Interest rates are going up, it’s spring and homes are coming on the market. It’s time to jump in! Hold on there, buster. Buying a home today almost 10 years after the real estate bubble burst is not a no-brainer. Buying a vacation home is even more confusing. So let’s pause a bit and go through the advantages and disadvantages of owning. The decision will only be right for you, so disregard what others are saying.
Where you live matters. It often determines how and where you spend your time away from work. It can be where you go to build community or where you hide from it. It’s where you wake up to start your day and where you lie down to end it. While we all eventually habituate to what we have, feeling comfortable where you live makes a difference. In other words, finances are only part of this decision. Let’s first explore the finances and then other considerations.
When you buy a home with a mortgage, you are taking money that could go into investments and placing that in a down payment. When you calculate the costs of owning, the opportunity costs of what that down payment could earn should be included. Every month, you pay principal and interest on your mortgage; as you pay principal, your ownership percentage of your home’s purchase price grows and the bank’s percentage of ownership diminishes.
You also have other costs of owning a home such as property taxes, upkeep, maintenance and insurance. Taxes and mortgage interest are currently deductible, so the government is subsidizing these costs. The government’s share, though, is determined by your tax rate and other itemized deductions (since we are entitled to a standard deduction if we don’t itemize). To determine your annual home costs you need to add up the opportunity costs, the maintenance and repairs, insurance and the after-tax costs of property taxes and mortgage interest.
In different markets and at different times, the benefits of owning vs. renting clearly favor one or the other. If costs are the same, then owning may give you a slight financial advantage because of paying down the mortgage, but that is only if you stay in the home long enough to recover the costs of selling. There is no guarantee that a home is going to appreciate. Given the number of new apartments coming on line in the Twin Cities, I think the financial advantage today is moving to renting.
But owning a home has some nonfinancial advantages to consider. You have more control over your housing future because, while property taxes may rise, you don’t run the risk of management changing or aggressively raising rents. While you can build a community renting, it is often more transient than the community you establish when you own. You retain more authority over the things you want to do to your home. And when you own, you have a different sense of ownership than when you rent.
But homes are also anchors — psychologically and financially. You may not feel like you can leave a home that has dropped in value. You may have thought that you were buying something different from you have and now feel stuck. Here is where you can’t treat a home like an investment. If you are unhappy in your home then figure out how to get out. The financial costs of leaving may be far less than the psychological costs of staying.
Second homes are more perplexing. These are discretionary purchases, similar to a trip. There are rarely financial advantages to a second home. Using the same exercise in cost counting, you would take your total costs and divide by the expected annual nights you will be there. When you do this, most of the time you will find that you could have been financially better off renting a VRBO, AIRBNB or staying in a hotel. Second homes are really not financial decisions.
We have had a number of clients lose money when they sold their cabins. They rarely experience regret, though, because of the family memories that were created there. Some clients have created memories through annual northern Minnesota getaways to lodges or rentals, but owning the cabin often means you create more of those moments, simply because of the flexibility in getting to them and using them when you want to.
The opportunities, though, for extended-stay rentals have become far more prevalent, especially in warmer clients. Renting someone’s home for a few months is invariably less expensive, but often hit or miss. Your vacation landlord’s tastes will not be your own, so you will always feel like a guest.
Extended-stay rentals are fantastic ways to see where you may wish to spend more time. We have had clients who have purchased second homes before they discovered that they were not a fit for them and extricating themselves was costly. If you are serious about spending considerable time in another area, then I encourage you to rent before you buy. This gives you an opportunity to test drive the next stage of your life.
No matter how analytical you claim to be, homeownership is an emotional decision. Set yourself up so that you can make a happy one.
Ross Levin is the chief executive and founder of Accredited Investors Wealth Management in Edina.