What is the American Dream
According to Merriam-Webster, the American Dream is:
“a happy way of living that is thought of by many Americans as something that can be achieved by anyone in the U.S. especially by working hard and becoming successful with good jobs, a nice house, two children, and plenty of money…”
Yes of course, it is indeed true that the U.S. is the land of opportunity in so many ways. But, is buying a house for you and your family to live in so important to achieving and enjoying the american dream?
Home ownership is the quintessential goal of many americans. It represents the most perfect example of quality or class. Arguably, homeownership builds wealth. Many Americans work hard, save money and put down a down payment to buy a personal residence. The hope is that the house will increase in value. Over time, the homeowner will have more equity in the house. This is achieved with the potential increase in property value and the slow reduction of principal (amount owed) by the simply paying the monthly mortgage payments.
But is your own house an investment?
It is often said that buying your own house is the single most important investment in your life. This assumption is flawed for many reasons. The premise of potential increase in value is not alone a good reason to assume that buying a personal residence is a good investment.
Don’t be disappointed. The house you live in is not an investment!
Yes, real estate values have the potential of appreciating dramatically. But when was this ever guaranteed? Although likely, there is no guarantee that the value will increase! And even if it does, it might not increase enough to outpace inflation and offset the carrying costs and expenses of owning and living in the house.
For the house to be an investment, it must be treated as an investment. You must have complete control over it as a business. This is often very difficult to accomplish in a personal residence because you live in it. Your family lives in it. Your kids go to the schools in the neighborhood. Packing up and moving is far from convenient. The fact that the house increased in value does not really matter if you don’t have access to the cash. For it to be an investment, you must maintain control over the ability to sell and cash out the equity, and use that equity to make more money. Even those who sell and cash out the equity often end up upgrading and moving to a more expensive house and then repeat the process again and again and again. This could increase wealth but only in one single property that is a money pit left right and center.
And even if you borrow money on the house by leveraging a home equity line of credit (HELOC) or by refinancing, it still does not matter. None of these strategies change the fact that your house is still not an investment. It doesn’t change the fact that the bulk of your hard-earned money is still trapped in the house. The HELOC is also more debt acquired that you have to pay off with interest. What if the house drops in value and you end up underwater owing on it more than its market value? Refinancing is also overrated because it does again reset the amortization table and puts you in a position paying a ton of interest while pushing the payoff date of the mortgage to another 15 or 30 years down the road. This is the definition of insanity!
The house you live in is nothing but a glorified savings account, at best!
Your own house is a liability
If you live in the house, then it is not an investment. Instead, it is a liability.
This is controversial and not everyone agrees. But think about it. If the house is costing you money and not making you any money, then how can it possibly be an investment? Let’s set the terminology aside. Suppose you insist on labeling your own house as an “investment”, how can it possibly be a good investment? How can it possibly be the best place to invest your money when you can achieve higher rates of return on your money by buying rental properties?
Owning a house costs money, lots of money. The bigger and more expensive the house is, the more money it will cost you on the long run. All that, is just to live in it. All the house is providing you with is shelter.
Not only do you have to set aside a large down payment to buy the property, but you also have to make the mortgage payments, pay real estate taxes, insurance, utilities, repairs and maintenance. You can’t forget to account for the expenses of costly repairs that will most definitely be needed over the long run. Sooner or later, you will need to replace the roof, heater, HVAC system, windows, flooring and appliances. How about that bathroom or kitchen remodel you’ve been thinking about? Add all these up and you’re looking at tens of thousands of dollars.
It’s easy to justify these costs because, after all, you live in the house. No one is disputing the necessity of these expenses. No one is suggesting ignoring a leaky roof and settling for a water bucket. The house provides shelter. It needs to be safe and comfortable. But this gets back to the main point that the house you live in is not an investment. It costs you money and doesn’t make you money; therefore, it is a liability.
Let’s talk numbers
Wait, there is more! It is bad as it is that the house you live in costs a lot of money to upkeep. But it gets worse. Let’s hammer the main point again that your primary residence does not generate any cash flow.
It is very important to distinguish between your primary residence and an investment rental property. When you invest in a rental property, you expect it to make you money. You expect monthly cash flow from the property in the form of rental income. This is the cash flow that is completely non-existent in your primary residence. Why in the world would you dedicate most of your energy towards an asset that does not generate income?
