Robert Kiyosaki was the first and has been the only
financial pundit to suggest that your home is not an asset.
As they so often do, Kiyosaki's statements fly in the face
of prevailing financial wisdom.
David Bach, author of Automatic Millionaire, not only says
that your home is an asset, he asserts that home ownership
is the first wrung on the ladder of wealth creation in
America. He encourages everyone to buy a home as soon as
possible to begin building their wealth.
CNN Money does their Millionaire in the Making profiles and
I am shocked to find that in almost all cases 50-75% of the
wealth of the families profiled is locked in their home.
Given that people have to have a place to live, this is a
problem.
Does home ownership produce wealth or are wealth and home
ownership produced by sound wealth-producing financial
habits?
The Economist, tracking real estate over the past decade,
has concluded that the economics no longer support home
ownership.
I bought my first home in 1991. The housing market in the
North East had not recovered. The savings and loan
collapse of the mid 1980's depressed home prices and
brought the condo market to a halt. Multiunit condominium
properties were vacant. Many of the properties continued
to sit vacant because banks had strict owner occupancy
ratios for condominiums. Mortgage money was tight.
First-time home buyer programs were coming on the market
and the minimum down was ten percent. I was raised to
think that a home was an investment. My mortgage broker
sat me down and said, "it is best that you think of your
house as a roof over your head, not as an investment."
That was incredible advice. Prices dropped another 10%
after I moved into my home. After 3 years of living in my
home and 2 years of renting it out, I sold it for what I
paid for it. After closing costs and realtor fees, I
received a check for 447 dollars, significantly less than
the $14,000 dollars that my family gave me for closing
costs and the down payment. I always intended to pay them
back with the proceeds from the sale. All told the housing
market was depressed in the North East for over 10 years.
Even in an appreciating market, home ownership is no
bargain. And a home is not an asset.
Let's tackle the issue of equity as a component of wealth.
Let's say you buy a $100,000 home and put money down. That
down payment is 20%. In real terms at the time of closing
you have 20% equity in your home. If you had $20,000
dollars in your bank account, you had $20,000 in wealth.
If you move that money to your home in the form of a down
payment, you may have $20,000 in wealth as long as the
market at least stays flat. For this illustration, we will
say that is the case. You have $20,000 wealth stored in
your home. Now what can you do with that?
If you borrow against your home, you erode your equity and
your wealth. If you sell your home and get your $20,000
back, then what? You have to live somewhere and living
somewhere costs money. The equity in your home is
essentially dead. You cannot do anything with it. Sell
your house and you reinvest that money into a new home,
borrow against your equity and you lose it.
In short, the equity in your home, once in your home, will
remain there. Useless to you in real terms. That equity
will do something that is quite dangerous, however. It
will cause you to feel wealthy, wealthier in fact than you
are and spend money, money that you, in reality don't have.
It might be helpful if I defined an asset here. Kiyosaki
calls an asset anything that retains or appreciates in
value that pays you. For Kiyosaki a house does not fit
that definition. I define an asset as anything that retains
or appreciates in value that I can sell and dance around my
house throwing the proceeds of the sale in the air and have
a jolly good time. Can't do that with a house because,
once again, I need someplace to live.
Someone might say that they want to downsize. Sell their
home, pick up something smaller and bank the rest of the
profits.
The numbers don't add up. One of the columnists for the
WSJ wrote that he doubted that he had made much money on
his home although it was valued at half a million dollars.
He had lived in his home for 10 years and paid just under
$300,000 dollars for it. When he factored in taxes,
insurance and maintenance, he figured that he broke even.
Broke even!
What that means is that he actually spent the $200,000 on
his home in other ways and the sale of the home would just
result in returning that money to him. Two hundred
thousand dollars equity and wealth gone when you actually
look at the numbers. So much for great profits! So much
for down sizing and banking the difference.
Here is an example of what happens when you refinance or
draw equity out. For the amount of time that I have
actually lived in my home I have made $82,800 dollars in
payments. These payments went primarily to interest so
let's deduct the top tax rate. The top tax rate is the
best-case scenario, a lower tax rate means you deduct less
and pay more. Deduct $27,324 and get $55,476. Taxes and
insurance paid amount to $20,460. Now the total paid is
$55,476 + $20,460 = $75,936. Maintenance, landscaping,
updates, repairs total $29,779. Add the two, $75,936 +
$29,779 and get $105,714. I refinanced the house in order
to take money out and buy my first investment property.
Add in the unpaid mortgage balance and the total owed, paid
and put into the house is $188, 715.
Critical concept: Improvements on a home don't necessarily
increase the value of that home. Every neighborhood has a
trading range. The trading range for an area is based on
location, size of the homes in that area and amenities.
Homes will trade at the high end or low end of a
neighborhood based on those factors. If my home sold for
$170, 000, the financial gurus would say that I have
$87,000 dollars of wealth based on the difference between
the unpaid mortgage balance and the sale price. Because you
have seen the numbers, you know better. In fact I lost
$18,715 dollars. When I take into account the money I
borrowed out to buy my first investment property, I broke
even. I am assuming that I sell my home myself. Using a
realtor would increase my losses by 6% of the sale price.
How can I call home ownership the greatest financial scam
of the 20th century? I call it a scam when you buy
something (a house) expecting it to lead to something
(wealth) when that purchase can in no way produce that
result. I call it a scam when the brokers who sell you the
house know it won't.
Sound financial habits will lead to wealth but home
ownership in and of itself will not. Home ownership can in
fact lead to poverty as people struggle to make payments
and find that they are unable to maintain their homes.
Sell and they risk owing more than the home is worth. Stay
and their standard of living is reduced to pay for the
house. Sounds like a winning formula for wealth to me.
While 20% of the homes in this most recent real estate
bubble went to investors who were speculating in the
markets, 80% of the homes went to people who believed that
home ownership, not sound financial habits, were the first
wrung on the ladder to wealth creation. They just believed
what the gurus, the realtor, the mortgage broker and the
banker told them. In a consumer society where everything
is reduced to the lowest common denominator, they believed
that a home could be purchased for little more than a
moderately-priced flat screen TV and that down payments
were a nuisance. They did not understand that as a worse
case scenario, down payments are actually insurance against
downside fluctuations in the housing market. Many people
are finding that instead of the wealth they expected, they
have a financial nightmare.
Perhaps moving forward into the 21st century, we will
decide that sound financial habits and financial education
are the first steps on the road to wealth. Maybe we will
decide that wealth is created through work and due
diligence and not by betting on the financial product of
the day.
----------------------------------------------------
Ouida Vincent is an active real estate investor and
entrepreneur who has watched her friends and family members
struggle under the burden of home ownership in today's
market. She is launching
http://www.freeagentnationonline.com to promote financial
education and entrepreneurism.
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