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Written by J.P. Wicklein
I consider there to be four, primary financial benefits to owning your own home.
1. Tax deduction: The federal government will allow you to deduct all of the interest on your mortgage payments and your property taxes. (For many 20 Somethings this will be the event that causes them to shift from claiming the standard deduction on their tax return to itemizing their deductions.)
2. Appreciation: Over time the value of your home will almost certainly appreciate, creating equity.
3. Fixed payments: Assuming you take out a fixed interest rate mortgage your monthly payments will not increase as the years pass. This is one of the biggest reasons to own your home as opposed to renting someone else’s.
4. The end of payments: Once your mortgage loan is paid off you will realize a sizable drop in your monthly expenditures. When you rent a home your monthly expenditures will only increase over time. (Note: As a homeowner you will still be required to pay for property taxes, homeowner’s insurance, and any additional maintenance costs).
Upon further analysis, however, two of these benefits aren’t as sweet as they may initially seem. When first time homeowners calculate how much money they’ll save from deducting their mortgage interest and property taxes they often forget to consider that they’re losing the standard deduction ($5,350 for single filers in tax year 2007). Here’s an example:
|
2007 Tax Year of Claiming the Standard Deduction |
2007 Tax Year of Itemizing (assumes full year of ownership) |
Increased Tax Deduction |
|
Standard Deduction: $5,350 |
Mortgage Interest: $7,500 |
Itemized 2007 Tax Year ($11,700) – Standard Deduction 2007 Tax Year ($5,350) = $6,350 |
|
Property Taxes: $2,000 |
||
|
State Income Tax: $1,700 |
||
|
Charitable Deductions: $500 |
||
|
Total: $11,700 |
Whereas one may initially think that they’re gaining a tax deduction of $11,700 they’re really only gaining a deduction of $6,350.
The second financial benefit that may not be as great as it would seem is appreciation. You will not be able to realize your appreciation (short of taking out a home equity loan or refinancing) until you sell your home. Selling your home will incur costs that will eat into your appreciation. The biggest drain on appreciation is realtor costs. Assuming your transaction involves a selling and buying agent you can expect that at least 5% of the selling price of your home will go to the realtors. Closing costs will also reduce your financial gains. Sell your home too soon after you bought it and you may come away from the transaction owing more on the home than what you paid for it.
Even with the loss of the standard deduction, realtor fees, and closing costs owning a home is a better financial decision than renting if you plan to live in the home for at least 3 years. (On average it takes 3 years for your home to appreciate enough in value to offset the expenses associated with the buying and selling transactions.) When you sit down to run some numbers, though, remember that the appreciation and tax deduction that comes with owning a home may not have as large an impact as you may initially think.
6 responses so far ↓
1 Ryan // Nov 5, 2008 at 8:02 pm
I wonder if they will ever get rid of the mortgage interest deduction… It’s such a sweet deal. I’m sure the gov’t loses a tons of tax revenue through it.
2 R. Schmidt // Nov 11, 2008 at 6:53 am
No one should ever look at a home as an investment. People pushing the idea of homes as investments have helped cause the financial crisis we are in today. Only individuals who can afford their mortgage, taxes, and insurance payments easily with at least 40% of their income remaining for other living expenses should even consider purchasing a home. An individual that rents will be much better off in the long run by investing/saving the difference in their monthly housing costs.
3 John // Nov 11, 2008 at 12:23 pm
R. Schmidt -
Thanks for your comments. I am in total agreement about folks that consider their primary residence as an investment. I’ve written another article on this topic that I will post in the upcoming weeks.
4 B. Estey // Nov 14, 2008 at 9:05 am
Good point from R. Schmidt. 20 somthings should strongly consider a two-unit flat as their first time home purchase. Then you have a place you can call your own that is truly an investment as well. Your tenant covers a significant portion of your note, and when you’re ready to move on to bigger and better things, you have a perfectly good rental property that’s paying for itself.
I always get the same response when I suggest this option to clients: “I don’t want to be bothered with a tenant.” Well that’s a fascinating story, but is it a reasonable concern? I don’t think so. For example, lets say you have a 150k mortgage with a PITI payment of 1200 a month. If a tenant could reduce your out of pocket expense by 750 a month, don’t you think it might be worth the little hassle a tenant may create? That’s 9000 dollars a year you could use for something else. I don’t know any 20 something who couldn’t use that.
Once you move on, rent the other identical unit for 75o and you have a positive cashflow. It is a very simple way to invest with little risk. You were going to pay the 1200 a month anyway, right?
5 Studenomics // Nov 20, 2008 at 11:25 am
I am a Canadian and the one thing that makes me envious is hearing how U.S citizens are allowed to claim the interest on their mortgage. We CAN NOT claim this nor any interest, and we just have to accept the interest as apart of life. I have recently purchased property in the city of Toronto, and to make things even better we are the only city with a municipal land transfer tax. So on top of paying a provincial tax for purchasing property, you must now pay a municipal tax, great.
6 Financial Fellow // Nov 20, 2008 at 10:25 pm
Studenomics -
I agree the mortgage interest deduction is pretty sweet. That said, I’m sure that the U.S. does have some taxes that Canadians do not - and vice-versa. We have a real estate transfer tax in Chicago. I think this is probably the same as your “municpal land transfer tax”. For us it is $7 per every $1000 of the purchase price for the buyer. I think the seller pays around $3 per every $1000.
That said, I understand your pain.
Thanks for the comment,
John
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