RealEstate101 #StarterHome #WhyBuyAHouse
What’s the Deal with Buying a House You Don’t Plan to Fully Pay Off? 🤔
If you’ve ever wondered why people buy homes they don’t plan to pay off completely, you’re not alone! Buying a home without the intention of paying it off might sound strange, but it actually has several benefits. Let’s dive into the economics of real estate to uncover the wisdom behind this common practice.
Building Equity 🏡
When you buy a house, you start building equity.
- Equity: The portion of the property you actually own.
- It increases as you pay down the mortgage.
- You can leverage equity to buy a bigger, better home later.
Renting vs. Owning: A Financial Perspective 💰
Renting might seem cheaper upfront, but owning has long-term benefits:
- Forced Savings: Part of your mortgage payment goes towards building equity rather than to a landlord.
- Potential for property value appreciation.
Tax Benefits 💼
Homeownership comes with tax perks:
- Mortgage interest and property taxes are tax-deductible.
- These deductions can save you a significant amount on your yearly tax bill.
Stability and Control ✨
Owning gives you more control over your living situation:
- No sudden rent increases.
- Freedom to renovate and decorate.
- Stability to plant long-term roots.
Real Estate Investment 📈
Think of your home as an investment:
- Property values generally increase over time.
- When you sell, you can make a profit.
- The capital gain could be significant even if you don’t pay off the mortgage entirely.
Starter Home Strategy 🔑
Why do people buy starter homes?
- Affordable entry into the real estate market.
- Learn the ropes of homeownership with a smaller, manageable property.
- Build equity and credit history, making it easier to upgrade in the future.
Renting Out: A Source of Passive Income 💸
Another advantage:
- Renting out your property can provide passive income.
- Rent payments can help cover the mortgage and maintenance.
Inflation Hedge 🛡️
Real estate can protect against inflation:
- Fixed-rate mortgage payments remain steady.
- Property values and rent prices often rise with inflation.
Diversifying Assets ⭐
Diversifying your assets is crucial:
- Real estate serves as a tangible asset.
- Balances other investments like stocks and bonds.
Buying a house, even if you don’t plan on fully paying it off, comes with multiple financial and lifestyle benefits. It’s a strategic move to build equity, enjoy tax advantages, and have a stable living environment. The increase in property value over time also makes it a sound investment.
So, would you consider buying a home now? 🌟
The idea is that owning a property builds wealth because it goes up in value.
Over time you’ll be able to increase your net worth via equity in the home. So if you wanted to you could borrow against the equity in the home to pay off debt or make investments.
Additionally the cost to borrow against your home is cheaper than other lending alternatives because the expectation is that homes hold their value well and even appreciate in value. So there’s less risk for the lender.
Let’s say you have two choices – rent an apartment, or buy a $400,000 starter home. You’re going to stay there for five years, then you’re gonna buy the $550,000 house you actually want. All the numbers below are made up and grossly oversimplified, but I think they’ll give you the idea.
**Rental scenario:**
You pay rent for five years, then you have (whatever you’ve saved up) to put toward your “keeper” house.
**Starter scenario:**
You get a $400,000 mortgage on your starter house, and make payments on that for five years. During that time your payments chew the mortgage down so you only owe $350,000. After the five years, you sell the house for $400,000. You spend $350k of that to pay off the mortgage. Now you have $50,000 that you can spend on hats…or add it to your savings for the “keeper” house.
**Ways this is oversimplified:**
* It assumes rent and the mortgage cost the same. They’re not completely different leagues, but the mortgage is almost certainly higher.
* Some (many? most?) mortgages penalize you for closing out early.
* Depending where you are, you might be able to sell your house for the same amount you paid (or more! Dare to dream!)…or you might not. Hope you took care of it. Hope the market is positive. Hope your realtor doesn’t take too big a bite for themselves.
* You have to pay for maintenance on the starter house while you’re in it. That can be no big deal, or your starter can be a total vampire if it’s old, or if you’re unlucky.
* You have to pay property tax on the starter house while you’re in it, unless you know some tricks I don’t.
