Thursday, July 19, 2007

Economics of Homeownership

The naive thinking in this kind of article is just poor economics. It's the way most people think though. Yes it's true that the homebuyer's mortgage payment falls in real terms over time and eventually goes to zero while the renter's rent will rise over time. But:

1. Property taxes and maintenance will rise with inflation over time just like rent.

2. As you pay down the mortgage you tie up capital in the house. This capital has an opportunity cost in foregone investment returns. This implicit cost never goes away.

3. The value of the house may rise over time but so will the value of alternative investments.

The bottom line is that there aren't many free lunches out there... A renter does need to invest the cash that would have gone into principal payments in an investment that can in the future pay their rent. Such an investment may be risky but need not probably be very risky in order to keep up.

Home ownership is beneficial if someone enjoys the control of owning their own home (in terms of remodeling etc. and not dealing with a landlord) and/or finds it hard to be disciplined to save the money that would have gone into paying off the mortgage.


Anonymous said...

however, tax treatment for home equity is much better than a normal taxable investment account.

mOOm said...

We're going to need some very detailed scenarios to really investigate the different options and their implications. Maybe I'll do that some time.

Adventures In Money Making said...

A home is not an investment.

When the people say their home is their best investment, it only means they don't have any other investments.

You buy a house to establish your roots, to start a family, to decorate according to your whims, and basically to actually "live life" in.

Its nice that the government provides an economic incentive via tax-breaks, but that should never be the underlying reason to buy a house.

I think most of the articles written on buying vs renting are crap.

mOOm said...

The Austalian government treats an owner occupied house purely as a consumption good. There is no tax break for interest but no capital gains either. It's not counted as an asset when seniors try to claim benefits either. The age pension is means tested. The latter is problematic perhaps as the age pension is set so low it pretty much requires you to own a house to avoid paying rent.

It's interesting you mention roots. I guess I never had much sense of that or lost it early on. I like to feel I could be mobile rather than put down roots. In practice in the last decade I've lived in the same apartment for five to six years at a time. I'm glad I don't have to sell a house now and just tell my landlord I'm going. I can't see why I couldn't have a child in a rented house too. This is different in some countries that have poor rental markets like Israel.