Home ownership has always been part of the American Dream. Because of that, many people accept owning a home as the right thing to do without considering the benefits or risks. If you are contemplating buying a home, you should know and review the advantages of the investment decision you are about to make and all that comes with it before signing on the dotted line.

Key Takeaways

  • If you are considering homeownership, be aware of and review the advantages along with any potential risks you may face before you close the deal.
  • Benefits include appreciation, home equity, tax deductions, and deductible expenses.
  • Risks and caveats can include high upfront costs, depreciation, and illiquidity.

Attractive Long-Term Investment

Buying a home is one of the best long-term investments you can make. According to the Federal Housing Finance Agency (FHFA) House Price Index (HPI), U.S. home prices rose an average of 34.71% over the five-year period ending Dec. 31, 2017. On average, homeowners saw the value of their real estate investment grow by 6.94% per year during that period. That’s not a bad return on an investment that also provides you with a place to live.

High Upfront Costs

There’s more to buying a home than the selling price and interest rate. You can expect to pay anywhere from 2% to 5% of the purchase price in closing costs. For this reason, buying a home is not a very good short-term investment. Experts say you should plan to stay in your house at least five years to recover those costs. Some of the most common closing costs include an application fee, appraisal fee, attorney fees, property taxes, mortgage insurance, home inspection, first-year homeowner’s insurance premium, title search, title insurance, points (prepaid interest), origination fee, recording fees, and survey fee.

Appreciation

Appreciation represents the increase in home values over time. Although real estate prices are cyclical, they generally increase in value or appreciate over time. Don't expect the value to increase drastically if you're in it for the short-term. But if you stay in your home long enough, there's a very good likelihood you will be able to sell your home for a profit because of appreciation later in the future.

Real estate appreciates primarily because of the land on which the home sits, while the actual structure depreciates as time goes by. So the expression "location, location, location" is not just a real estate catch-phrase, but a very important consideration when buying a home. The neighborhood with the amenities it brings—school districts, parks, condition of roads, etc.—and the city the home is located in all factor into the property's appreciation.

Consider a home that is run-down and dilapidated to the point that it's uninhabitable. In this case, the land underneath the home may be worth a significant amount of money. A seller may consider selling it as is—with the structure still intact—or spending a little extra to demolish the home and sell the land at a higher price on its own.

Appreciation is the change in value of your home over time, while home equity is the difference between the balance on your mortgage and your home's market value.

Building Equity

Home equity represents the difference between how much you still owe on your mortgage and the market price or value of your home. Home equity and appreciation may be considered together. As noted above, your home is likely to grow in market value over time. Your equity also grows as you pay down your mortgage, with less of your payment going toward interest and more toward lowering the balance on your loan.

Building equity does take some time because it takes time to lower the principal balance owing on the mortgage loan—unless, of course, you make a large down payment or regular prepayments. One thing to keep in mind, though, is that the length of time you have your home is a big factor in how much equity you build and the appreciation you can realize. The longer you keep it, the more equity you obtain.

Home equity provides flexibility to get a loan that is tied to the amount of your home equity. Many investors follow their home equity and home appreciation simultaneously. If an investor believes their home value is greatly appreciating they may put off a home equity loan to have a better opportunity to realize seller’s appreciation. 

Pride of Ownership

One often-cited benefit of home ownership is the knowledge that you own your little corner of the world. You can customize your house, remodel, paint, and decorate without the need to get permission from a landlord.

Location, Location, Location

While paying down your mortgage works the same no matter where you live, market-value growth varies with location. Although the FHFA says average home prices rose by 34.71% in the U.S. over the five-year period ending Dec. 31, 2017, prices in the Middle Atlantic census division only rose by 18.48%. Prices in the Pacific census division, however, rose by an average of 57.06% between Dec. 31, 2012, and Dec. 31, 2017.

To see how this might affect prices where you plan to buy, check out the full FHFA chart below:


Division



Division


Ranking



One-Year



Quarter



Five-Year



Since


1991 Q1



USA



 



6.68%



1.61%



34.71%



152.69%



Mountain



1



8.81%  



2.29%



49.34%



233.83%



Pacific



2



8.79%



1.65%



57.06%



193.65%



South Atlantic



3



6.55%



1.59%



38.01%



154.37%



West South Central



4



6.44%



1.67%



34.12%



170.39%



East South Central



5



6.27%



1.51%



25.73%



129.93%



East North Central



6



6.13%



1.55%



29.58%



109.50%



New England



7



5.80%



1.51%



22.34%



135.78%



West North Central



8



5.46%



1.36%



26.32%



149.93%



Middle Atlantic



9



5.26%



1.40%



18.48%



130.58%


Source: FHFA. U.S. Census Divisions, Percent Change in House Prices. Seasonally Adjusted, Purchase-Only HPI, Period Ended Dec. 31, 2017.

Capital Gains Exclusion

Eventually, you will sell your home. When you do, the law allows you to keep the profits and pay no capital gains taxes. That’s tax-free profit of up to $250,000 for single homeowners and $500,000 for married couples. This is for your main residence only—not for a second home or vacation property.

