Should you buy a home in your 20s or would renting be a better choice?
Our 20s represent an extremely exciting and often volatile times in our lives. Somewhere between adulthood and still living a somewhat carefree lifestyle, many young adults in their 20s are still establishing themselves in their career and family. Often, in our early and mid-20s, we experience an immense amount of transition – ranging from graduating from college and entering the workforce to marriage and children.
Somewhere in the middle of this stage of life, we often hear that the next step on our journey to adulthood entails buying a home.
While purchasing a home in your 20s and paying off the mortgage over the ensuing decades may seem like an investment to those who have been “throwing away money” by renting, home ownership may not represent the most prudent choice for many young adults’ financial situation.
Here are 5 reasons you should consider buying a home in your 20s:
1. The “Investment” of Owning a Home
Perhaps, the investment of owning a home provides the most obvious starting point when considering the pros of purchasing a home in your 20s.
Unless you have the ability to pay cash for your house in your 20s, buying a home represents the largest single leveraged investment you will undertake in your life. While leverage may invoke negative connotations and overleverage can certainly lead down a dangerous road, by having a mortgage on your property, you control 100% of the asset with a relatively small percentage of your own money down.
Let’s look at a very basic example to illustrate leverage:
Let’s say you bought a $100,000 home with 20% down on a 15-year, fixed-rate mortgage at 3.92%. Based on this information, your monthly mortgage payment would be $473 per month or $5,676 per year. Ignoring realtor fees, closing costs, and other expenses with completing the transaction, you now have control of the $100,000 asset with only a $20,000 equity position at closing.
According to the National Association of Realtors, nominal home prices have risen 7% on average since February 2012. If this trend continues, your home will be worth $107,000 after the first year. Since you only have $25,676 of your own money comprised of the down payment and first year’s mortgage and interest payment, you would be able to realize a ~27% rate of return ($7,000/$25,676) if you sold the house (ignoring transaction fees, repairs and maintenance, and taxes).
While this example certainly does not correlate with the real returns you should expect after maintenance, repairs, taxes, insurance, and other holding costs that come with a home, the example demonstrates how leverage magnifies any increases in value. However, should prices dip, the reciprocal becomes true as well.
Increasing Value Through Renovation
Not only does home ownership allow for leveraged returns, owning a home allows you to perform renovations and improvements that can increase the overall value.
In your 20s, you probably are not accustomed to living a life of luxury just yet. More than likely, you spent the last 4+ years living with roommates in college or your first few years working. Assuming you do not mind a little sweat equity, buying a home that requires a little TLC may allow you to put your personal touch on the home while you increase the overall value of the asset.
While not all renovations increase the property’s value, updating kitchens, modifying the layout to add another bedroom if square footage permits, or performing work to improve the overall aesthetics can certainly add value to your real estate.
More than likely, your first home will not be your “forever home.” As a starter home, adults in their 20s should look to buy a home under market value, improve their residence through renovations, and roll their equity into the next residence as their needs change.
2. You Build Equity in Your Residence Over Time
In addition to owning an appreciating asset, owning a home in your 20s allows you to begin building equity in your residence.
Since equity represents the home’s value minus the mortgage outstanding, each monthly payment steadily increases your ownership stake until you own the home outright. While renting may be cheaper in any given year after considering maintenance and repairs, taxes, and interest that comes with owning a home, renters never eliminate their housing costs.
Forced Savings Account
With each mortgage payment, you own an incrementally larger percentage of the home. In a way, your principle payments act as a forced savings account.
For those young adults who may not yet be investors, forcing yourself to make these payments could help you make meaningful strides in building wealth. While you will pay tens of thousands of dollars in interest over the life of your mortgage, with each principle payment, you save yourself the interest on that amount of principle.
As an example, if you have a mortgage at 4% interest, the principle payments you make have an effective return of 4% on your money.
However, you should keep in mind you still pay thousands in interest that can be avoided if your mortgage was repaid. Therefore, make every effort to pay your home off as soon as reasonably possible.
3. Buying a Home Provides Stability
Regardless of age, home ownership provides a level of emotional and financial stability that renting does not provide.
While this may not be a purely financial motive to owning your residence, emotional stability in your living situation could be a welcome reprieve for those in their 20s who are used to moving every couple of years.
