This article is a guest blogger submission written by ‘frugal’ and first published at 1stMillionAt33. If you like what you see, why not subscribe to his RSS feed?
Well, I should really qualify the title of this to specify not buying the home in a bubble. Whether our current housing market is a bubble or not is debatable. Under normal circumstances however, buying a home is usually your best investment. And the reason is inflation. Historically, housing price tracks inflation fairly well. Since inflation is seldom zero, or negative, buying a home is a financial transaction that has two very big advantages, assuming that you acquire the home with some amount of mortgage.
1. Leverage: A leveraged transaction means that your return (or loss) is magnified by the amount of leverage that you use. In a leveraged transaction, you use a lower amount of cash to take control of a much bigger asset with debt. If the asset goes up in value, then you are rewarded with extra returns.
2. Inflation: Your home value is almost guaranteed to go up in value in a very long term perspective (I’m talking about 10+ years) because of inflation. Since you repay your mortgage debt by cash gradually, the debt burden actually goes down as your wages experience inflationary increases. $100K owed now will be less burdensome 10 years later, even if you have not paid down a cent in principal. Inflation is the best for debtors, but worst for creditors.
3. Tax: At least in the United States, federal tax laws clearly have a preferential treatment for homeowners. You can deduct mortgage interest which is also AMT-deductible. You can also (possibly) deduct the use of your home as a home office. Property taxes are deductible, too. And the best thing is that capital gains on the home are usually tax-free under $250K for singles, and $500K for couples.
Thus, real estate is often touted as a good investment because it is really true, with the following assumptions:
1. You didn’t buy it in a bubble.
2. You have sufficient positive cash flow to carry you through enough years for inflation to increase your return.
3. You can take good care of the home or property.
I have constructed a Rent vs Buy calculator for you to experiment the outcomes of the two choices.