* Imagine that the house you want is finally up for sale, so you put your starter up for sale…and you don’t get any offers. Time passes. You’re worried somebody is going to snap up your dream house, but you need the old house to sell so that you’ll have your $50,000 to put down on the new one. More time passes. No offers come in. You feel slightly ill.
When you sell the house, the money you get is used to pay off the rest of the loan. So if you buy a house for $400,000, pay off $100,000 and sell it again for $400,000, then you get $100,000(minus some closing costs) and you can use that towards another house. More importantly, houses tend to appreciate in value, so you might actually be selling the house for $500,000, in which case you get $200,000.
Compared to renting, where the money you pay just goes into someone else’s pocket, it’s usually a pretty good deal.
I buy a house for $500,000 with a $400,000 loan and $100,000 down payment. On day 0 I have $100,000 in equity, because I own the amount I already paid. I make mortgage payments to pay off that house over 30 years. Over 10 years, $100,000 of my payments have gone into principal, which means that my loan is now $300,000.
But during that time, my house has gone from being worth $500,000 to $700,000, and I still only have $300,000 on the loan.
If I sell the house, I can get $400,000 cash.
Of course there are things like property taxes, loan interest, homeowners insurance, and maintenance costs, but that’s out of scope for ELI5.
If you rent, you just pay out, and get housing. If you buy you get equity, the house, which holds value and also houses you. If the house value goes up well past the debt you have, you might be able to sell the house, pay off the loan, and come away with a gain.
The value of the home is very likely to go up over time, so when you sell it you make money.
Not fully paying it off is completely irrelevant here and quite simply doesn’t matter.
If you buy a home for 100k and then you are able to sell it for 200k in the future you made 100k. Having outstanding loan doesn’t change anything, in what way do you think it would?
There’s a bunch of other potential benefits of owning a home but they all kind of come back to “homes go up in value, its good to own things that go up in value”
Your rent money is just gone. Your mortgage payments are at least partially “recoverable” when you sell the house.
Because you own the equity you’ve already paid into it.
If you buy a $500,000 house and take out a 30 year mortgage, but after 5 years you need to move. Even if you sel the house for $500,000, you get back the principle you already paid. So say $20,000 (or whatever) so the interest payments you can consider as “rent” also, if the house is now worth $800,000 then you only have to pay the bank back whatever is owed on the mortgage and pocket the profit.
Depending on the interest rate environment, it may be preferable to invest your money in the financial market, instead of paying off the mortgage. I.e. the interest you pay may be much lower than the return you can achieve on your assets.
Well to be clear, it is not a decision that is at all “automatically good”. If someone believes that
a) they will likely stay in that house for 5+ years (rough guideline)
b) have a relatively stable income during that period (to cover mortgage and still have living expenses and some savings) plus savings to cover downpayment.
c) that home prices will appreciate in that period by at least 10%-15% (in most markets, home prices generally appreciate over long enough periods) Some people have become over optimistic of short term property price appreciation.
d) can have the personal discipline or satisfaction to manage a property, pay taxes, repair and maintenance (this takes more time than one imagines)
then buying a starter home might make sense – financially. Even if the person decides to move (upgrade or relocate) after 5+ years, the home appreciation would likely have made up for the loan costs, property taxes paid etc.
However if the conditions above don’t hold, then there is risk of financial loss although if someone is very home proud, the added satisfaction of owning their own home might make up for it. The point of the starter home is also “forced savings” which makes it much easier typically to purchase the next home since the equity is easily reinvested.
The point is that landlords don’t work for free so by owning a home and renting to yourself, you can absorb whatever profit landlord usually gets.
Being your own landlord also means you have rent control and decision over additions, paint, maintenance and improvement.
Buy house.
House increase in value.
Sell house for more money.
Bank gets what you borrowed and you get the rest (i.e. More money than you had).
Repeat.
Houses sit on land. Land is a commodity that is not increased. Outside of UAE, they ain’t making anymore. The demand will increase while the supply remains fixed, making it a safe investment.
A starter home is unlikely to cost more than rent for that particular size home, but rather than you just paying to live there, you will very likely get the money back if you move after some time.
