Buzz
You’ve paid off your debt and now you’re focusing your funds on your next major financial milestone: buying a home.
For years, the common belief was that as you grow up, you should purchase a home because that's simply what you're supposed to do. However, more recently, people have begun to realize that it may not always be the best financial choice. The housing crisis during the Great Recession has played a significant role in this shift, causing many to reassess the idea that owning a home automatically means financial security.
Check out the video below for more insights on buying a home:
How can you determine if buying a home is the right choice for you? Should you purchase a house or continue renting?
Homeownership isn’t inherently good or bad. Like many financial decisions, it all depends on your personal circumstances. At times, buying a home is a smart move; other times, it may not be. Whether it’s the right decision for you will hinge on several factors. Here are key things to consider.
Don’t treat a home as your primary investment
The main argument for owning a home is that it serves as an “investment.” However, many people overestimate the returns from this investment.
Many assume that homes appreciate in value over time, but this isn’t always the case. Yale economist and Nobel Prize laureate Robert Shiller has publicly discussed this, having analyzed the data. His conclusion is that, in general, the housing market doesn’t provide a strong long-term return. It only slightly outpaces inflation. He shared this insight with USA Today:
If you examine the history of the housing market, it hasn’t been a strong source of capital gains. Instead, it has mainly provided housing services... Capital gains haven’t even been positive. Between 1890 and 1990, real inflation-adjusted home prices stayed nearly the same.
In 2014, The Washington Post looked at Shiller’s data and reported that over the previous century, home prices increased at a compound annual rate of just 0.3%, adjusted for inflation. Meanwhile, the S&P 500 had an annual return of 6.5%. That’s a significant difference.
While that single real estate asset might offer some protection against inflation, a diversified stock and bond portfolio appears to be a more solid investment. Yet many people’s portfolios are largely made up of their home’s value. You wouldn’t allocate 80 percent of your portfolio to bonds just to guard against inflation (unless perhaps you were nearing retirement), so why let your home account for such a large share? That’s the case against viewing a home as an investment.
It’s still possible that you could time the housing market perfectly and sell for more than Shiller’s data suggests. But most experts agree: while housing can be an investment, it’s not a great one. So, if this is your primary reason for buying a home, it’s likely not the best one.
Determine what you can afford
When deciding if you can afford to buy a home, you need to determine how much home you can actually afford in the first place.
A common guideline to estimate this number: Your home should cost no more than 2.5 times your income. Naturally, this is just a rough estimate. It doesn’t account for your net worth or other financial goals you might have.
Once you have a clearer idea of the amount you're working with, you'll be better equipped to assess whether buying a home is the right financial decision for you.
Consider the opportunity cost of renting versus buying
While your home may not be the best investment, at the end of the day, it’s still yours. Even if it just barely beats inflation as an investment, you own it, and that ownership holds value.
When you rent, you don’t own anything—the rent money goes to someone else. This leads many people to argue that buying a home is better because eventually, you’ll own it outright instead of paying rent forever.
This argument highlights opportunity cost: the value of what you forgo in choosing one option over another. By renting, you miss out on owning an asset. Even if your home doesn’t appreciate faster than inflation, you still have an asset—your house—that reflects all your financial contributions.
But the situation is more complicated. You must also think about the opportunity cost of buying. There’s the down payment, closing costs, and mortgage interest payments. What is the opportunity cost of those? What could you potentially earn by investing that money in the market instead?
At times, renting and investing can actually yield better financial returns over time than buying. But whether or not this holds true depends on a few important factors:
Your rent cost: If your rent is less expensive than a mortgage for a similar property in your area, you could invest the difference and potentially earn a higher long-term return.
Down payment and mortgage interest rate: The same logic applies here. If you invested $50,000 instead of using it for a down payment, and also invested the mortgage interest you would have paid, how much more would you have in the long run? In some cases, you could end up with more than the value of your home.
Where you live: The housing market is influenced by many variables, and where you live plays a significant role. Your rent and home prices may differ greatly from national averages.
The New York Times offers a helpful interactive calculator that takes all factors into account. Enter details like home price, interest rate, housing growth rate, closing costs, rental expenses, and more, and it will provide a comprehensive breakdown of costs and opportunity costs.
Most rent vs. buy calculators typically focus on how much you’ll save based on the home’s appreciation, along with your down payment, interest, and monthly payments. However, this one incorporates opportunity costs, which makes a significant difference.
Factor in your total net worth
Many experts suggest that your home should account for only 20-40% of your total net worth. Ideally, as you expand your portfolio, your real estate investment will shrink, but this percentage may rise again as you approach retirement. This is a broad guideline, influenced by factors such as age and risk tolerance.
As previously mentioned, the key point is: Your home should not be your most significant asset. You shouldn’t drain all of your savings, especially your retirement funds, just to become a homeowner.
If this seems too extreme, at the very least, ensure you’ve built a solid emergency fund before purchasing a home. You’ll also need to save for various unexpected costs—maintenance, home decor, renovations, and other unforeseen expenses.
Steer clear of becoming “house poor”
We’ve discussed adhering to the 20% rule. This is a general guideline suggesting that you should wait to buy a home until you can afford a 20% down payment. Here’s why this rule makes sense:
You won’t need to pay private mortgage insurance
You’ll borrow less, resulting in smaller mortgage payments
You’ll likely secure a lower interest rate (or at the very least, pay less in interest overall due to a smaller loan)
It ensures you can genuinely afford the home
However, some believe this rule is too stringent and that putting 20% down is excessive for a home purchase. The case against the rule:
In some regions, homes are so costly that affording a 20% down payment is unrealistic for most people.
It might be wiser to contribute less upfront and invest the difference elsewhere.
It could be too large a portion of your net worth to lose all at once. The goal is to avoid becoming house poor.
Whether you put down 20% or not, the concern about becoming “house poor” is legitimate. You don’t want all your assets to be tied up in your home, which is exactly what happens when you’re house poor—unable to cover your living expenses because your money is all in the house.
For the first and last points, one could argue that you should simply keep renting and saving until you can afford to put down 20% (and still comfortably manage your monthly bills).
Clearly, after your down payment, you need enough to cover both your mortgage and other ongoing costs. But beyond just scraping by, it's crucial to ensure your overall financial security. That’s why considering your net worth is so important.
And as we’ve mentioned before: You don’t have to buy a home. Don’t compromise your financial well-being just to purchase a house for emotional reasons or because society expects it.
No matter what rule you follow to determine whether you can afford a home, the main point remains the same. It’s often wiser to rent than to fall into the trap of being house poor. The stress of living paycheck to paycheck is just not worth it.
Of course, aside from financial concerns, your long-term aspirations also matter. If there’s a strong likelihood you’ll sell the house in five years, renting is probably the more cost-effective option (and most rent-vs.-buy calculators will confirm this). Whether you’re moving for work, needing a larger space for a growing family, or for other personal reasons, your unique milestones should influence your choice.
In the end, purchasing a home is a personal decision that requires careful consideration of your situation. Homeownership isn’t automatically a smart or poor choice—it really depends on your personal circumstances and financial standing. But weighing these factors should help guide you toward making the right decision for yourself.
