In Y2K I arrived in Seattle for a new job and immediately set out to buy a house. I have no idea why; I was just following the rules society had laid out.
I had just received an offer on my Chicago area house for 178k. Houses close to work started at $550k. I was experiencing major sticker shock.
Price forced me to widen my search to nearby commuter communities, where I found a great looking house in a nice neighborhood. It had easy highway access, a nice view from the upstairs office, and was barely in my price range at $292,500. Nearby was a newly constructed office park that would attract potential future buyers, and an elementary school in a good school district was a 5 minute walk up the hill
With a 20% down payment of $58,500, I had just purchased the biggest house I could afford, the smallest house in a good neighborhood. Remaining in my bank account was a lonely $20.
5 years later, I sold this house for $394,500, a gain of $102k! At the closing, I received a check for $143,842.
In just 5 years, the house had increased in value by 35% and I nearly tripled my down payment. Leverage is awesome! Over the same period, inflation was up only 14% and the S&P500 was down 11%. Those people who say houses are a terrible investment are idiots! But not me, I was some kind of Real Estate genius!
And I’m not the only one, these stories are everywhere. Ask anyone if you should rent or buy, and you will hear success stories even greater than this one.
But seldom do you hear the whole story.
The Rest of the Story
There is a lot more to purchasing a house than just making a down payment.
The list of fees is long and nearly incomprehensible. Many of them aren’t even clearly disclosed until you are sitting in an escrow office signing 80 different sheets of paper with onerous terms. You want my first born? OK. My kidneys? Sure. My dignity? Be my guest.
A list of fees is boring stuff to read. But in this case, I must insist.
Loan origination fee: $2,340
Title Insurance: $556
Settlement or Closing Fee: $510
Appraisal Fee: $410
Application fee: $375
Tax Registration Fee: $80
Sales Tax: $44
Recording Fees: $26
Credit Report: $21
Flood Determination Fee: $19
Courier Fee: $17
Sales Tax: $2
And of course, they don’t just get you coming, they get you going too
Buyer’s Agent Commission: $11,685
County Tax: $6,933
MLS Listing Fee: $495
City Tax: $250
Sales Tax: $56
County Fee: $42
Over $21k to sell a house? WTF? I had no Seller’s Agent Commission, because I did all the work myself. Hiring a Realtor would have increased my sales expenses by another $11,685 (over $5k/hour, good work if you can get it)
Once you move in, the expenses are just getting started. A washer and dryer weren’t included in the sale, regular maintenance must be done or the value of the house goes to zero, and I made a few changes to improve energy efficiency.
A common estimate for maintenance expenses is 1% of the home value per year. I did 90% of my own labor, and spent ~3% of the purchase price ($9,225), although I’ve surely
forgotten suppressed some expenses.
Bonus: During the purchase inspection, rotten siding was discovered where water had seeped into a gap in the metal flashing near the fireplace. Repair estimates averaged $5,000. The Buyer’s Agent very much wanted this to be a credit at closing, “so as not to impact the neighborhood resale value.” I think she was more motivated by the 3% commission on that $5k. Negotiating it as a reduced sales price saved me over $250 in commission and taxes
Part of the payment received after the sale was the return of principal payments, the portion of the mortgage payment often referred to as “forced savings.” In my case, this was $15,949.89
After including all fees, all real expenses, and return of principal, my incredible gain of $102k looks much smaller at $55,767
But hey, I still doubled my money! How cool is that?!
But again, this isn’t the whole story
The Cost of Excess
What does a single guy need with a 3 bedroom + office, 2.5 bath, 2,000 sq. ft. house with a 2 car garage?
I probably lived in 500 sq. ft. of this house. I used the home office, where I kept my computer and guitar. I used 20% of the Master Bedroom and 50% of the Master Bath. I used the refrigerator, microwave, and oven often, but the dining room only once.
My car and motorcycle each had 5 feet of empty space around them in the garage. There was a shovel in the corner and a few cobwebs
Unused space costs time and money. I couldn’t heat only 20% of the bedroom and 50% of the bathroom. I couldn’t clean only part of the house.
