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Buy a House?

IS A HOME a good investment? We’re talking here about purchasing a place for your own use, rather than as a rental property, though many of the same issues arise.

There are two key factors to consider. First, there’s a question of time horizon. Because of the hefty costs involved in purchasing and especially selling a house, few people would advise buying if you have less than a five-year time horizon—and even that’s arguably too short. Think about it this way: The roundtrip cost to first buy and later sell a home might be 10% or more of a home’s value. To make money on a house, you need enough price appreciation to offset that cost. That’s tough to do over a short holding period, unless you get lucky.

But let’s assume you foresee staying put for a good long time. That brings us to the second issue: Is buying a house a good use of your money? It’s tough to calculate the return on homeownership because there are so many moving parts, including any mortgage debt, the cost to buy and sell, and ongoing expenses like property taxes and maintenance.

Still, as you ponder the return from homeownership, it’s helpful to keep three basic notions in mind. First, as the owner, you benefit from all of a home’s price appreciation, no matter how large your mortgage. That’s the good news. The bad news? The larger your mortgage, the more you’ll pay in mortgage interest. The upshot: A mortgage can leverage a modest down payment into big gains in home equity—but those gains in home equity are often offset by the mortgage’s cost.

Second, homes have historically appreciated slightly faster than inflation. But once homeowners deduct property taxes, maintenance costs and homeowner’s insurance from that price appreciation, they’re often barely breaking even.

Third, the one sure gain from homeownership is the ability to live in the place. This is what economists call “imputed rent.” Moreover, the value of this imputed rent typically goes up every year, and yet homeowners don’t face the regular rent increases imposed by landlords on their tenants.

Where does that leave us? Home price appreciation—even when leveraged by mortgage debt—often proves to be disappointing, once you figure in all the costs involved. But owning a home still has two key advantages. First, you lock in your housing costs, rather than facing endless rent increases. Second, a mortgage is a form of forced savings, as you’re compelled to pay down a huge loan over 15 or 30 years. Thanks to those two benefits, real estate has proven to be a winner for many American families—provided they own their home for a good long time.

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