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Housing May Not Be as Cheap as It Looks

Home prices have crashed. Interest rates are at all-time lows. If you're in the market to buy, homes are more affordable than they've been in years.

Or are they? An interesting counterargument was made by analysts Andrew Davidson and Alexander Levin of consulting firm Andrew Davis & Co. this week. By their reckoning, homes are barely more affordable today than they were at the peak of the housing bubble.

How? Because there's more to the cost of buying a house than home prices and interest rates. There's a down payment, too. During the housing bubble five or six years ago you could "buy" a home with no money down. Today you'll likely need a 20% down payment before a bank will look at you. Factor that in, and it takes about the same financial effort to buy a house today as it did in 2007.

Some background: In 2005, the median down payment was 2% of a home's value. Nearly half of first-time homebuyers bought homes with no money down. In California, 60% of mortgages were interest-only or negative amortization.

That's all changed, as this report from The Wall Street Journal showed last year:

The median down payment in nine major U.S. cities rose to 22% last year on properties purchased through conventional mortgages. ... That percentage doubled in three years and represents the highest median down payment since the data were first tracked in 1997.

This is how it should be, of course. A 20% down payment (at least) had been the norm before the housing bubble. In the 1950s, homeowners had more than 70% equity in their homes, financing only a small portion with mortgages. By 2006 that fell to 55%, and now sits at around 36% after the housing bust.

Going back to a sane world where large down payments are necessary changes a lot of perceptions about housing. The weight of writing a large check has to be taken into consideration to get the true cost of buying a home. And it's not just coming up with a chunk of cash that poses a burden. The opportunity cost of tying that money up in a house has to be included, too.

Here's a true story from someone I know who bought a house in the early 1990s and paid all cash. Let's say the house was purchased for $100,000, and sold in 2010 for $160,000 (I've changed the numbers, but the percentage increase the owner experienced was the same). In the 17 years the house was owned, the owner paid $18,000 in property taxes, $13,000 in homeowners insurance, and spent $15,000 for repairs and upkeep. In total, they got back just about every penny they put into the house, plus a little extra. They basically got a free place to live. That's great! Had they rented a similar house for 17 years, they would have spent something like $200,000 on rent. They clearly came out ahead.

But hold on. Had they put their $100,000 down payment in a simple Dow Jones (INDEX: ^DJI  ) index fund, their investment would have been worth more than $400,000 in 2010 (including dividends). That's the opportunity cost of their down payment. Yes, there are intangible benefits of homeownership like security and social standing. But financially, these people would have actually been better off renting, even after paying capital-gains taxes on their stock investment. I suspect this is true for millions of homeowners across the country.

Now, most people don't pay all cash, so the opportunity cost of the down payment isn't as large. But running through the exercise is important regardless of how much you're putting down. A 20% down payment is a lot of money for almost anyone buying a house. The average home in America now sells for $272,000, so a 20% down payment totals about $55,000. The median household net worth, meanwhile, was $67,000 in 2010, suggesting the average homeowner needs to tie up a tremendous amount of their net worth in a down payment. Can you really afford to part with that much of your savings? Is it money you might otherwise need for an emergency fund, or saving for college tuition? Would it be better off somewhere else? There's a real cost of sinking that money into a house that can't be ignored.

This is especially true when you detach yourself from the widely held belief that housing will make a good investment over the long run. As famed Yale housing economist Robert Shiller told me in an interview last year, that's just not the case:

Davidson and Alexander's report is a reminder that buying a house isn't as simple a transaction as it looks. It's a complicated trade-off between a need (shelter) and a want (an investment). Those two don't always mix.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 21, 2012, at 4:16 PM, Seanickson wrote:

    Very interesting article. The difference between buying a house and investing in the stock market is something ive considered before. Although to make a fair comparison, i think it would be helpful to consider what that $200,000 that was saved on rent would be worth if it was invested incrementally as it was saved.

  • Report this Comment On June 21, 2012, at 4:28 PM, leconspirateur wrote:

    I was thinking the same thing as Seanikson. Take that $200,000 in rent savings, add it to the $160,000 they got for selling the price. So far, they're $40,000 behind the $400,000 they would have had if they'd just rented and invested.

    But when you add in the interest they would have gotten by investing the roughly $1000 a month in rent savings in that same index fund over 17 years. I'm guessing it would come to more than $40,000. A lot more.

    And they also got to deduct all that prioperty tax. And what about renters' insurance? Would they have been going bare all those years?

  • Report this Comment On June 21, 2012, at 4:59 PM, mikevilkin wrote:

    Folks, we are approaching an end game. Stock market has been propelled by demand from the baby boomers. Now baby boomers are retiring, and a lot of stocks will be on sale. That is the first point.

