Dumb moves that sound smart: Buying a house


Updated at 3:46 p.m. ET

(MoneyWatch) Buying a house isn't a bad thing to do with your money, if you're ready to be a homeowner and you understand what you're getting into. But if you're justifying the purchase with the well-worn: "I just want to stop throwing away rent money," you are about to engage in a dumb money move that only sounds smart because no one has worked out the math.

How could I possibly question the clear logic of this age-old wisdom? After all, you build up equity in a house. You don't build equity by renting, right? Absolutely. But to inject a tiny bit of reality into this dubious wisdom, let's look at the numbers.

To make the comparison simple, let's say you bought a $240,000 home, putting $40,000 into a down payment. That leaves you with a $200,000 loan at 4.5 percent (assuming you have great credit and interest rates don't rise). Your mortgage payment on that loan would be $1,014. Again, just to make this simple, we'll assume that's roughly the same amount you'd pay in rent. (Obviously adjust the numbers if your rent is lower or higher.)

But to get the mortgage loan, you would need to pay "closing costs" -- these are a variety of fees that are paid for appraisals, title insurance, escrow services and to the lender to process your loan. Bankrate.com estimates that a homeowner who borrows $200,000 will pay an average of $3,754 in these costs. (You can get "no-fee" loans, but you usually pay a higher interest rate to get them, so you pay one way or another.)

In other words, if your rent and mortgage were exactly the same, you'd start out $3,754 in the hole by buying.

"Never fear," you say. "I'll get that back by building principal as I pay off my loan!"

Reality check: At the end of the first year, your mortgage balance has declined to just $196,498, according to the amortization calculator at Bankrate.com. In other words, the total equity you've built up is $250 shy of paying the closing costs on your loan.

The second year will be better, you think? Not so fast, Mr. Happy. You probably forgot about property taxes, right? If you're in a district that has no special assessments (and they're rare), property taxes will run you about $2,400 annually -- about 1 percent of the assessed value. Realistically, you're likely to pay more -- somewhere in the neighborhood of $3,000.

And, you'll be needing homeowner's insurance too, since you can't get a loan without it. To be conservative, we'll assume that insurance costs you just $500 more than your renter's policy (if you had one). So now you're out about $3,500 annually (about $300 a month) over the cost of renting.

Do you get that back in built-up principal in your home by year two? Sorry, no. At the end of your second year of home ownership, you've built up another $3,388 in equity. You owe $193,110. Again, your equity is a few hundred dollars shy of what you're spending on just property taxes and insurance.

Worse, even though your equity starts to build up a touch faster in subsequent years, your property taxes can also rise. County governments typically "re-assess" property values and taxes annually.

Lest we forget, you are probably paying considerably more in utility expenses, such as water, gas and electricity, than you spent as a renter, too. And you've got maintenance costs now. After all, you are now the gardener -- or need to hire one -- and if your plumbing backs up or the dishwasher is busted, you have to call a repair person, not your landlord, to get it fixed. At minimum, you should figure that the repairs and utility expenses will set you back about $150 a month on a modest home.

What about those crazy lucrative tax deductions that you've heard about? As a homeowner, you get to deduct the cost of mortgage interest and property taxes. However, these deductions only help you to the degree that they exceed the standard deduction, which is $8,950 if you're single and $12,200 if you're married.

Deductible mortgage interest in the first year of this loan was $9,500. Add in the property taxes and you're up to $12,000 in deductions -- less than the standard deduction if you're married and about $3,000 more than the standard deduction if you're single. Assuming you pay 30 percent of your income in tax, these lucrative tax deductions of which you speak save you $1,000 annually if you're single and nothing if you're married.

But the home's value will appreciate and you'll walk away with a fortune when you sell, you say? Assuming there's not another housing bust and your home does appreciate, your house would have to appreciate substantially before you would be better off than your average renter.

Let's assume you wanted to sell in five years and that your house was worth 15 percent more at that point than when you bought it. That means you would sell it for $276,000.

Realtors, however, are likely to take 6 percent -- $16,560 -- off the top for their sales commission. You'll likely pay another 1 percent of the sales price in closing costs. So now your net sales price is $256,740. But because you have been paying down your loan a little bit each month, you only owe $181,968. You cash out with $74,712.

Brilliant move? Well, let's compare your net profit to what your renter twin would have. He didn't get your tax deductions, which we'll estimate at $100 a month. But he didn't have to put $40,000 into the house down payment and he had more spendable income because he didn't have to pay property taxes, insurance, additional utilities and maintenance. Assuming he put that $40,000, plus $350 per month (that's the $450 per month more you spent minus the $100 monthly tax benefit) in a mutual fund earning an average of 7 percent over the same five years, he'd have $81,762 - about $7,000 more than you.

But why does it always seem like home owners get rich faster? Probably because most renters don't save the money they're not spending on homeownership. A home is a form of forced savings plan that you must participate in as long as you want a roof over your head. Renters are not forced to save. They can go to bars instead.

Am I saying home ownership is stupid? Not at all. If you want a home, it's a great way to spend your money. There are few places where you'll spend more time or appreciate more than your own kitchen, living room or garden. But don't kid yourself into thinking it's a fabulous "investment."

Editor's note: An earlier version of this article contained a mathematical error. It has since been clarified and we apologize for the mistake.