Your own residence
For example, you buy a house for you and your family to live in for $200,000. The specifics of financing don’t really matter. But The point is that you will be sinking $200,000 plus interest of your own hard-earned money in one single address over the long run.
Suppose you put $40,000 down and finance the remaining $160,000 at 4% for 30 years. You would be looking at a total of $114,991 in interest and $96,000 in taxes and insurance over 30 years. This assumes that you stay put in the same place and don’t refinance. If you move and upgrade to a bigger and more expensive house, the situation deteriorates exponentially especially when it comes to the debt cost. Every time you start back at the top of the amortization table, you start to pay much more interest and less principal again. It’s a never ending vicious cycle.
Continuing with the same assumptions, now we’re looking at the total of all payments being $410,991 over 30 years.
We arrive at this number by adding:
$40,000 down payment
$96,000 taxes and insurance
Wait, there is more! Let’s assume that you replace the roof, HVAC, heater, a few windows, and appliances. We all know that appliances are not going to last more than 10 to 15 years. So we will assume that they all will be replaced just once for the sake of not making this example overly aggressive. And, do you think you will settle with that old kitchen or bathroom for 15 or 30 years? It’s unlikely. Let’s factor in only $15,000 for remodeling budget which is extremely conservative.
When it’s all said and done, you will be looking at a minimum of $42,000.
At this rate, the total cost of owning and carrying the costs of your own house will certainly exceed $453,000. All this is just for a primary residence that is making you no money at all. Even if the property increased in value, it doesn’t matter because all that money is still trapped in the property. You have to borrow money on the property, refinance or sell it to have access to that cash. And plus, the appreciation is not even guaranteed to keep up with inflation in the first place. The market could crash. The economy could tank. A lifelong worth of hard work could remain trapped in one single address.
Going back to the property analysis chapter, we learned that investing $24,000 to buy a $120,000 rental property could yield $7,140 in annual cash flow. Think of the magnitude of the strategy differences between arguably wasting $410,991 of your own money on your personal residence compared to investing at least part of that money over time in rental properties.
If you manage to buy four properties, you will be cash flowing $28,560 yearly while the rental income from the tenants is effectively paying down the mortgages on the properties for you over time. You will be running a business and increasing wealth exponentially compared to having all your money stuck in one personal house with no other sources of income.
You can set aside the income earned and use it to buy even more properties. But let’s assume that you stop at just four properties. Stretch that income over 30 years, and you will be looking at a minimum of $856,800 in cash earned from just those four rentals. This doesn’t even take into consideration increases in rental income or the priceless fact that the properties will be completely paid off in 30 years as well. This is a total of $480,000 in equity.
So what are we really suggesting here? Are we saying that buying a personal residence is a big mistake? Not always! Are we saying that renting is the smart way to go? Maybe! The answer is very difficult and varies dramatically based on the area you live in, your family needs, your investment strategy and your financial goals.
If you are working hard 9 to 5 just to spend your money on mortgage payments and car loan/lease payments, then you are wasting your energy! It is certainly wiser to dedicate your financial energy towards assets that make you money such as investment rental properties that produce monthly cash flow. This strategy could lead one day to financial independence.
You could get to the point where the rental income exceeds your job’s salary. You could even buy more properties and use the income to cover the rental costs of the house or apartment you are renting. You could then revise your plan and decide to buy your own house. But at this point, you have assets producing income that can help make the mortgage payments of your own house. Now you are no longer fully dependent on your job’s income! You can finally hop off the hamster wheel! You are financially independent.
The general piece of advice here is to avoid dedicating large chunks of your hard-earned money to your personal residence whether it’s owned or rented. Renting certainly gives you the advantage of mobility. It’s easier to move without having to worry about timing the sale when the market is hot. You won’t have to worry about repairs, maintenance or remodeling when living in a rental. You can simply choose another more modern rental to move to. You can do this while investing in several rental properties. What’s wrong with living in a rented house or apartment while working on owning and renting several other properties?
You can build wealth by owning rental properties. You don’t have to buy your own!
There is one exception to be noted. If you buy a duplex or a large enough house that you could rent half of it, then the case can be made that the house is an investment, at least partially. But other than this, it remains important to acknowledge the facts and accept the reality that your primary residence is not an investment.
The american dream should be about seizing opportunities where found. It should be about doing well and achieving wealth. It does not have to involve buying a house to live in.
Buying a house to live in and upgrading three times in a lifetime is the american dream of american banks. It should not be yours.
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