A home is a horrible investment. More so, a mortgage is a terrible investment. The obtainer of a mortgage is paying interest to get principal. That's an astonishing fact, let me elaborate. When one obtains a mortgage, they are paying let's say 5% to get their payment back. To make matters even worse, the banks have stacked the chips against the obtainer. Mortgages are front loaded to pay interest off before principal. Let's look at a scenario:
Your wife fell in love with this beautiful 3 bedroom, 2 bathroom ranch that will be the perfect starter home for your (soon to be) family. You've punched some numbers and found your monthly payment on the $250,000 home will be comparable to your current rent payment: $1,100 at the market rate of 5% after your put 20% down ($50,000). You think, "Great! Home ownership here we come!"
So you're ready to do it! Then your agent tells you your closing costs will be $4,000, your insurance will be $750 a year and property tax will be about $2,500 a year. Bummer. But at the cost of owning a home and obtaining your largest investment, no big deal. You've done it! Closed on your first home.
Month one rolls around and you write your $1,100 check. Where does that money go? Well, $850 goes to interest (rounding) and $250 goes to principal. This is great. Instead of throwing away the $1,100 expense a month like you were with renting, you got $250 in equity back. And this goes on religiously for 30 years, each month you gain incrementally, a little more equity in your house. At the end of 30 years, you are free and your expense column looks somewhat like this:
So to obtain that $250,000 house, you ended up paying $613,011 (total payments + down payment + closing costs + taxes + insurance). Ouch. For real ouch this time. But what is your house worth? It must be worth much for than you bought it for, right? Well I don't have a crystal ball but it's some output of (population growth / new home builds) mixed with a bit of psychology and location preference. Robert Shiller famously documented that home prices from 1900-2000 increased by 0.2% a year over inflation (but no one believes that). So let's be fair and say your home increased in price by 2% annually (which may or may not be the rate of inflation). Now your home is worth $452,840. Awesome!!!
On the flipside, you have to live somewhere so instead you decided to rent through the 30 year period and invest the money from the downpayment, taxes, and insurance in an S&P 500 index fund. You were fortunate to gain the historical 10% per annum over the holding period!
Over the 30 year period, your landlord (wise in the field of purchasing power) also kept up with inflation, increasing your rent 2% per annum for the 30 years bringing your total payments to $537,491. Ouch. But what about that money you have been investing? You put $54,000 down at the start (downpayment and closing costs) and continued to contribute $270 per month (taxes and insurance) Well, that little nest egg is now worth $1,457,228.
Seeing it on paper is almost surreal. The author will be the first to admit there are many assumptions in this example and a major difference between empiricism and reality (new roof, accelerated payments, renter's insurance, moving costs etc. etc.) that could skew the numbers a few points one way or another but the results provide a large margin of safety:
Owning - ($156,171)
Renting - $919,737
Over a $1,000,000 difference on that $250,000 house that your wife fell in love with. Incredible.
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