    The second point is rather interesting. People are realizing that saving money is foolish. You saved and saved and saved, and then you have one prostate surgery, or a few days in a hospital for whatever reason, and you write a check for $100,000. The poor who spend all their money, get the same thing for free.

    The point is that most people spend their money and enjoy themselves. The fools save and pay for the other guy. Get this: that $100,000 hospital bill includes costs of providing medical care to the poor. The hospital bills you to cover medical care for the poor. That is why there will be much less demand for stocks and much less monetary savings.

  • Report this Comment On June 21, 2012, at 5:29 PM, eckhlmroad wrote:

    High downpayment wasn't the only factor for a loan.,Another in the 50 & 60's you could only use the income from the husband. A second income from the wife couldn't be used for determining if you could afford the payments.

  • Report this Comment On June 21, 2012, at 5:45 PM, JadedFoolalex wrote:

    Everyone is making the same mistakes again. Your house is NOT an investment! It is a place to live and keep your stuff! Money spent on a house is only for upkeep, nothing more! Ask those people who spent half a million or more on their houses what the house is worth now and I'll almost guarantee you that they will say a lot less than what they paid!! So much for investments! No, a house is not an investment. The only sure way to make money is to put your all money in the stock markets then go live in a box under an overpass somewhere :)

  • Report this Comment On June 21, 2012, at 5:51 PM, xetn wrote:

    The problem with housing was that at least since the '60s, when rapid inflation took place, many people believed the big lie that housing would always go up.

    That became their number one (and for most their only) "investment".

    In fact, the only time housing is an investment is when it is used to generate income.

    While housing does provide a place to live, it is not the only method. As Morgan pointed out, there are apartments, as well as condos, town houses and manufactured housing.

    Although manufactured housing is probably the lowest total cost, you tend to get what you pay for.

  • Report this Comment On June 21, 2012, at 5:51 PM, diablo1234 wrote:

    I guess it's all relative. I was once told that buying a whole-life insurance policy for my daughter was stupid and idiotic. That policy paid for 1)a new car, 2)braces for her and 3)the downpayment on her house.

    And oh yes...the policy is still in effect and yes I still pay the OUTRAGEOUS amount of $20/month for it. In it's lifetime, so far the policy has cost me around $6,000.

  • Report this Comment On June 21, 2012, at 8:22 PM, nolanryan wrote:

    Uh yea the stock market did better in that same time frame, who do you think profited off the pump and dump scheme?

    People just lost their life earnings to a glorified gambling ring, and the government thats given the rest of a persons life earnings to protect them from such blatant fraud decided to just collect from both ends

    You want absentee income buy some vending machines, this is the farthest thing from a free market and will be looked back as one of the most pointless and destructive human pursuit/indulgence

    And what the S/P just bets on the obvious winning ponies on a streak? Brillant, lets all invest in the same 5 companies/ideas in the world, itll really nurture the economy by investing in companies that have already been invested beyond fruition

    Dribble, take your money, sit down and use your own brain to put it to use. And maybe something that doesnt aim to harm your audience in the process or defraud them.

    Its called being an adult, not needing someone else to reprimand you or tell you not to do it. Like dont use overlycomplicated financing terms and methods for the sheer purpose of taking advantage of someone less educated in deception

    Should anyone need to be told this? A law? Serious? Its like you should be in playpens its so pathetic

    Its shocking that adults spend time actually writing this up, discussing this seriously, and then having meetings with those who needed these laws and regulations. Might as well be in diapers

  • Report this Comment On June 21, 2012, at 9:39 PM, Chontichajim wrote:

    We have been both property savers and equity savers all our lives and I would never consider doing one to the exclusion of the other. Rental properties with no more mortgage bring income which tends to go up when equity returns go down.

    The pleasures of living in a place you own has an intrinsic value and day to day pleasure I just can't get even from big bull market days.

  • Report this Comment On June 21, 2012, at 11:37 PM, kyleleeh wrote:

    Even today most banks don't require 20% down as long as you can get PMI. My real estate agent says almost all the loans she is seeing right now are FHA loans that only require 3.5% down. Of course you have to add the $1000 or so a year in PMI to your costs but still, unless you're credit score isn't high enough to get PMI you don't need to put 20% down.

  • Report this Comment On June 21, 2012, at 11:49 PM, TMFMorgan wrote:

    <<My real estate agent says almost all the loans she is seeing right now are FHA loans that only require 3.5% down.>>

    FHA's total market share right now is less than 16%.

  • Report this Comment On June 22, 2012, at 1:53 AM, kyleleeh wrote:

    Fair point. I never looked into the data, just went off what she told me.

