When you’re young, the idea of owning a home may seem like an impossible task. But for many, the concept gets more appealing as you get older—especially if you have a growing family.
With that in mind, is buying a house a good investment, or does it make more sense to keep renting?
Keep reading to learn all about the benefits, risks, and costs involved with homeownership, so you can determine if it’s the best investment move for you.
The hidden costs of homeownership
As a homeowner, you’re going to lose more than you bring in at first. But don’t let that scare you away, because it can also be one of the best personal finance decisions of your life.
Here are some of the top costs that you can expect when buying a home.
- Closing costs
- Upkeep and maintenance costs
- Homeowners insurance
- Fluctuating home prices
- Mortgage insurance
1. Closing costs
One of the hardest parts about buying a home is coming up with enough cash to cover closing costs, which typically run anywhere from 2 to 5% of the loan principal.
Closing costs may include inspections, appraisals, title transfer fees, title insurance, and property taxes, to name just a few examples. They can cost tens of thousands of dollars.
Homeowners typically have a few options when paying for closing costs.
The first and most recommended is to pay them in full at the time of closing if you can afford to do so. Alternatively, you can bundle closing costs into your mortgage, but this means driving up the loan’s overall cost and higher monthly mortgage payments.
Simply put, closing costs are required for purchasing property, and you’ll have to pay them whether or not your investment property makes money.
2. Upkeep and maintenance costs
Your closing costs and down payment are in the rearview, and you’re now living in your new home. (Or, you are the landlord for your rental property).
Now is when the real fun begins with maintenance and repair costs.
As the homeowner, the responsibility is yours to pay for repairs and property maintenance, which can add up quickly. New appliances, roof repairs, landscaping, and plumbing issues can pop up at any time.
There are two leading schools of thought when it comes to determining how much money to set aside annually for home repairs.
The first is the one-percent rule, which says you can expect to pay approximately one percent of your home’s value annually toward home repairs. So, if your home is worth $300,000, you can expect to pay at least $3,000 for annual repairs and maintenance.
Another way to calculate your home’s expenses is the $1 per square foot rule, which states that if your home is 2,000 square feet, for example, you can expect to pay at least $2,000 annually for repairs.
Of course, these are low-ball estimates. If you need a new boiler, or septic tank replacement, you can expect to pay much more. Your best bet is to set aside as much as you can so you never have to worry about going into debt over an unexpected repair bill.
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As I like to say, time is more valuable than money.
Many first-time homebuyers overlook how much time it takes to maintain and run your home. The fact is that purchasing a home or investment property can significantly eat into your schedule. Unless you hire people, this means you’ll have less time to spend with your family and focus on revenue-generating activities.
Owning a home can also make it harder to travel or participate in fun activities. I’m talking about spending your weekend raking leaves or shoveling snow, instead of going to the beach with your friends.
Of course, time spent around the house can also be rewarding and fun. It all depends on your mindset and how you want to spend your time.
If chores like chopping wood or painting the deck excite you, then you might be ready for the responsibility. If not, you might be better off renting or paying others to take care of things for you (which of course means higher maintenance costs).
Utility costs, including gas, electricity, heating oil, cable TV, and internet services can quickly run a few hundred dollars each month.
Be prepared to pay for all of these things, on top of your mortgage, plus maintenance expenses. In some regions, you have a variety of options when it comes to TV and internet providers. In others, you have no choice but to sign up for the only provider available in the area, and it may be more expensive than you anticipated.
Before buying your next home, make sure to get a firm understanding of your monthly utility costs so that you can factor them into your monthly budget.
5. Homeowners insurance
Most mortgage lenders require borrowers to carry homeowners insurance, a form of property liability coverage that covers your home and its contents.
The cost of your homeowners insurance policy will vary depending on your property’s location and value. On average, you can expect to pay between $600 and $2,000 annually (or from $50 to $166 monthly) for homeowners insurance.
Residents of areas prone to flooding or other natural disasters should expect to pay even more.
6. Fluctuating home prices
When you buy a house, the hope is that you can eventually sell it for a profit. In some cases, this can happen in only a few years. In other cases, it can take decades, or it never happens, and the purchaser takes a loss.
