Purchasing your first home, or any home for that matter, is a big deal! It is without a doubt the most significant purchase that most of us will make in our lives. We contrast this want of a home with the allure of living rent-free. Living rent-free sounds like a fairy tale to most of us. We are usually so excited to purchase a home that we never really stop to consider if it is a good investment. It is not just if we like our home or can afford it, but does it truly makes sense and align with our goals. In all my life, I have never heard anyone say they would like to be in crippling debt and financial stress for their entire lives, but often the home is nothing but a liability for us financially rather than a benefit to us from day one.
The traditional method is to wait at least five years, and you will be able to break even on your home while you are paying off debt for the next 30 years. The problem with this method is we don’t evaluate the house like an investment. We need to consider the true costs of homeownership. This article will highlight a few ways to look at the purchase of your home so it can benefit you from day one rather than just a long-term investment or liability in the present.
1) Home vs Investment
“Home is where the heart is” I like to take that literally whenever we think about our housing situation. The most traditional way to generate wealth is by purchasing property, primarily a single-family dwelling. There’s nothing wrong with this method, and it has been highly successful for many people for thousands of years. However, the conventional home only offers one consistent way to generate income: allowing appreciation of the land and property to occur over time. Typically this takes a minimum of five years for appreciation to occur to a point where it can be financially profitable. In the past few years in this unbelievable market, it has taken five minutes to sell a property and be profitable instead of five years. This, however, is unsustainable and should not be banked on.
The only problem with the traditional home-buying approach is it doesn’t help you today other than locking in your housing expense. Your home has the potential to bring payments to you today rather than just you paying out today. Typically, when evaluating a home, you are only concerned with what you can qualify for. The home is viewed as a fixed expense, and if we make money on the home, eventually fantastic. We need to view homes differently as investments.
Here are a few key ideas to treat a home as an investment.
- The purchase price of the home is only a partial equation to the cost of the home.
- Purchasing a larger house does not equal a larger return.
- Appreciation of the home gets hit by inflation.
- A home gives you the ability to eliminate the expense of housing from your life. Plus it gives you an asset to to generate income from if you can be creative.
- What you qualify for is not necessarily what you can afford.
- Shoot for a 20% home payment to income ratio. Of course you can offset this by receiving income on the property.
2) Understanding Good Debt.
When you look at your 30-year mortgage, it can be depressing and sometimes overwhelming. We sign up for an obscene amount of debt and agree to pay it off for the rest of our lives. It is true that we are locking in our housing expense which is a great thing, but there has to be a better way.
When evaluating the home, we often look at the total purchase price rather than the payment. We need to be reviewing the ratio of payments to our whole income level and budget in addition to the loan amount. Debt can be used to our advantage if we genuinely think it through. Too often, though, the home is just a place where we lay our head down at night with no real financial value for today. Differentiating between payments and debts may seem simple, but it’s crucial to our ability to live rent-free.
Good Vs. Bad Debt
The difference between good debt and bad debt is simply if you can receive money on the debt or not. Suppose you are paying money to pay off debt; that typically makes no sense. If you can make money by acquiring debt, you might have something there.
For example, going into debt to purchase a new car is not a good idea. That car is depreciating from the moment you pull it off the lot. You are only paying money towards the car, and it is offering no financial value to you. Contrastly, if you purchase a rental property, you are going into debt to receive money each month in the form of rent. This is a much better use of capital and debt because you have an asset that gives you options, and someone else is paying for it.
3) 1% Rule
We all know there are many costs when it comes to homeownership, such as taxes, insurance, repairs, the list goes on. Whether we are trying to earn extra income by renting out a bedroom or viewing a rental property, a good rule of thumb is if you can make in rent one percent of the total purchase price, you have yourself a winner. This will typically allow you to cover all expenses related to the house and potentially have a little leftover to go against the mortgage or directly into your pocketbook.
Let’s Get Practical:
Let’s say we are looking at purchasing a home worth $400,000 in Dallas, Texas. The 1% rule says if we receive $4,000 a month, that will cover all expenses related to housing. Let’s see if this holds.
- Purchase Price: $400,000
- Interest Rate: 3.906% 30 Year
- Down Payment: 3% ($12,000)
- PMI: $317/mo
- Property Taxes: $730/mo
- HOA: $381/mo
- Utilities: $200/mo
This property in downtown Dallas has a pretty hefty HOA and property taxes but is standard in the area. We can use the 1% rule to see what it would take to offset our housing costs and evaluate a property’s rent potential. Our total monthly payment for this home is $3,599. The 1% rule would allow us to profit $400 or at least use the money to cover unexpected expenses. This deal cash flows nicely with a $4,000 rental income. Remember just because the 1% rule works on paper does not mean it is a good deal. It just means that it is worth a deeper look at the home and to see if it makes a good investment.
Things to consider if the 1% rule holds true:
- Will I reliably be able to charge 1% over time as rent?
- What are other comparable rents in the area?
- Can I afford the payment for 90 days without a renter?
- Is the area appreciating or depreciating?
- How will you manage the property?
4) Get Creative
Affordable housing is starting to seem like a myth right now, and inflation is running wild. Even with interest rates at historically low levels, finding a house within a budget is proving to be almost impossible. In times like these, we need to get creative because there are still many options in front of us. We just need a change in perspective.
The traditional single-family home in the city or suburb might be out of reach right now, but if that is our goal, we need to focus on creating more financial margin in our lives. We might just need to sacrifice what we want now with what we want most.
Tiny homes, multi-family housing such as duplexes, triplexes, ADUs (Alternative Dwelling Units) are becoming increasingly popular. They offer flexibility and affordability with the potential to earn income on the side.
It may look different than what you thought, but let’s face it, normal isn’t working. It’s time to start thinking and looking at things differently.
If you are interested in talking with one of our experienced financial coaches please click the link here! We would love to walk through this journey with you!
As always, you got this!