Many home owners appreciate the consistency and security of owning a home. By contrast, renters must continually assess whether they should renew their lease or look for a new place to live. Additionally, The competence of the landlord, property management company, or apartment’s management largely determines the overall rental experience.
Fixed Housing Payments for 15+ Years
In addition to the emotional stability provided by owning a residence, as long as you take out a fixed-rate mortgage, you can expect stability in your monthly housing payment.
However, for those who rent, you can generally expect rent increases ranging from 3-5% or more each year depending on the demand in your local area.
As a result of having fixed housing payments, home owners realize the full benefits of any salary increases that could be invested elsewhere to save for retirement, college, or other needs. As an added benefit, their “real” housing payment steadily declines due to the impacts of inflation.
Generally, most consumers perceive inflation as negative because it causes the price of goods and services to increase each year. However, for fixed liabilities, inflation results in the “real” value of the liability to steadily decrease. Coupled with higher salaries from cost of living adjustments and wage gains, each year homeowners possess more money to spend as they please rather than on their housing costs.
4. Tax Advantages for Home Owners
While you should never pay interest solely for the tax benefits, a couple of tax deductions exist in the tax code to alleviate some of cost of borrowing for your residence.
Mortgage Interest Deduction
In 2018, the Tax Cuts and Jobs Act (TCJA) allows couples filing jointly to deduct the interest on up to $750,000 in qualified loans. No worries if you are single in your 20s. You can still deduct interest on up to $350,000 in qualified debt. Effectively, this tax deduction for the interest paid reduces the cost of borrowing on your primary or secondary mortgages by offsetting some of your tax obligation.
Let’s look at an example:
A 25-year old saved $60,000 as a down payment on a first home with a list price $300,000. Therefore, they will take out a $240,000 mortgage with their local credit union. They credit union approved a 15-year, fixed-rate mortgage at 4% interest.
At the end of their first year, based on the amortization schedule, our new home owner paid $9,383 in interest that can be taken as an itemized deduction. This deduction reduces their gross income on their tax return. Depending upon their tax bracket, this can result in hundreds or thousands of dollars in tax savings.
However, because of the expanded standard deduction of $12,000, the subject in our example would need to have another $2,600 in itemized deductions to justify taking the mortgage interest deduction rather than the standard deduction. In this example, the individual would need to take out a loan on the full $350,000 at 4% to justify itemizing versus taking the standard deduction.
Property Tax Deduction
In conjunction with the mortgage interest deduction, home owners may also deduct taxes assessed on the value of their property up to certain limits.
Because of the state and local tax limitations imposed by the TCJA, individuals in certain high-tax states that impose a state tax in addition to property and local taxes may not realize the full benefit of deducting all of their property taxes. This is because the limit for the sum of all these tax deductions comes capped at $10,000 in total.
However, for those that live in states that do not impose a state income tax, you may be able to take full advantage of deducting all of your property taxes (up to $10,000) in conjunction with the mortgage interest deduction.
5. You Eventually “Eliminate” Your Cost of Housing
Perhaps, the most underrated aspect of owning your primary residence is the fact that you eventually eliminate the vast majority of your housing expenses after you repay the mortgage balance.
While you may not be considering this benefit in your 20s, eliminating the bulk of your housing cost in your mid-30s or early 40s sets you up to build immense long-term wealth. Instead of paying tens of thousands of dollars each year to housing expenses, your money can be redirected into 401(k)s, IRAs, or brokerage accounts. Because you will still be relatively young and in your peak earning years with a paid for house, the additional money you were able to invest compounds over the ensuing decades and allows you to build a substantial investment portfolio.
Even before retirement rolls around, you more than likely will experience financial freedom since your living expenses are drastically reduced. This provides the freedom to leave your 9-5, take a chance on a business venture, or simply work part time or retire early to spend more time with family and friends.
Imagine, what would you do today if you did not have to pay rent or make a mortgage payment?
Let’s discuss the 5 reasons you should avoid owning a home in your 20s:
1. Is Owning a Home REALLY a “Good Investment?”
Because of their relatively young age, individuals in their 20s more than likely will experience an unprecedented rise in their overall life expectancy due to medical innovation.