Real estate market fluctuation occurs due to a variety of circumstances beyond your control.
Take the pandemic, for example. Urban home prices—which were previously on the rise—were negatively impacted. Meanwhile, suburban areas—which were previously on the decline—started going up.
As with stocks, you only lose money when you sell. So it helps to have time on your side and avoid situations where you are forced to sell. If you are forced to sell at a bad time, you can easily lose tens of thousands.
7. Mortgage insurance
Private mortgage insurance (PMI) is a form of insurance that lenders often require when a borrower has less than a 20% down payment saved for a home. The cost is typically included in your monthly mortgage payment and ranges between 0.5% and 1% of the annual mortgage amount.
Lenders require PMI because, according to their calculations, borrowers with lower than 20% equity are at a higher risk for default (i.e., not paying their loans back).
Mortgage insurance exists solely to protect the lender from a default, and it is usually required until the borrower achieves 22% equity in the home or six years passes (whichever occurs first).
Looking at the numbers, if the loan amount is $400,000, a borrower can expect to pay from $2,000 to $4,000 annually for PMI, or $166 to $333 monthly. The worst part is that this expense does not contribute toward your equity in the home.
Signs you’re ready to be a homeowner
Buying a home isn’t for everyone. Use the following checklist to see if you’re ready to take on the responsibility.
You have a steady cash flow
This is a no-brainer. If you don’t have a steady job, buying a home can be very risky. In fact, you probably won’t be able to secure a loan if you can’t demonstrate a steady employment history.
You have money in savings accounts
It’s also important to have money socked away to cover closing costs, ongoing maintenance, and emergency expenses. The more money you have put aside in the bank, the easier it is to secure a loan and meet your ongoing monthly expenses.
Your investment portfolio is diverse
Stop and think about how your house aligns with your overall financial portfolio. Hopefully, you also have money set aside in the stock market through an IRA, 401(k), or brokerage account.
Real estate investing should only be one branch of your investment tree. The last thing you want is to have all of your money tied up in a property investment that crashes.
Whether you’re new to investing, an experienced trader, or somewhere in between, Ally Invest offers many different account options, no minimum to open, and some of the lowest commissions in the industry.
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You aren’t drowning in debt
Taking on a mortgage with excessive credit card debt or student loan debt is not advisable. This can make it extremely difficult to make monthly payments, potentially causing you to fall behind and spiral deeper into debt.
If you’re in consumer debt, focus on paying down your balances and fixing the behavior that got you into trouble in the first place.
You can stick to a budget
Sticking to a budget is critical for success when buying a home. Expenses are going to come at you left and right and the only way for you to manage them all is by staying on top of your monthly cash flow.
Practice budgeting before you apply for a mortgage so you can get a sense for how much house you can afford.
How to maximize the ROI for your home
Here are a few strategies to consider that will hopefully increase your chances of profiting from your next home purchase.
Find the right deal
Think strategically about the house you’re buying. Often, homebuyers go in with a certain set of expectations (e.g., being in the best location, or having the perfect yard or two-car garage). And as a result, they often wind up spending too much money.
As a new homeowner, you don’t necessarily need to find your “dream house.” Rather, you need a property that meets your key criteria and housing needs at the present time and for the next few years.
Unless funds are no issue for you, you may have to sacrifice having a designer bathroom, for example, in exchange for being in an area with a top-rated school system. With that said, many real estate experts would suggest that you place an equal value on the quality of the neighborhood as you do on the home’s features. All of these things can make a big difference when it’s time to sell.
Most likely, you will be better off having a decent house in a good neighborhood than having a top-of-the-line house in an undesirable area.
Find the best realtor
In your quest to find the best deal, there is no better sidekick than your realtor.
Don’t settle for just anyone. Working with a top-selling realtor in your target housing market increases your chances of finding the best home at the best purchase price.
Not only can your realtor make your home search process much easier, but they can also connect you with local contractors and other resources you might need.
Find the best mortgage rate
The mortgage interest rate you pay has a major impact on your real estate investment’s success. When applying for a home, make sure to shop around and get the best rate available to you.
