You hear it all the time “your home is your greatest asset” but, is it really? Look up the definition of an asset and it’s something that puts money in your pocket, not one that pulls money out of it. Ask yourself, when was the last time your home made you money versus how many times it has cost you money. Now, that simple prompt may have shattered many people’s perception of this common piece of financial wisdom but this is just the tip of the iceberg because whether you realize it or not, your home is a foe and not an ally and may be slowing down your quest to financial success. Here are three reasons why that’s the case!
Reason #1: Overextended homebuying
Have you ever felt buyer’s remorse? It’s that feeling you get when you buy something you thought you’d love only to be disappointed when you actually go to use it. When it relates to a $20 purchase, I think we can all agree that it’s no big deal. You just return the item to the store and move on with your life. However, when you get in way over your head by overbuying, the issues can be absolutely crippling to your financial progression.
For some, there would seem to be an easy solution to this issue — just don’t overspend and to that I say “Thanks Captain Obvious!”. In the current home buying climate, your chances of buying a home that meets your criteria for affordability, style and size is about as likely as catching a Mewtwo with a Pokeball. Now, there is a solution to this issue however it involves, you guessed it, spending more money. In fact, meeting any housing criterion can be accomplished if you have the money but as you guessed this is where the financial issues begin.
If you ask me, there are typically two reasons why people end up spending way more than they should on a home. The first, and the more excusable reason is that home prices are generally high across the board. This is a phenomenon that we’ve experienced in the last year. Home shortages mixed with an increasing number of people wanting to own versus rent has driven up real estate prices in the West. As such, that $350,000 home that you could have acquired two years ago is now selling for $500,000 which means that most people are being forced to take on larger mortgages if they ever want to exit the renting rut.
The other reason, and the less excusable one if you ask me, as to why people overextend themselves when buying a home relates to the fact that in today’s society, your home acts as a symbol of status. Similar to owning an expensive car or having an impressive job title, many people attach their value to the size of their home. Own a fiscally responsible, smaller home and you’re seen as a failure. Own the biggest house on your block and all of sudden you’re seen as a great success. It’s not right but this is just how the world we live in works. Now, of course you may temporarily derive a sense of success from acquiring an impressive home but we all reap what we sow and overextending yourself when going through the homebuying process will come back to bite you. How so? Let me explain!
Easily the most costly financial consequence of overextending when buying a home relates to the interest fees you’re going to incur. Unless you’re buying cash, financing your home purchase will require you to take on a mortgage. As you know, the banks won’t lend you money without lining their pockets by collecting interest payments from you every month which means an ongoing expense that will cost you a fortune and keep you broke. Sadly, most people never even crunch the numbers on how costly this interest expense will be and instead allow themselves to remain ignorant to this massive cost. Well, I’m here to open your eyes and will do it with the following example.
Assuming an interest rate of 3% in both examples, taking on a mortgage of $400,000 versus $250,000 would result in you paying over $167,000 in interest instead of just over $100,000 over the course of a 25 year mortgage. That’s over $60,000 leaving your pocket over the next two decades that could be retained if you decided to take a more fiscally responsible approach to your homebuying experience.
Now, you may argue that based on your lifestyle you need a larger home and that spending a lot of money is justified. To that I’ll respond, “do you really?”.
Presently, new home sizes average over 2,600 square feet, up over 1000 feet from just four decades ago. But you have greater space needs than families from back in the day right? Unlikely. In fact, in the last 40 years, the number of people living in the home has decreased from 3 persons down to 2.5 persons. With some quick math, we can see that 40 years ago, one person typically required 533 square feet to live whereas today people are enjoying more than double that room with over 1000 square feet to themselves. Now, maybe people have gotten bigger over the last half century or perhaps they just need more room for all the shit they buy but there’s no doubting the fact that increases in home size is keeping people broke.
Now, while I’ve already shared with you the largest financial consequence of owning an unnecessarily large home, being the interest costs, let’s briefly dive into other ways overextending is going to be draining your pockets on a monthly basis. The first cost that will have you scrambling for more money are utilities. It doesn’t take a genius to figure out that when you have a bigger home, it’s going to cost you more money to heat, cool and run electricity amongst all that extra square footage you have.
Next, there’s insurance. While you hope you never use it, having insurance on your home and the contents within it is of great importance. Unfortunately, when an insurance company takes on more financial risk by insuring your larger and more valuable home, they are going to charge you a pretty penny for doing so. As a result, your insurance premiums will be greater than if you were to own a less expensive home.
Finally, there are property taxes. There’s nothing like having to pay tax on a home just to have the privilege of owning the home in the first place, am I right? Well, property taxes are just a necessary evil we must all live with if homeownership is part of our life plan. Unfortunately, property taxes tend to scale as the value of your property rises. It’s not uncommon for your annual property tax bill to be anywhere between 0.5–1% of the total property market value. This means that if you own a $500,000 home, you can expect to pay anywhere between $2,500 to $5,000 in taxes alone.