Energy bills were substantially higher than if I had lived in something appropriately sized to my needs. I also had bills for water, sewer, and garbage, services that were always included in our rent. I estimate these cost $100/month more than renting, or $6,000+ over 5 years
My house was located 16.4 miles from the office and 28.4 miles from the airport, which I used for work travel at least 4 times per year
Compared to living in the City where I would eventually settle, I was driving an additional 3,800 miles per year in work and airport commute. Public transit was as expected for a commuter community.
Using the IRS Standard Mileage Rates, I spent an additional $6,800 over 5 years on commuting costs
Back in 2000, interest rates were a little higher than they are today. My 30-year fixed rate mortgage came with a competitive 7.625% interest rate.
As interest rates declined, I refinanced twice, first to 5.625% and then to a 5-yr ARM at 3.0%. Each time $2,000+ in fees was added to the mortgage. But at least there were no out of pocket expenses. Banks are nice like that.
Property Taxes, Insurance, & Homeowner’s Association
Immediately after buying this house, the housing market softened in the area. The County revised the property value downward twice, and my property taxes declined from $4,200 to $3,800/yr. Neighborhood Homeowner’s Association Fees were $288/year
Insurance on the property started at $759/yr and increased each year after. By contrast, I’ve never had renter’s insurance. If my stuff was stolen or lost in a fire, I would simply replace it out of savings.
Mortgage Interest & Income Taxes
Over 5 years, I would pay $64,502.53 in mortgage interest
Because I was single, lived in a big house, and interest rates and property taxes were high, I saved over $16,300 in income tax. Pay a bank $1.00, the government gives you back $0.25. Seems legit. Although you are still out $0.75…
Today, being married and with much lower interest rates, we would have zero tax benefit
I once spent a 3-day weekend of 12 hour work days installing 6 yards of cedar mulch with a wheel barrow and rake. Staining the deck began with 2 weeks of evenings and weekends spent sanding. I may still have splinters from this project.
Assuming 2 hours/week spent on house work, I would have lost 511 hours, 64 8-hour work days, 3 full months of work.
In that time at the office, I would have earned over $25,000
$6,000 in utilities, $6,800 in commuting costs, $48,181 in mortgage interest after tax benefit, $19,483 in property taxes, and Insurance & Homeowner’s Association expenses of $5,148.
Not even considering the value of my labor, that is a lot of money.
I would have been much better off by renting
You Have to Live Somewhere
But you have to live somewhere. Better to buy yourself a little home equity instead of throwing away your money on rent and paying somebody else’s mortgage. So they say.
My mortgage payment (principal and interest only) started at $1,676.56 and dropped all the way to $980.09. At the time, the average rent in Seattle was less than $750.
Over the course of 5 years, I would have paid $47,568 in Rent. That seems like a lot. But it is a far cry from the $94k+ I paid out of pocket while living in the house with a lower quality of life
How much better off would I have been financially by renting?
Investing the down payment and monthly savings each year in an 80% stock / 20% bond portfolio would have done poorly. The stock market fell 11% over the 5 year period. (DQYDJ’s new S&P 500 Dividend Reinvestment and Periodic Investment Calculator is fantastic for this analysis)
But even in this investment environment, and even assuming my labor was worth $0, I would have come out ahead by over $8,000.
Instead of receiving a check for $143,842 upon sale of the house, I would have had a portfolio worth $151,883.
Got Out Just In Time
Projecting forward to 2015, that $151,883 portfolio is now worth $560k. Investing the monthly savings over the past 10 years would add an additional $270k. I could buy that house today with cash, and still have over $300k in walking around money.
In practice the delta is even greater, as we never would have been able to move into an apartment in a walkable neighborhood and become car free.
Staying in the house we would have less than $160k (a ~$13k gain since 2005.) We would still be working.
So, Rent or Buy?
Are you or someone you love thinking about buying a house?
Real Estate is a great way to make money. Did I ever tell you about the time I made $102,000 on my house?