Why your House is your Biggest Liability
Sure, we’ve always been told the wonders of home ownership, many of which are true. But generally, most people tell us our homes will be our biggest investment and become our largest asset. I disagree. For the average American, your house will be your biggest liability.
Asset vs. Liability
Let’s start with the basics. When you think of the words asset and liability, what comes to mind? In simplest terms, an asset earns you money, a liability costs you money. Assets are things which generate cash flow for you, while liabilities generate expenses, or negative cash flow. This seems simple (and it is), but many people try to complicate it. Just always remember assets put cash in your pocket, liabilities take cash away.
But everybody has a friend that got rich in real estate, right? Many smart investors make a lot of money in real estate. Lots of real estate can become assets and generate positive cash flow. Don’t get this confused with your house though. Cash generating properties require tenants. This way somebody else is covering the expenses associated with the building, and the building becomes a pass-through for cash. In this instance, real estate is an asset and could make the owner a lot of money. However, with a house, all the expenses are on your shoulders.
The Asset Fallacy
You’ll often hear that houses are assets because property values generally appreciate over time. So what? What does that do for you today? Is that putting cash in your pocket? Appreciation doesn’t do you any good until you sell the property. Most people will live in a house for several years or a lifetime before selling it, so money is rarely created for the owner.
Perhaps you’ll tell me good investors are patient, and we cannot expect to make money over night. There is a lot of truth in this statement. Being patient often pays off in other cases, but the longer you own a house, the more money you’ll spend on it.
Liabilities Created by Your House
You may still say the appreciate over time will out-weigh the purchase price of your house, and this makes it an asset. But look at all the expense you’ll have:
- Mortgage Principal
- Mortgage Interest
- PMI or Private Mortgage Insurance Not applicable to everybody
- Home Owner’s/Liability Insurance
- Maintenance
- HOA Fees Again, N/A to Everybody
- Taxes
- Renovations
- Landscaping and Lawn Care
- Utilities
Even if you are able to save up for a house and pay cash in order to avoid interest payment, look at all the other expenses that add up very quickly. For now, let’s assume everybody reading has financed their house. If you bought a house 15 years ago for $100,000, you may be able to sell it today for $200,000. However, look what it has cost you.
If you financed the whole amount with a 6% APR loan for 30 years, you will have spent $78,968 on interest and $28,951 on the principal of your loan for a total of $107,919. Plus, you still owe $71,049 to pay off the bank. Look at the total when you add all your other monthly expenses:
Considering these estimated expenses (they would likely be higher), even if somebody was to offer you double your purchase price of $100,000, you still would have lost more than $50,000 over the period you lived there! Plus you’ll have to pay the realtor! If you consider the time value of money and inflation, you’re losing even more money because $200,000 today isn’t as much as $200,000 fifteen years ago. (Note: I’ll be discussing time value of money, inflation, and mortgage options in future posts)
So is Home Ownership a Bad Thing?
No, it’s not. There are many more things to consider, everything from tax benefits to the alternatives (rent). Once you own your house (ie mortgage paid off), your expenses will go down drastically, and you’ll never have to worry about paying rent to somebody else. Also, shelter is a necessity. You will either have to rent or purchase. When done right, with the appropriate mortgage, and in a good location, purchasing is the right decision. Just don’t fool yourself that your house is an asset.
September 17, 2010
9:50 PM
“Utilities” are an expense even renters typically pay.
You did not include the tax deduction for interest.
Maybe you should get a degree in finance or economics before you start pretending to be an expert.
September 18, 2010
7:23 AM
Dude,
Yes, utilities are an expense that renters pay, too. But the point is that it is a continual outflow of cash and therefore should be included on any list of liabilities. The fact that it is a liability for both homeowners and renters does not make it any less of a liability.
The tax deduction for mortgage interest is deducted from the taxable income, not from taxes owed. It is not a one-for-one exchange. The reduction of tax burden is less than the amount of interest paid. Therefore, it is better to pay off a mortgage and keep what you would be paying in interest than to keep a mortgage for a relatively small tax deduction.
I do not have “a degree in finance or economics” but I have taken a lot of Organizational Budgeting and Accounting classes and the principles behind this article are the same principles that most large corporations operate on.
September 26, 2010
8:47 PM
So, if you DO NOT buy a house, where do you intend to live? And what is that going to cost? I rented a nice 3 BR house for 9 years and paid over $80k in rent — gone, vaporized, never see it again. And every place I’ve rented I had to pay most or all the utilities on top of rent. I don’t expect my property to make money; just cost LESS than renting.
