For potential homeowners, the decision to buy a home is one of the largest financial decisions they will ever make. Like many purchases, the decision may be driven by emotions. In this article we will try to quantify some of the tangible benefits and costs of owning a home, which will give potential buyers a rational basis for making a housing decision.

Measurable Benefits of Homeownership
The largest measurable financial benefit to homeownership is price appreciation. Price appreciation helps build home equity, which is the difference between the market price of the house and the remaining mortgage payments.

The chart below, from the Office of Federal Housing Enterprise Oversight (OFHEO) shows rates of home price appreciation from 1990 to 2007. The OFHEO publishes a quarterly Housing Price Index, which has many subcategories, including state and metropolitan statistical areas (MSA). OFHEO's website also has several tools for estimating the value of a home based on average rates of appreciation. (For related reading, see Why Housing Market Bubbles Pop.)

Figure 1
Source: Office of Federal Housing Enterprise Oversight

Using one of the tools provided on OFHEO's website, we calculate the following home values and rates of appreciation for the following select cities. Each is based on an initial price of $250,000 in the first quarter of 1990. The ending values are based on the first quarter of 2007.

Home Price Appreciation from Q1 of 1990 to Q1 of 2007 for Select Cities
City State Initial Value Ending Value Total Appreciation %
Alexandria Va. $250,000 $697,635 179%
Anaheim Calif. $250,000 $691,776 177%
Anchorage AK $250,000 $752,155 201%
Billings Mont. $250,000 $673,39 169%
Boise ID $250,000 $786,843 215%
Buffalo N.Y. $250,000 $394,981 58%
Charleston S.C. $250,000 $750,493 200%
Chicago Ill. $250,000 $619,046 148%
Clearwater Fla. $250,000 $767,523 207%
Denver Colo. $250,000 $709,583 184%
Des Moines IA $250,000 $534,767 114%
Honolulu HI $250,000 $583,680 134%
Huntsville Ala. $250,000 $438,807 76%
Kansas City Mo. $250,000 $514,225 106%
Little Rock Ark. $250,000 $492,915 97%
Madera Calif. $250,000 $898,232 259%
Miami Fla. $250,000 $1,042,106 317%
New York N.Y. $250,000 $647,707 159%
Raleigh N.C. $250,000 $482,343 93%
Salt Lake City UT $250,000 $870,683 248%
San Antonio TX $250,000 $519,712 108%
Source: Office of Federal Housing Enterprise Oversight

As you can see from the above table, all of the areas saw home prices increase over the 17 years. However, there was a lot of variability in the total appreciation percent between the areas.

Location, Location, Location
Based on the data above, it is clear that where you live plays a large role in building home equity and wealth. Unfortunately, it is not always possible to decide where you live. Most importantly, past rates of home price appreciation are not necessarily an accurate indicator of future rates of home price appreciation. For most people, a high rate of home price appreciation should be considered good fortune. However, it may be wise for buyers to study demographic and economic trends in deciding where to purchase a home - this includes a local analysis within a certain geographical area - assuming that location is a choice.

Tax Benefits
The second largest financial benefit of owning a home is tax savings. For most Americans, there are tax savings associated with owning a home. The biggest of these is the ability to deduct the annual interest paid on a mortgage from income. (For more on this, read The Mortgage Interest Tax Deduction.)

For example, an individual or family with a 30-year 7%, $400,000 mortgage would pay $4,063 in principal and $27,871 in interest in the first year of that mortgage. If they were in a 28% tax bracket, their tax savings would be $7,804 (.28 x 27,871 = 7,804). Private mortgage insurance (PMI) may also be tax deductible for many Americans. (To learn more about PMI, read Outsmart Private Mortgage Insurance and Six Reasons To Avoid Private Mortgage Insurance.)

Costs of Homeownership
Homeownership is expensive and time consuming. Below is a list of several expenses and an estimated monthly cost.

  • Upkeep and Renovations - $100.
  • Furnishings - Cost to furnish a new home over 3 years: $300.
  • Utilities and Utility Hookups - $450
  • Taxes - $500 (At 1.5% on a $400,000 home, the annual taxes are $6,000)
  • Insurance - $100 (Homeowners insurance on a $400,000 home is estimated at $1,200 annually)

Benefits Verses Costs
Using the same 30-year, $400,000 mortgage at 7%, the tax savings are $7,804 and the principal balance of the mortgage is reduced by $4,063 in the first year of the mortgage. The principal reduction in the mortgage is a benefit because it increases home equity. Adding the two together, we get a total tangible benefit of homeownership of $11,867 in the first year.

If we add up the estimated costs (excluding the estimated cost of furniture) we get $13,800. The costs are slightly higher than the benefits. But because housing is a necessity, it's important to compare the costs of owning versus renting as well. (For related reading, see To Rent or Buy? The Financial Issues - Part 1 and To Rent or Buy? There's More To It Than Money - Part 2.)

Price Appreciation
Home price appreciation is the largest determinant of the economics of homeownership.

For example, as shown in the chart above, a $250,000 home purchase in 1990 in Miami, Fla. would be worth $647,125 more today than a $250,000 home purchased in Buffalo, NY. This difference in appreciation will outweigh any differences in costs and benefits. The problem is, future home price appreciation is impossible to predict. The bottom line is be smart about it, and understand that it is the largest variable in the home ownership equation.

Other Considerations
There are several other important economic considerations in homeownership.

First, a home is generally not a good short-term investment - the transaction costs are too high. A homeowner should expect to pay a realtor between 4-6% of the sales price to sell a home, which is $24,000 on a $400,000 home. This percentage is more than the average long-term annual national home price appreciation rate. If you own a home for a short period of time, you might end up paying more to a realtor than the amount by which the home appreciates. (To learn more, read Investing In Real Estate.)

Second, the choice of a mortgage is very important. There are a variety of mortgages available, and there is almost always a tradeoff between risk and reward. While certain mortgages, such as adjustable rate mortgages (ARM), may offer initial low monthly payments, those payments will increase as time passes, sometimes at unexpected dates and by large amounts. It may be wise to make a risk-based mortgage decision. (For more insight, see Make A Risk-Based Mortgage Decision.)

Third, make reasonable assumptions about your own finances and the potential or likelihood of future increases in income. Be conservative in your estimates. Don't assume that your income will increase along with the payments on certain types of mortgages or you may end up "house poor".

Conclusion
Home price appreciation is by far the most important variable in a homeownership costs versus benefits analysis. It is wise to look for local trends and long-term averages. Intangible benefits, such as peace of mind, pride of ownership and security are important; they should be part of a homeownership decision, but don't let emotions overrule a rational decision.

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