You have 2 dollars and want to buy a house for 10,the bank gives you 8 dollars.
Now you have 2 dollars worth of a house and with your recurring payment you pay 1 dollar of interest (cost of the loan) and another 1 dollar as paying off the loan.
So after a year you will pay 2 dollars and own 3 dollars from your house, the bank will own 7.
This does not sound good, except there are two additional things happening. You don’t have to rent and inflation is affecting the loan.
You probably save a dollar on renting, so it’s not more expensive. Additionally if the price of the house increases to 15 dollars, the bank still own only 8 dollars, so now you have 7 dollars worth.
The generic advice is that you should always pay back the loan as soon as possible, because house price inflation is rarely higher than interest rates.
A home gives you more options.
There’s utilizing the equity you build.
Rental potential.
Leverage opportunities via government subsidies.
Credit line diversification.
…and you have somewhere to live.
You buy the house for $100,000. You live in it for 10 years. You pay off $20,000 in that 10 years. Now that you’re ready to move, it’s time to sell the house. But in 10 years the housing market has gone up and now the house is worth 150,000. You only owe $80,000, so you sell it and make $70,000.
If you had been paying rent somewhere for that 10 years you would have $0, which is way less than $70,000.
Those are obviously simple numbers, but that’s the general idea of what people are hoping for when they get a house they know they aren’t gonna live in forever.
You can buy a house and leave it letting someone else pay for your mortgage and repeat this as many countries or houses you want while accumulating houses.
It always good idea to accumulate houses/assets.
Let’s say you love video games and want to spend some money. There are two ways to pay for games: pay for game pass every month (renting) or buying a physical game.
Game pass route: you get enough money from your mommy and daddy every month to pay. You don’t own any of the games, but you have the option to play any game you want. If you try one game and decided you don’t like it, you can just play a different one. You have a lot more options, but you don’t own anything at the end of the year. Also, if game pass cost increases, you have to pay more while your allowance doesn’t change frequently.
Buying a physical game route: you don’t have enough money up front, so you ask your parents to give you allowance all up front. You won’t get any money for the rest of the year, but you get enough money to own a game. You play it through and decided you want to play a different game. So you go to gamestop and trade it in. Depending on what you get, you might have to pay more to get the new game, or they pay you the difference because what you had was more valuable than what you bought as a replacement. You might only get to play one game at a time, but you have more money in the form of a game (as asset).
There are tax incentives for getting a loan, owning a home makes it easier to get more loans, you get a permanent address and more control over when to move, etc. But those are hard to explain in 5 year terms. If you’re looking to buy a starter home, I would look into 1.) How much you can realistically afford to pay every month and not go house broke, 2.) How much money you have to have upfront (in US, I believe the first home owners loan needs 3% down payment), 3.) Figure out how much upgrade and maintenance your house would need and take that into account in your budget, and 4.) Make sure you love the climate, location, and house (you have to pay fee to get a loan. You don’t want to be selling and buying too frequently. You also may have to pay 6% in sellers fee when you sell, but that depends on the market). Anyway, good luck with your house hunting and hopefully you can get a good deal. The interest rate is currently high and house price hasn’t gone down too much since COVID, so it’s tough right now to buy. Nonetheless, it’s good to have everything ready so that you can jump on it when the opportunity rises.
OK. Speaking as a homeowner. (You can’t spell homeowner without *meow*.)
* My mortgage is around 60% of what my rent would be.
* Much of the money I pay into my mortgage goes into *equity* – the proportion of the value of my home that I own. Overall it’s *wildly* cheaper than having a landlord.
* Property, long term, beats inflation in my country. And every bit of that rise in value belongs to me.
* That equity is about half of my retirement saving. It’s going to provide me with a house to stay in for free when I retire. Hopefully this house I’m in right now, but maybe a smaller one or one in a cheaper town. Given that my mortgage is a huge chunk of my costs day to day, I won’t see a big drop in my standard of living when I retire.
You might not plan on paying it off, but you might pay off *a* house one day, and owning a house is the way to start.