A Torrey Honors alumnus, Micah Snell, posted this interesting piece in an online forum arguing that in many circumstances the conventional wisdom of taking out a large loan for a house might not be wise at all. His blog can be found here, and the post is pasted below.
"Owning property is a very good thing and the US govt provides lots of incentives to do so.
"However nobody should enter into home ownership lightly because the stakes are very high and there's plenty of potential to lose a lot of money.
"Home loans are configured so that in the early years of the loan practically NOTHING of your payments goes towards the principle amount of the loan. It all goes to interest. If you sell in ten years you have paid no substantial amount towards the amount that you actually owe, it's more that you've paid for the privilege of owing the lender money. Over time this balance is reversed and towards the end almost all of your payments go towards principle. However the typical home loan is a 30 year loan and the typical home goes on the market every 8 years, and this would infer that the average home owner is not earning significant equity by paying the loan off. There are of course exceptions and ways to win at doing this.
"So, money paid as loan payments doesn't all come back with the sale of the property. And, every time you start a new loan the process starts over. Only old loans are cost effective. Further, if you pay off your loan according to schedule it's typical to pay multiple times the sale price of the home in interest and principle payments. If you did pay it off and then sold it, even in SoCal it takes a lot of doing to sell a house for three times what you paid for it, and even if you did you'd only be breaking even on what you've paid the lender.
"Many people, especially in CA, get their equity from appreciating property values, but again this is only an effective strategy in the long term unless you're really smart about playing the game. Otherwise the cost to buying and selling is so substantial that realtor fees, maintenance, etc. can eat a significant chunk out of your profit. I fear the recent hot market has led many buyers towards impending doom.
"And there are some perks to renting: If a pipe blows in your wall and does $30,000 worth of damage you're not out $30k. You don't have to wonder if an earthquake is going to destroy your most expensive asset. You don't have to worry about maintaining it so that it keeps its value. If you have a personal crisis and have to default on payments you don't lose whatever you've paid towards a loan. If you want to move or trade up the cost is minimal. One of the smartest financiers I know refuses to own a home because of the hassle and worry involved.
"Owning a home is great and offers a lot of really wonderful advantages financial and otherwise. One of my higher goals is to own a home free and clear. But it's not all white picket fences and there are important reasons to know what the cost of your investment is relative to your benefit."