At the time of this writing, interest rates are close to an all-time low. If you aren’t happy with your current rate, you might want to refinance, which can save you many thousands over the course of your mortgage loan.
Furthermore, during the period of time before you apply for a home loan, make sure not to take any steps that might damage your credit score. Avoid opening up or closing any lines of credit.
The months or years before applying for a mortgage are also your best chance to pay down any debt. All of these things impact your credit score, which in turn affects your mortgage interest rate.
Maximize tax deductions
When you buy an investment property, there are many things that you can claim as tax benefits. For example, building a new staircase or putting a fence in the yard can count as capital improvements, resulting in annual tax breaks.
Fewer items count as tax breaks when you own your primary home, but you can still make some deductions.
For example, if you work from home or run a home-based business, you may be able to deduct home office expenses such as your phone and internet bills. You may also be able to deduct an amount based on the square footage of your home office.
Before you write anything off, check with your accountant to ensure you won’t be waving any red flags at the IRS.
Homeownership vs. investing
For starters, it’s important to understand that buying a home is technically a real estate investment. After all, you’re most likely taking out a massive loan to buy a piece of property, and then you agree to pay this loan down over the course of your mortgage (usually 30 years).
This money could otherwise be invested in the stock market, for example, but you still have to live somewhere.
If you buy a solid property in a prime area, there is a good chance you will earn a profit down the line when you sell it. You will also enjoy the peace of mind that comes with owning your own home and making something your own.
However, there’s a big difference between buying a primary home and buying an investment property.
When it comes to owning your primary residence, the goals should be stabilizing your living expenses and improving your quality of life, both of which are usually attainable. You might also make some money on it.
With investment properties, the goal is purely to make money, which can be risky, but it’s also doable.
Alternative real estate investments
Once your primary home is covered, you can start exploring alternative real estate investments. Here are some of the more popular options to explore.
A rental property is a type of investment property that generates passive rental income on a monthly basis from renters.
Some rental properties are homes, while others are storefronts, industrial facilities, or office spaces.
Rental properties offer great tax incentives, allowing you to save money while bringing in steady cash. They can also be risky and can take a lot of work to maintain.
Fix and flips
A fix and flip is a type of investment property that you buy with the intention of fixing it up and selling it for a higher price, usually within a short time frame. Your real estate agent can be your best resource for finding a low-cost home that you can improve and sell for a profit.
Real estate investment trusts (REITs) allow you to invest in real estate without actually purchasing the property directly. They are offered as shares by publicly traded companies that buy and sell commercial real estate.
REITs can be a great way to dabble in real estate investing without having to take on all of the risk or hefty upfront costs.
Frequently Asked Questions
Is it hard to invest in real estate?
Real estate investing can be very hard if you’re inexperienced or lack sufficient funds. However, it can also be easy if you find a great opportunity and have the means to pull it off.
All real estate buyers are different and it’s important to think about your situation and capabilities before you dive in. Purchasing real estate is a big decision, regardless of which option you pursue.
What is home equity?
Home equity is the amount of your home that you own in comparison to what the lender owns.
As you make mortgage payments over time, your equity—or ownership stake—increases as the loan balance goes down.
Generally speaking, the more equity you have, the better. This is why it’s advisable to save up a 20% down payment so that you are already walking into your home with a solid amount of equity.
What is a primary residence?
A primary residence is an official address where you live for most of the year. It’s also where your state and property taxes are based.
When applying for a home loan, one of the first questions the lender will ask is if you intend to use the home as a primary residence. In short, it’s much easier to secure a loan on a primary residence than it is to get financing for a second home or investment property.
The Bottom Line
Buying your first home is a quintessential component of the American dream. But remember that this is a big financial decision that you shouldn’t rush into. As you can see, the process is expensive, and it’s not likely to make you rich in the short term.
However, owning your own home (or an investment property) might be one of the best long-term investments you can make. That’s because, with each mortgage payment, or rent payment from your tenants, you’ll be increasing your net worth.
Here’s to finding the home or investment property that fits within your budget and helps you build wealth!