Myth 1: Interest and taxes are deductible. You are getting paid by the government to own a house
Lets walk through an example. You make $100K a year. Pay $6K in real estate taxes and $10K in mortgage interest. There are two types of deductions available when you file your tax returns, a standard deduction and itemized deduction. For 2011 the standard deduction is $11,900. Assuming you did not buy a house your taxable income = $100K – $11.9K = $88.1K. At a marginal tax rate of 35% you will owe $30.8K in taxes. So effectively you paid $30.8K out of your pocket. Now assume you took the itemized deduction and deducted the entire taxes+interest. So taxable income = $100K-$16K=$84K. At 35% tax rate, tax = $29.4K. So great right, you paid less tax, so less out of pocket?
You forgot about the $16K you already paid in taxes+interest. So the total cash out of pocket = $29.4K+16K = $45K which is a good 19% more out of pocket if you have a house! The mortgage deduction is exactly that a “Deduction” not a “credit”. A deduction does not wipe our your tax obligation. The tax benefit only comes into play on the amount that is greater than the standard deduction. You are not getting a free ride, you still end up paying more out of pocket!
Myth #2 – You are owning an appreciating asset
House prices will always go up! The Case Schiller index shows how bad this recession has been for house prices. There a lot of ground to cover for prices to get back to just what they were before!
For followers of this myth, I always pose the question, why is it that for all other goods that we buy for personal use, we expect the value to always decrease, but when it comes to a house, we expect appreciation? What makes the house so special?
Myth #3- You are building equity.
The common line is – You are investing in yourself by putting money into your own house, If you rent you are throwing money away. To address this myth, lets first tackle what does “Equity” really mean. Simply put, it means you own the asset, in the case of the house you start off as a fractional owner (since you have a mortgage) and in the end you own the whole asset when you pay down the entire mortgage.
Huge myth again, you are ignoring the opportunity cost that is involved when you to have front the 20% down for your mortgage. If you had invested that in alternative investments you are still building equity, just in another asset. Once you own your house outright, you still need to sell it to another person to actually convert your equity into cash. We all know that housing is an illiquid market (compared to say stocks) and every time you sell you are going to lose 6-7% in commissions. The only way you are going to make money is your house appreciates more than that. Think this is going to happen in the near future? See myth #2.
Renting has huge advantages. Typically the net $ out of pocket is less than owning a house. There are also other qualitative advantages. In today’s tight job market. you can move at the drop of a hat to a new location in pursuit of a good opportunity. Renting makes you highly mobile.
Myth #4 – You are forced into saving.
There is some truth to this, having a mortgage will make you make sock away money into an asset (your house) by force. But isn’t this more about self control than anything else? If you can be disciplined enough to pay a mortgage, you can be disciplined enough to save.
In my opinion, for the house you want to live in, buy it because you need the space, like having a yard and/or just like the concept of a house. It’s not an investment, its a lifestyle choice. Real estate is only an investment if you are getting cash flows from it (rent) i.e its not your primary residence!