Why I’ve brought up these ancillary costs of owning a home is to make you aware of a home’s hidden costs. Most people think that the financial pain ends when you hand over your down payment but the costs of homeownership never let up and as such let’s move onto another major factor in why your house is making and keeping you broke!
Reason #2: Renovation and repairs
Let’s say that you heeded my advice when buying your home and didn’t overspend, you should be in the clear right? Unfortunately, while I tip my hat at your financial prowess, there are just some aspects of homeownership that are inevitably going to cost you money. Now, the two forms of financial outlays that no homeowner can avoid are the two Rs: renovations and repairs. Let’s talk about renovations and then we will move onto repairs.
Is there anything more exciting than getting renovations done to your house? Other than the constant delays, exorbitant prices and anxiety of only having one toilet as your other bathroom is being worked on, renovations can add value to your homeownership experience. Now, when I say add value, I only mean that your precious bath time will be more enjoyable in a larger tub and not that spending on renovations will actually add incremental value beyond what you pay to actually have the work done.
You see, there’s a general misconception around renovations and home values. Most people lean on the fact that their renovations are justified because it adds value to their home and they’re right. Unfortunately, the added value rarely extends beyond the cost. Don’t believe me? Check out Remodeling Magazine’s annual cost versus value studies from the last few years and none of the common renovations that most homeowners undertake actually provide a positive return on their investments.
Now, to add salt to the home ownership wound, let’s talk about repairs. Kind of like how our bodies break down over time, so do our homes and as such repairs are required to keep your property in working order.
You may have heard of the general advice of setting aside 1–2% of your home’s value for repairs and this is indicative of the typical costs of home maintenance. For a home worth $300,000, it’s not uncommon to spend a few thousand dollars a year fixing an appliance, changing your electrical or maintaining some of the exterior aspects of your property. Again, similar to renovations, these repairs are zero-ROI expenditures but at least they keep your house from falling over which is a plus if you ask me, right?
Reason #3: Opportunity cost
Whenever you take a breath, you’re filling your lungs with oxygen. Can you see the oxygen? No, but you sure as hell know it’s entering your body. If it weren’t, you’d be turning blue and trust me blue isn’t your color. This is all to say that there are some things in life that we interact with without realizing it and opportunity costs definitely make it onto this list.
Now, for the uninitiated, opportunity costs are alternatives that are given up when another alternative is chosen. For instance, if you have 1000 calories left to eat in the day, when you eat a hamburger, you are giving up the benefit you’d receive if you ate a bowl of pasta instead. As an Italian, I can’t imagine giving up an opportunity to eat pasta but hey to each their own.
When it comes to homeownership, there are numerous situations where we are incurring opportunity costs without even realizing it but let me focus in on three that are the most insidious. The first relates to one of the hardest aspects of becoming a homeowner which is amassing your down payment. Your down payment represents your skin in the homebuying game and is usually a significant amount of money. While this is a price of entry into the market, it’s worth considering how else that down payment could have been used.
For instance, in my case I put down $100,000 on my home. While this has allowed me to decrease my monthly mortgage payments, by putting this amount down, I have given up using that money in a variety of ways. For example, I could have put down less and spent the difference on a vacation. Alternatively, I could have invested that money back into my business or into the stock market and gotten better returns than the 2% interest I avoided by having a larger down payment. These are all examples of benefits I gave up by putting down a larger down payment and are all examples of opportunity costs I incurred.
The second opportunity cost comes with ongoing homeownership costs, one of which are property taxes. As a renter, you avoid this annoying expense but as a homeowner, you are left to deal with it every single month. This again presents an opportunity given up since you are spending hundreds of dollars a month meeting this expense instead of enjoying that money or investing it into other ventures.
Finally, there’s the opportunity cost that comes with the static nature of a home. When you own a home, generally you are committing to stay in one place for the foreseeable future. While there is nothing wrong with this, it does limit your ability to pursue activities that when looked at more closely can be seen as opportunity costs. For example, if you’re rooted in your city as a homeowner, you’re more likely to pass on opportunities to work abroad even if they would be beneficial to your career. Alternatively, you may hesitate to travel due to your homeowner responsibilities and as such the experiences you pass up on add up over time as opportunity costs.
As you’re coming to see, there are a lot of costs that are involved in owning a home. Some are obvious like the massive purchase price you have to swallow, while others are rather discrete like having to give up sending your kids to a better school in a different district because of where you bought your home. At the end of the day, whether you rent or buy, there will be many costs involved . Fortunately, by remaining cognizant of these costs, you can ensure they don’t hinder you financially on your quest to greater levels of wealth and prosperity!