Their increased investing horizon coupled with their current youth means the opportunity cost of buying a home that may appreciate 3-7% rather than owning good growth stocks or growth-oriented mutual funds that increase 10-12% per year limits the total wealth that could otherwise be accumulated.
For this reason, the opportunity cost of tying up hundreds of thousands of dollars in an underperforming asset must be evaluated.
Let’s Evaluate the Net Cost of Home Ownership
While home values have increased 7% since the Great Recession in 2008 and 2009, no evidence or expert guarantees these gains will continue. After all, this recovery period comes after one of the greatest real estate collapses in modern history. Therefore, these annualized gains arrive from a very low basis.
Even at a nominal 7% rate of return, home owners consider themselves lucky to break even on their homes after accounting for upfront real estate commissions (5-6% of sales price), inflation (~2%), repairs and maintenance (1-3%), property taxes (national average ~1.15%), and interest (3.5-8%) on the outstanding loan.
Repairs and Maintenance
Home buyers often completely neglect to consider ongoing repair and maintenance costs in their “investment” equation.
While you may hear from someone living in an established neighborhood ecstatically state that their property has doubled in the last 15 years, have you ever thought about how much unaccounted money they sunk into the property to replace the roof, air conditioning units, and any updates or remodels? What about the thousands of dollars spent each year on aesthetics such as flower beds, mulch, and lawn care?
In addition to these upkeep and maintenance costs, owning a home comes with other increased costs that typically get forgotten. For instance, our homes generally come with higher electricity and water bills due to the increased square footage compared to renting an apartment. Home owner’s insurance further adds to the cost.
After all of the work and effort property owners put into upkeep, do you really want to own a home in your 20s for the “investment?”
2. While Building Equity is Good, Paying Interest is NOT
While each month a homeowner pays down the mortgage balance, not nearly all of their monthly payment goes to solely principle and to building equity.
Depending upon the interest rate, length of the mortgage, and principle borrowed, the total amount of financing charges may cost tens of thousands of dollars extra and negate much of the equity you have build in your home. Often, many homeowners do not even realize that 40% plus of their monthly payment could just be going to interest. Granted, over time, the percentage of principle pay down gradually increases.
However, in your 20s, you could have instead invested this amount which could potentially be worth millions of dollars over the course of your life.
Let’s Revisit Our Example
In our previous example of a 25-year old who took out a $240,000 loan for 15-years at 4% interest, the home buyer pays an additional $80,000 in interest on top of the $240,000 in principle.
Of the $320,000 total amount paid, nearly 33% of the total can be attributed to just interest. This averages out to nearly $450 per month in interest.
While you may not be able to find an apartment for $450 per month, these avoidable interest charges put a significant dent in the economics of home ownership in your 20s. When you include other costs such as maintenance and repairs, upkeep, property taxes, insurance, and the value of your time, renting clearly becomes more appealing until you are ready to bare these costs.
While equity builds with each payment and the overall increase in value, ignoring the significant borrowing costs that mortgages present can be detrimental to the home buying equation for someone in their 20s.
3. Buying a Home Limits Your Flexibility
While those with families and looking to put down roots appreciate the stability of home ownership, for those of us in our 20s, we need flexibility in our living arrangements.
While we are young, living in different parts of the city and checking out different neighborhood vibes can be exciting. Renting allows you to experience certain areas you may be interested before you take the financial leap to commit to one particular area. Often, you may not find that the area you thought best suited to your needs ends up being where you want to be in 5 years.
Because of the commissions and expenses of buying a home, breaking even on the purchase of a home often takes 5-7 years. For those of us in our 20s, we may not be willing just yet to commit this length of time to our first home – especially in a new area we have never lived.
New, Unstable Careers
Often, those of us in our 20s are just now graduating from college and starting our first “real” job in the workforce.
For a variety of reasons, buying a home right out of college may not be the best financial decision to make in the middle of such a huge transitionary stage of life. After all, Millennials are not well-known for loyalty to their employers, and if our first job does not work out, we would need the flexibility to look elsewhere.
Therefore, we require flexibility in our living arrangements during our 20s as our careers have not been established and uncertainly exists in what we will be doing longer term.