There are a few requirements you need to meet in order to qualify for this exclusion. You must own the home for at least two years—24 months—within the last five years up to the closing date. The residence requirement dictates that you should have lived in the home for at least 730 days, or two years, during the five-year period leading up to the sale. The final requirement, the look-back requirement, outlines that you didn't profit from selling another primary residence during the two-year period leading up to the most recent sale.

Moving and Other Expenses

If you don't qualify for a full capital gains exclusion, you may be able to claim moving expenses. Although it may not be as much as a capital gains exclusion, you can still recoup some costs if you can prove the sale was precipitated by a change in workplace, health reasons, or other events you could not predict.

If you claim moving expenses, your deductions will generally cover moving your goods and personal effects including in-transit or foreign-move storage expenses, costs incurred traveling to your new home including lodging but not meals, utilities hookups and cancelations, and costs to ship vehicles and pets to your new home.

In order to qualify for moving expenses, you must prove the following to the IRS:

  • Move time and distance: Your move must take place within a year from your start date at your new job. And the distance between your new home and job cannot be more than the distance between your old home and the new job.
  • Distance test: Your new job and, thus, new home must be at least 50 miles away from your old ones.
  • Time test: The IRS requires that you work full-time for a minimum of 39 weeks during the first year after you move.

Tax Deductions

After appreciation, the benefit of home ownership that is cited most often is tax deductions or savings. When you buy a home, you can deduct some of the expenses of owning that home from the taxes you pay to the government. This includes mortgage interest on both your principal residence and a second home, which can amount to thousands of dollars per year.

Interest on home-equity loans or home-equity lines of credit (HELOCs) is also deductible if the funds are used to substantially improve your home.

You can also deduct up to $10,000 in state and local taxes (SALT), including property taxes. 

The New Tax Law

The new Tax Cuts and Jobs Act, passed in December 2017, made substantial changes to the parts of the tax code that have to do with home ownership. Unless a future Congress amends the law, all provisions will expire after Dec. 31, 2025. 

The new law limits mortgage interest deductions to $750,000 of total mortgage debt, including for a first and second home and any home-equity or HELOC loans. The previous limit was $1,000,000 in mortgage debt plus an additional $100,000 in home-equity debt.

There is an exception allowing $1,000,000 in total mortgage debt if you bought your home on or before Dec. 14, 2017. This provision even applies if you refinance that older mortgage. Home equity loan interest is only deductible if the money is used for substantial improvements to the home on which you took out the loan. Previously, interest on up to $100,000 was deductible no matter how the home-equity money was used.

SALT deductions, including property taxes, are now limited to $10,000. Previously, all SALT payments were deductible, unless you were subject to the alternative minimum tax. Other new provisions include restrictions on claiming casualty losses except for federally declared disasters and no moving expense deductions except for the active-duty military.

All these changes have lowered the value of owning a home—including the fact that, with the standard deduction doubling, also under the new tax law, fewer people will have enough deductions to file Schedule A instead of taking the standard deduction. So the fact that you are eligible for a tax deduction does not mean that it will end up being useful to you. The severe limiting of the SALT deduction will be particularly detrimental in lowering available deductions for people who live in highly taxed states.  

Forced Savings

As you pay down your mortgage and reduce the amount you owe, without realizing it, you are saving as the value of your home is increasing—just like the value of savings account increases with interest. When you sell, you will likely get back every dollar you paid out and more, assuming you stay in your house long enough. Over time the average ~6% return (interest rate) on your savings should more than cover your outlay.

Potential Depreciation

Not all homes grow in value. The housing crisis of 2008 resulted in many homeowners being underwater, which means owing more on your mortgage than your home is worth. It doesn’t take a housing crisis for home prices to stagnate or drop. Regional or local economic conditions can result in home values that don’t keep up with inflation.     

Remember, as well, that the actual structure you live in will depreciate over time. This may be because of the general conditions of the property, or a lack of maintenance and repairs.

Financial Responsibilities

Ownership comes with responsibilities. You must pay your mortgage or risk losing your home and the equity you’ve built. Maintenance and upkeep are your responsibility. You can’t call the landlord at 2 a.m. to have a leaky water pipe repaired. If the roof is damaged, you must repair it—or have it repaired—yourself. Lawn mowing, snow removal, homeowners insurance, and liability insurance all fall on you.

Illiquidity

Unlike stock, which can be sold within a matter of days, homes typically take much longer to unload. The fact that you may have access to $500,000 in tax-free capital gains doesn’t mean you have ready access. Meanwhile, you still must make mortgage payments and maintain the house until you sell it.

The Bottom Line

A home is an investment that comes with many investment benefits but also risks, which makes it an investment that is not for everyone. Thus, weighing the investment benefits against the risks is important. A rational comparison of pros and cons can help you decide whether to put your money into a home investment or potentially find better returns elsewhere.

If you are a first-time homebuyer, consider taking an education course to learn more about homeownership. Some homebuyer education courses are free and offered locally while others may charge a small fee.