November 25, 2010
11:10 PM
I so Agree with Wayne BOB as if we dont buy a house u would end up payin a rent anyways soo even if we get 200,000 after 15yrs we only loose 50k but if we rent for 15 yrs we would end up paying a lot more thn 50k and still tht apartment would always be of the landlord so … please clear the point u want to prove as buying a house is much better thn renting it.. no matter it is asset or liability…
December 14, 2010
10:24 AM
I think you got something wrong with your ‘simplest’ definition of asset. Since I couldn’t find the right words to describe an asset, I looked at wikipedia for the wording and it states “Simply stated, assets represent ownership of value that can be converted into cash”. That was exactly my understanding of asset. What is the difference? An asset can (but doesn’t have to) be converted into cash. There is always the chance that your asset will depreciate or appreciate over time (and sometimes over night. They may and often will require maintenance (= costs). Even assets that are intangible (you can’t touch them) may incur costs, e.g. advertising to maintain a brand or defense costs for a patent. Wikipedia states that you need to be able to control an asset and that it has a positive value. The positive value comes from the fact that you can actually sell it.
That means that at the moment you buy a house, it becomes an asset, regardless whether you sell it for more or less the amount you paid for it.
So why do you confuse it with a liability? Because you (inaccurately) combine the asset of the house with the liability of the mortgage. But the house is not connected to the mortgage, except for the security function of the house. However, you can always pay off the mortgage without affecting the asset “house”. In addition, some of the costs that you list, only incur when you use the house (which represents a value (quality of living) for you). Also when you mention the cost that a house generates, especially when you actually use your house (living in it), you need to consider the ‘opportunity costs’ – the rent for an apartment. If you choose to live under a bridge, the opportunity costs are small and it would be a smart business decision not to buy the house. For the rest of us it would be an apartment with rent, utilities, and other expenses (like higher insurance premium for your car, because it is parked on the street). Meaning you need to consider what the other choice (living in an apartment), will cost you (as already mentioned by others). So the question you wanted to answer was actually: Is it a wise business decision to buy a house.
So please be more careful when simplifying a definition, so that you don’t start out with the wrong assumptions. When the starting point is wrong, you end up with the wrong results.
P.S. I just found another description for asset on Wikipedia. “An ‘asset’ in economic theory is an output good which can only be partially consumed (like a portable music player) or input as a factor of production (like a cement mixer) which can only be partially used up in production. The necessary quality for an asset is that value remain after the period of analysis so it can be used as a store of value.” — look at the last sentence: It can be used as “store of value”. That means an asset (like a car) can also depreciate without becoming a liability.
February 10, 2011
10:21 AM
I agree with the author. He’s not saying it’s unwise to buy a house, just that it is an expense and doesn’t generate cash flow.
Consider the differences between owning a stock and owning a house. You buy a stock with money you own – you don’t borrow the money, so there is very little cost (broker’s commission) compared to a mortgage. The stock doesn’t require upkeep, you just own it. The stock may generate a dividend, meaning positive cash flow into your account. Again, a house requires that you fix toilets and spend cash out instead of receiving cash like you do with stock. And then, of course, you can ideally sell stock later and make money paying just broker’s commission (as low as $4.95 per order) instead of a real estate broker’s commission – 6%, or $12,000 on a $200,000 sale.
So, maybe the author’s wording isn’t perfect, but I think his overall point stands. Home ownership isn’t the best way to invest. People should stop comparing renting to owning and start saving regardless of where they live and invest in positive cash flow “assets” like stocks, bonds, mutual funds, rental properties, etc. instead of financing luxuries with their credit cards.
February 17, 2011
6:13 AM
The real question is, why do people feel they need to live in a 3-4 bedroom house?
Why can’t people just live in a 1 or 2 bedroom Apartment or Condo?
If you compare Owning a 3 bedroom house with living in a 1 Bedroom Luxury Condo you will see a dramatic difference in cost.
A 1 Bedroom Condo or Apartment will have a Power bill of around $50 per month tops.
A 3-4 bedroom house will have a power bill of around $350 a month.
That’s $300 a month going out the door.
If you want to get rich, do what I do: Earn $30,000 or more a year after taxes and RENT a 1 Bedroom Luxury Apartment owned by a massive corporation.
My rent is only $700 a month and I never pay: Taxes, Insurance, I pay ZERO Maintenance, No lawn to mow, No roof to repair, No gutters to clean out, Even my appliances are included so if my Washer or Dryer breaks it’s not my problem. If the dishwasher breaks it’s not my problem.
My utilities are FAR LESS than a home owners. In fact, cable and Road Runner High Speed internet are INCLUDED in my $700 rent along with water/sewer, pest control. The only utility I pay for is power.
I only pay $8400 a year for a very nice comfortable place to live.
I eat the same food as home owners, I drive a nice car, I use the same internet. etc. etc.
I don’t see why so many people think they MUST have a house.