The personal finance advisor frequently challenges conventional wisdom about housing.
- Ramit Sethi says that the idea that house prices always go up is financial propaganda.
- Nor does he agree with those who say that renting is throwing money away.
- Simplifications like these give people inaccurate ideas about buying a home.
“House prices always go up. You’re throwing money away renting and paying the landlord’s mortgage while you’re at it.” Chances are you’ve heard this oft-repeated financial advice before.
To Ramit Sethi, author of I will teach you to be richIt is not financial advice. It is financial propaganda. He says that renting can be a better option than buying a house and that house prices don’t always go up. He recently compared buying a house to buying a car, because the moment you make the purchase, you’re underwater.
Considering how often we hear about the importance of home ownership, Sethi’s take may seem far fetched. But he does make some good points worth thinking about, especially if he’s debating whether to buy or rent.
House prices don’t always go up
It’s amazing how it’s so widely accepted that house prices will always rise when we had a real estate crash less than 20 years ago. Real estate, like any other market, goes through ups and downs. Some experts even say that we are in a real estate recession right now.
Now, one could argue that, given enough time, house prices will go up. That’s true, but there’s a counterpoint homebuyers need to know.
The real estate market may increase as a whole, but this varies quite a bit from home to home. Some houses could double in value over the next decade. Others may only go up 10% or not increase in value at all.
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That’s the problem with the idea that house prices always go up. It can give you a false sense of security in what you are buying. When you own a home, it’s not the entire market that matters, it’s the value of your specific home. To get ahead, you need the value of your home to increase more than what it is costing you in maintenance, repairs, interest for your mortgage lender, etc.
“The moment you buy a house, you are under water”
A common saying about buying a new car is that as soon as you pull it off the lot, you’re under water. It is no longer new, so it is worth less. If you paid for it with a car loan, then you could be in debt for more than the car is worth now.
Sethi applied that same logic to buying a house, though it’s not a perfect comparison. Home values don’t go down immediately like a new car, so it’s not underwater because his house lost value. What puts you under water are the closing costs you pay when buying a home. According to Zillow, these typically equal 2% to 5% of the home’s purchase price.
As your home equity increases over time, it balances out and outweighs the additional fees you paid. Assuming your home’s value grows enough, you’ll eventually reach a point where you could make money selling it.
However, this does not happen overnight. Sethi recommends buying a house only if he plans to live there for at least 10 years. The reality, as he puts it, is that “if he buys for a short period of time, when he takes into account all the costs, he will almost certainly lose money.”
There is nothing wrong with renting or buying
Sethi sometimes gets flak for being against buying a house, but that’s not really true. He is one of the most prominent financial personalities who goes against the grain on some common advice, but also says that there is nothing wrong with buying a house. The important thing is to see if it makes sense for his financial situation and lifestyle.
Specifically, here are five guidelines Sethi recommends for deciding if you’re ready to buy a home:
- You will live there for at least 10 years. If so, you are much less likely to lose money selling your home after all the costs involved are taken into account.
- Your total monthly housing costs will be less than 28% of your gross monthly income. If they are higher, you could be overwhelmed by expenses. Sethi says that there are some exceptions to this guideline, such as if you live in a high-cost-of-living area.
- You’ve saved a 20% down payment. It’s possible to buy a home for less, but Sethi recommends this number to get you in the habit of saving and avoiding private mortgage insurance (PMI).
- It’s okay if your home value goes down. The price of your house may go up, but if your primary goal is investing, an index fund could give you a much higher return.
- You are excited about buying a house. Buying a house should be something that makes you happy. If you do it because people pressure you, you better keep renting.
If you want to buy a house and it fits your situation, great! But if you’re perfectly happy with the rental, or it’s a better fit for you right now, there’s nothing wrong with that either. Base your decision on what works best for you, not clichéd advice or what other people think you should do.
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