for the half the mortgage. This is the best of the house / Investing comparison. Granted dealing with renters has its headaches, I think I could deal with it.
That’s thinking outside the box. You’d just have to hope you had that much money to go around!
My wife and I decided to buy a home in 2009. Since then it seems like the maintenance and projects are endless. After calculating all of the money that we’ve put into home ownership I always wonder if we would have been better off renting and saving the difference. I think home ownership is part of the American dream and people push for it as if it’s standard. It’s important to take a real hard look at all the costs of owning a home and analyzing whether or not your money would be better saved elsewhere.
Owning a home is a great and rewarding experience. However, as an investment, it’s just not there in the present decade. I too have put quite a bit of upkeep and upgrades into my house that I will never get back. But we do those things to some degree because we want the place to look nice.
Maybe it’s just my displeasure at the idea of a lifetime or work, but I would say to start saving for EARLY retirement rather than a house, if you had to choose one or the other. Because you said exactly what I’ve always been thinking: a house is not an investment, it’s a consumer good.
I don’t know where we all got the idea that your home is the greatest financial investment you can make. I told a former coworker that if anyone gave her that financial advice, she was “to bludgeon them with a fire extinguisher and a sack of potatoes”.
Don’t worry, she’s used to my sense of humor.
Sincerely,
ARB–Angry Retail Banker
I think a lot of young people are starting to come around to the fact that your home is not really an investment. I remember in the Rich Dad Poor Dad that was a popular topic (although in a slightly different context). Now we unfortunately have yet another reason to see home ownership for what it is.
This seems like more proof that (if you’re going to buy) it’s best to buy as much house as you need and nothing more. Plus, of course you have to invest the difference…
I also had a situation where the mortgage was going to be as much as rent, and over the years it became much less than rent. So I’m happy with how things worked out. I recently sold and (without sitting down to do the math, just spitballing it) figured I made maybe 5%/year on the house. I’m calling that good luck, and not something I’ll count on going forward. Plus it was a very inexpensive condo when I bought so I think that helped.
OMG This totally hits home for me! I bought my house in 2007 at age 19 because I knew buying a home was a “better investment” and I wouldn’t be “throwing away my money.” After settlement my payments were $1195/month (I really bet I could have gotten a nice apartment for 1000…. And to top it off, my house is worth about HALF of what I paid for it. Not to mention that I’ve run new water line, built a shed, installed flooring and lights in the attic, and put a new roof on it. The amount I’ve dumped into this house in total….Oh gosh I can’t even think about it.
I completely identify. We’re still waiting for our other house to sell, and I don’t want to think about all the money we’ve poured into it over the years.