    Still I don't think the median down payment is going up because banks are requiring it. I think it's more that as the housing market has gone down so much, while bonds and dividend stocks have gone up so much, that investors looking for cash flow can get better yields from rental properties then bonds or dividends. They put the 20% down to get the 80% loan to value needed to avoid paying PMI, not because the bank required it. Based on my own experience buying a home this year, and from other people I know who are in the market for a home, 3-5% down plus closing costs are what the banks are asking you to put up. The zero down and financed closing cost days are over, but even with fair credit I don't know anyone who needed to put 20% down.

  • Report this Comment On June 22, 2012, at 5:06 AM, ir0b0t wrote:

    A few comments re not being able to make money off owning a house. Since we have been house owners for 20 years, we have consistently had flatmates or boarders, contributing approx $100 per week adjusted for inflation. Sharing ones home might not be for everyone, but it is regular, tax-free income.

    Being a home owner means that we can house swap with people overseas for a cheap holiday, anywhere in the world.

    Since our house was basically destroyed in an earthquake, we have been paid out enough to build a similar sized but much higher specified home. If we were renting and wanted to live in the same city near to our businesses and schools, we would have to be living miles out of town, if we could find a place that accepted dogs, cats and teenagers and cars.

  • Report this Comment On June 22, 2012, at 7:21 AM, Thaeger wrote:

    Love the article; the old saw about how paying rent to the bank / government is so unquestionably superior than paying it to a person needs to be poked and prodded from time to time.

    For a somewhat less anecdotal look, there are online calculators that let you plug in all your nitty gritty rent vs. buy assumptions ( ), for a sometimes surprising appraisal of ones' options.

    Regarding being the landlord...I've personally seen folks who thought they'd discovered a heretofore unknown method of generating easy money with minimal effort get burned by their naivety, as tenants that were supposed to pay their mortgage for them failed to materialize, being a landlord turned out to be as demanding as a regular job (maintenance, dealing with people, advertising and interviewing, etc), or they just plain wound up with the tenants from hell.

    So while hearing of the occasional responsible, well-behaved tenants (lots of those near military bases, FYI) can make it sound like a hands- and risk-free source of income, one really shouldn't count on it to be either of those.

  • Report this Comment On June 22, 2012, at 10:47 AM, Lucaskasan wrote:

    This article makes the same mistake as the recent articles about reduction in net worth have made. Paper value is not real value. A person who put $100,000 in the index fund would have $400,000 in 2010 only if they sold in 2010. More likely, they sold in 2008 for a whole lot less.

    Houses are not on sale right now. In some communities, they are still too high even if they are lower than the bubble highs if they are out of sync with the local wage demographics. It is silly to say houses are selling at a discount.

    People make a lot of big mistakes when they cannot tell the difference between reality and fantasy, or real wealth and false paper wealth.

  • Report this Comment On June 22, 2012, at 10:58 AM, TMFMorgan wrote:

    <<More likely, they sold in 2008 for a whole lot less.>>

    How do you figure?

  • Report this Comment On June 22, 2012, at 11:07 AM, TMFGalagan wrote:

    Personally, I think it all comes down to the fact that for any given house, you can't simply choose whether you want to buy or rent it. Anecdotally, in many of the places I've lived in, rental house offerings were pretty weak from a quality standpoint, especially when the housing market is healthy.

    For some, housing is fungible, and that makes it easier to rent if it's more cost-effective. But the free market doesn't give you unlimited choice on the buy/rent decision.


    dan (TMF Galagan)

  • Report this Comment On June 22, 2012, at 11:54 AM, Melaschasm wrote:

    I have done the rent/buy calculations many times with many different factors. I always end up with the same conclusion.

    If you are certain you will spend decades living and working in the same area, buying a house is usually the optimal choice. If you are going to be moving within a decade or so, you should probably rent.

    The primary exceptions to the above rule are:

    1. Do not buy in an area which is losing population

    2. The risk of buying and selling in an area of rapid population growth is often a long term winner.

  • Report this Comment On June 22, 2012, at 12:56 PM, craigrow wrote:

    Of course, this scenario assumes the person doesn't need a place to live from 2010 on. Of course, they do. And rents will just keep going up. If, instead of selling the house he just keeps living in it and pocketing the ever increasing rent checks then the value of home ownership just keeps getting bigger and bigger.

    I don't consider my home an investment that I will turn into cash one day. However, I do consider it an investment in my retirement. To retire I need to have investment income that allows me to live my current lifestyle or better. I can do that, in part, with income producing investments. I can also do it with investments that eliminate negative cash flow (such as rent payments). A big part of my retirement plan is having zero rent/mortgage expenses.

    The shoddy math in this article is actually quite shocking. There is just no way renting beats home ownership.

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