Is Your Home an Investment
- August 28, 2020
- by Ashley Chorpenning
Your home is probably the most expensive purchase you’ll ever make. However, not every major purchase is an investment. Investments are meant to be wealth-building tools, and buying a house is often marketed as an opportunity to stop ‘throwing money away’ on rent. However, owning a home can be expensive and may not be part of the American Dream the way it used to be.
So, before you decide to purchase a home, you should take the time to understand if your home is an investment. If it’s not, it is even more important to understand how to get the most out of your home.
What Is an Investment?
An investment is money put to use so you will have more later. This could come in the form of appreciation (sell it later at a profit) or an income stream (dividends, rents, etc), and ideally both.
Common investments include stocks, bonds, mutual funds, precious metals, etc. Buying a rental, a vacation home or even a timeshare could be considered an investment. Putting money into a business is a form of investment too, probably the most complex and hands on of everything else mentioned.
Investments can be ‘leveraged’ if part of the money used is borrowed. Leverage increases risk considerably. A common example of leverage is to get a mortgage when buying a house. You only need 5-20% down when buying a home and the bank will lend you the rest.
Investment can also be liquid or illiquid, depending on how easily they can be converted back into cash. Stocks, bonds, and most paper assets are considered liquid. Rental properties and homes are less liquid, because it takes time for them to sell and the funds to clear the escrow process.
Another example of an investment is a college education. Here a person “invests in themselves” and as a result is expected to earn more than they would if they had not put in the work.
Why Your Home Is Not an Investment
Based on what you now know about what an investment is, a house is not typically an investment. While many people believe that their homes will increase in value and earn them more money than they put into a home, that is not always the case.
For example, there are a lot of expenses included in purchasing a home including title searches, title insurance, underwriting fees, loan origination fees, and other closing costs. If these costs and the cost of your mortgage are less than renting each month, buying a home might be a smart financial decision. However, it still might not be an investment. Yes it would be great if it went up in value, but you have to live somewhere and your housing cost is going to be some part of your budget no matter what. In general, owning a house is not an investment per se, but it does help you get off the rent spiral and force you to save.
The key to a home being an investment is that it makes you more money than it costs you, especially over time. Costs like interest on your mortgage and home improvements can impede your ability to turn your house into a profitable investment. Additionally, your home may not grow in value at the same rate as other easier investments (like stocks, bonds or mutual funds). The return on investment (ROI) on a home will depend on the neighborhood, the local economy, and the overall economy, plus how well you maintain it. Therefore, you should do everything you can to get the most out of your home.
How to Get the Most Out of Your Home?
Although your home may not be an investment, you can still ensure you get the most out of your property. Before you purchase a home, you should know what to look for to ensure that you make the best possible buying decision. We created a home buyer’s walkthrough checklist you may be interested in.
The first thing you should consider when buying a home is its location because the location is one of the major factors in determining a home’s ability to appreciate. For example, if the home is under a freeway overpass, it is not likely to appreciate too much. However, if it is in a neighborhood that is undergoing a lot of direct investment (beautification projects, public transportation, schools, shopping centers) it has a higher chance of appreciating.
You should also evaluate the piece of land your potential home sits on. Make sure that the property is sound and that it is zoned appropriately. Homes that are in good school zones often make good long-term investments.
Next, evaluate the size of the home you are buying. One way to build equity in a home is to own the smallest house in the nicest neighborhood. Look to see what other homes on the block and in the area cost, and how large they are. If the house you’re looking at is slightly smaller or has dated features and can easily be improved to be in the same league as other houses nearby, then you can make some upgrades to the home to increase the value of the home. This will help you build equity quickly. Then again if the home you are looking at is the largest one on the block, the other homes will pull down its value per square foot.
If your home is in a good location and can be improved quickly, look at the exterior of the home. Curb appeal is important, but make sure you understand any risks on the outside of the home. This might include things that would be costly to repair like low-hanging branches in the yard or a roof that has issues.
Some exterior issues can affect the interior of a home as well. Keep an eye out for things like leaky drain pipes that may have caused sinkholes and impacted the integrity of the home’s foundation. Additionally, if a homeowner didn’t maintain the exterior of a home, they might not have cared for the interior well, either.
Once you’re indoors, look at the rest of the home. Some things can be fixed easily and offer a good ROI like poor decorating by the previous owners.
However, some things are more difficult and costly to fix. Be sure to talk to the appraiser and home inspector to ensure that the ‘bones’ of the home are reliable and that it will be worth it to update the home. If a home has serious issues, it might not be a good use of your time and funds.
The term ‘house poor’ means that a large portion of your income goes toward your home’s mortgage payment and general maintenance, leaving room for little else in your budget. When evaluating the price of your home, be sure that it does not leave you with no money to spend on your lifestyle or for investing.
A general rule of thumb is to ensure that you put 10-20% down on your home and keep your mortgage to a maximum of 25% of your take-home pay.
The Bottom Line
Buying a home can be a smart money decision, but it is not always considered an investment. An investment is money put into an account or real property and expected to earn an income. Homes are typically expensive and continue to require upkeep. However, by knowing what to look for in a home, you can make a smart buying decision.