If you've ever bought a home or even looked into the possibility, chances are you've encountered realty agents who insist “Your home is an investment!” (often while encouraging you to spend considerably more than can comfortably fit into your budget).
They're semi-right — your home is a major investment, but not the kind you might think. And I've long suspected that people's confusion over different investment types was one of the primary overlooked causes of last decade's housing bubble — and is helping to inflate the new housing bubble that appears to be expanding now.
Here's the problem: the English language has only one word — “investment” — to describe two completely different financial activities, which I'll call “income generation” and “expense reduction.”
Income-generating investments include stocks, bonds, even real estate in the form of rental or business properties — anything where the idea is to, as investment advisers like to say, “Make your money work for you.” (Of course, any investment has the possibility of going bad; if you buy stock in a company that later goes bankrupt, you'll lose money rather than make it.)
By contrast, expense-reduction investments are, as the name suggests, meant to reduce (if not eliminate) various expenses of ordinary living.
The first major expense-reduction investment I ever made was when I bought my first washer and dryer, to avoid the bother and expense of hauling dirty clothes plus multiple handfuls of quarters to the coin-op laundromat. Considering what I paid for the machines, how many loads of laundry they washed over the years I owned them, and what it would've cost to wash and dry that same laundry at a coin-op — yes, that washer-dryer combo was an excellent expense-reducing investment, saving me hundreds of dollars in laundry costs over the years.
A house — specifically, your primary residence — is also supposed to be an expense-reducing investment: you'll always have to pay something in exchange for a place to live, but if you buy a house and pay off the debt then, in the long run, your living expenses should be less than if you'd rented all the while.
Case in point: my next-door neighbor lives in a townhouse pretty much identical to mine, except he bought his in the late 1990s whereas I started renting mine a couple summers ago. Yet his monthly housing expenses — fixed-rate mortgage payment, property taxes and insurance — are less than half what I pay in rent (and mine is a cheap rent by local standards, too).
Your house only truly becomes an income-generating investment if you intend to rent it out, or at least take in paying roommates. Do not, however, make the mistake of thinking that borrowing against the equity in your house counts as a form of income — a home equity line of credit is not income but the exact opposite: debt. Money isn't “income” if you have to pay it back, with or without interest.
And if you're a current renter thinking of buying a house “because a house is a good investment,” that's only true for you if the numbers fit traditional pre-housing bubble mortgage-lending criteria: get a fixed-rate mortgage after making a down payment of at least 20 percent, and your total monthly cost for mortgage, taxes and insurance payments should be less than or equal to what you now pay in rent. (Based on your income tax bracket, the size of your mortgage and other factors, there are also mortgage interest tax-deduction factors to consider, though for simplicity's sake we're focusing on the more "fixed" costs, here.)
Of course, you can certainly “buy up” and move into a nicer house where your monthly housing costs actually increase in the short term, and that's fine provided you can actually afford to pay the mortgage. But don't make the mistake of buying more than you can afford on the theory, “It's okay, since housing is an investment!”
What about buying a house on the theory that its value is certain to go up? Any first-time home buyer hears such stories from the older generation: “I bought this house in 1980 for $100,000, and today it's worth $250,000!”
Wow! Sounds like a nice profit indeed — until you check the U.S. Bureau of Labor Statistics' online inflation calculator and learn that $100,000 in 1980 had the same buying power as $283,878.64 in February 2014.
That particular house was a bad income-generating investment — but probably still a good expense-reducing investment, compared to what its owner otherwise would've paid in rent between 1980 and today.
Even if the value of your home genuinely does rise when inflation is factored in — maybe you paid $100,000 in 1980 for a house now worth $325,000 — the only way to realize that profit is to sell the house you live in, at which point you need to either buy or rent a new place to live. And if your house now costs $325,000, comparable houses in the area are certain to cost about the same.
So if you're a renter thinking of buying a house “because it's a good investment,” make sure you understand what kind of investment it actually is.