TLDR: buying a house isnâ€™t the best way to build wealth – the stock market is better – but buying a home is still a great idea if you do it right.
Buying a House is Still Part of Our “American Dream”
And itâ€™s natural.
You finish school, you find a spouse, and you want to set up camp. Everyoneâ€™s doing it! Well, not everyone, but thereâ€™s a reason this common pathway exists. It works and it fulfills our basic human desires.
I certainly wanted to buy a house once I got married. I wanted to “participate in the real estate market.” “Yeah, bro!”
I will admit now that buying a house to live in isnâ€™t the best way to participate in the real estate market. But it is A WAY.
And that fact didnâ€™t stop me from wanting a home. And it isnâ€™t going to stop young Americans from wanting the same thing. Is it stopping you?
There are too many homes up for grabs and only so many landlords to go around. Someone has to do some buying. And the market will adjust (either through prices, regulation, format, or some combination of all of these) and people will want to buy.
The act of the home purchase will continue to be a part of the American dream. And…buying a house CAN make you wealthy.
Buying a House – If Done Right – Has a Side Effect of Making You Wealthy
Thereâ€™s no getting around it, the majority of houses appreciate over time, and this creates a large amount of wealth for a large number of people.
Exact numbers are hard to come by (due to changing home sizes and other factors) but historically, houses appreciate on average 3-4% each year.
And because the vast majority of homeowners put all of their “investment” into their house, they tend to credit this as being the source of their wealth. And it is.
For most people, their home is their greatest asset and given the appreciation they see throughout their lifetime (4% each year), itâ€™s no wonder they feel positive about it.
Good for us!
The problem with this situation is that some people think that because home ownership creates some wealth for many, it must be the key to wealth for everyone. This leads, in part, to things like the subprime housing crises of the ’00s.
Just because a house creates wealth for many, it doesnâ€™t mean it was the best path they could have taken, and it doesnâ€™t mean itâ€™s best for everyone.
Hereâ€™s why it works. A mortgage is somewhat of a forced savings account. And for a majority of people, itâ€™s the only tool strong enough to allow them to stash some money way (albeit in their home) long enough to amass wealth. It satisfies both the desire to spend and “save”.
Iâ€™ve purchased two houses in my life and thanks to some strong appreciation in my area, they have helped to make me wealthy (on paper at least). Iâ€™m not complaining. But I also realize what I’ve missed out on.
Buying a House is Not the Most Efficient Way to Build Wealth – Investing in the Stock Market Is Better
Historically, the stock market has returned an average of 7% annually. Real estate appreciates on average 4% annually. Stocks win. If you want your money to grow as fast as possible, you would put your money in the stock market (or a business) vs a house. End of story.
If you are pursuing FI/RE, and want to get there as fast as possible, you would be better off skipping home ownership and investing the money you would have used for a down payment and mortgage payments (and home improvements and repairs and taxes and insurance – ha).
But getting to FI ASAP isn’t everyone’s goal. My story even shows that you can beat the averages and actually come out ahead over something like a 10 year period.
My Story: AKA The 10 Year Counter-Anecdote
To add a real-world example, I’m going to share my story with homeownership. My story is actually an argument against the idea that stocks win over the long haul, but I’m still sharing it to: be transparent about my story and to give you an idea how to do your own evaluations.
I purchased my first house in 2007 for $205K. I put 20% ($41K) down. At the time, my wife and I were newlyweds and didnâ€™t have kids yet – DINKs. You can read more about how we purchased this home here.
In 2012, we decided we wanted to move across town – closer to a school we wanted our kids to attend and into a house with a yard. At the time, our house value was about the same as when we purchased (i.e. it rebounded from the housing crises of late 2007/2008).
But, the value wasnâ€™t enough for us to sell with the help of a Realtor and come out ahead. I didnâ€™t want to â€œloseâ€. So we held on the house and converted it to a rental property.
Then, we purchased our next house for $250K and put another 20% ($50K) down.
The first home is now worth $325K (6% average annual gain over 10 years), and the second home is now worth $384K (9% average annual gain over 10 years).
Had I taken my $41K in 2007 and my $50K in 2012 and invested it, they would be worth $60,000 and $88,500, respectively. That’s an annual average gain of 3.6% and 10%, respectively. (calc used for this)
- 2007 House 6% > 2007 Investment 3.6%
- 2012 House 9% < 2012 Investment 10%
My situation shows that you can, in some cases, buck the averages over a short period.
A Home – Not Just a House – Can Be Worth It
Just because it isn’t an efficient path to wealth, it doesn’t mean you shouldn’t do it. There’s more to life than money, after all. “Build the life you want, then save for it.”
Owning the place you reside – your home – has many benefits.
For starters, you get to call all the shots (within HOA and municipality rules, of course). Want a new floor covering? Do it. Want a pool in the backyard. Go for it.
Having a home gives you a sense of putting down roots, nudging you to invest in the community and culture of those around you.Click to tweet
Sure, you can still do this by renting, but I argue that it’s more common amongst homeowners to “own” their relationships with neighbors and other community members and organizations.
Having a home is also a natural way to diversify your assets. Most people will never become a real estate investor or buy a REIT or buy real estate in another way, so a home is a way to hedge against the rest of your finances.
For me, buying my first home was a gateway to becoming a landlord. I knew it was possible that one day I could rent out my first home. And that’s just what we’re doing – generating an extra $4,000 a year with it. I’m not sure I would have that now if I was still renting.
Buying a Home the Right Way
If you’re going to buy a home, here’s the best way to do it:
First, be at a place in life where it makes sense to make this kind of investment. For most people, this will be when they have a stable career, they are married, and they have the majority of the kids they are going to end up with.
Because of the public school system, people that meet this description have a high likelihood of remaining in their home for 15+ years. Given the cost of buying/selling a home (closing costs, realtors, repairs, etc.) it makes a big difference in the overall cost of ownership if you can stay in your home a long time.
Second, once you decide you’re ready to buy, you’ll want to have as much money as possible towards the purchase. At a minimum, you’d want 20% to avoid PMI, give yourself some cushion against market downturns, and to simply prove that you are ready for homeownership.
There are, however, legit ways to buy a house without putting 20% down. I don’t necessarily recommend this.
Of course, saving 20% is no small feat. For many people, it requires sacrifice in your budget, implementing an automatic savings plan over a long time, and even adding new streams of revenue.
To encourage you to save your 20% I would find some accountability.
The Down Payment Movement – Join In
For me, back in 2007, it was other personal finance blogs that motivated me.
Today, you can still follow your favorite blogs, podcasts, or Youtubers for inspiration, and you can even join a special movement dedicated to helping you save your downpayment.
So what’s your take? Are you pursuing FIRE and homeownership at the same time like me? Or are you on the fast track?