Possibility of Marriage
For many in their 20s, the possibility of marriage makes buying a home less ideal.
What if your potential spouse does not want to live in your current area, city, or even state long-term? Owning a home could pose real issues that may not allow for the flexibility of ease of mobility in these circumstances. Alternatively, you may have to sell the house for a loss if you have not lived there long enough to recover the costs of buying and selling real estate.
Not only does owning a home restrict your options for moving, often your new bride or husband may not approve of your choice of home. They may prefer living in a townhouse if you purchases a ranch-style home in the suburbs. They may prefer a traditional style over the modern-build homes.
Especially if you are in a serious relationship and nearing the next steps, waiting until your spouse can have input on where they live may be the best choice.
For those of us in our 20s, we pride ourselves on flexibility and the experiential aspects life offers. Renting allows us to experience different areas and not be tied down or committed to a single location.
4. Taxes and Other Expenses for Homeowners
Aside from the interest paid on the mortgage, potential homebuyers must also consider the ancillary costs of owning their home.
Often, new home buyers fail to consider the cost of property taxes, repairs, and maintenance that comes with owning your primary residence. By contrast, renters know the exact amount of their monthly rent. Should something break or maintenance be required, the landlord is responsible for paying these costs.
In your 20s, you may not yet have built up enough of a nest egg to cover any of these emergency costs such as a roof leak or pipe bursting.
Property Taxes
While certain taxes may be deductible up to specified limits as previously touted as a benefit, homeowners still must pay their share of ever increasing property taxes.
As the national average comes out to roughly 1.15% of the homes value, the amount of property taxes assessed quickly eats into any equity gains you may have experienced. Additionally, when the time comes for your residence to be reassessed, you could find yourself paying even more as the value of your home increases.
Maintenance and Repair Costs
Whether the repairs represent capital improvements such as putting on a new roof every 20 or 30 years or just involve buying and replacing light bulbs periodically, owning a home and property requires upkeep.
Typically, home repairs and maintenance vary depending on particular areas of the country, the age of the home, and how well the property has been maintained historically. However, estimates peg repairs and maintenance from 1-3% of the home’s value and act as a good basis to determine costs.
While you may not experience 2% in repair costs every year, certain years you may pay tens of thousands of dollars to replace air conditioning units, shingles on the roof, or appliances such as your refrigerator. Additionally, people generally upgrade to higher-end appliances or modernized finishes during periodic remodels.
In your 20s, you may not yet possess the skills to do your own repairs, so much of the cost must be paid to contractors.
Time Value
Additionally, unless willing to pay for contractors and landscapers for every cost that comes with owning a home, many young adults find themselves taking on these laborious tasks that come with owning their residence.
Home upkeep takes multiple hours per week to keep your home or yard from falling into disrepair. While you may enjoy spending Saturdays mowing the lawn or putting our mulch, many of us in our 20s wish to spend our free time with friends and family.
Instead, you may find yourself spending your available free time maintaining a larger residence, mowing the lawn, and paying for these extra expenses that come with ownership.
5. Higher Overall Monthly Expenses in the Short-Term
In the short-term, home buyers often end up paying more than they realize each month.
The holding costs that come with owning a home quickly add up and can require thousands of dollars at a moments notice. Because of the money “thrown away” on interest, additional taxes, maintenance and repair expenses, as well as other costs of ownership, those who purchase their home often pay more each month than those who choose to rent.
Often, in our 20s, we are earning the least amount of money we will ever make in our entire lives. Due to promotions and pay raises, someone in their 20s can reasonably expect their income to steadily rise over the ensuing years. After the first couple of years in an entry level position, you may find yourself set up for much more lucrative opportunities.
However, while in your 20s, you may not yet have the extra cash flow or savings to fund any issues that come up with your house. Additionally, you may not have the flexibility to pursue more lucrative ventures because you worry about making your mortgage payment or foreclosure.
For these reasons, owning a home could put a serious strain on your cash flow each month if issues arise.
So should you rent or buy a home in your 20s?
Home ownership certainly represents a great path to wealth and independence. Owning your home outright and eliminating your mortgage payment frees up a lot of excess capital that can be directed to more pleasurable activities. Buying a home in your 20s provides a head start to paying off the mortgage early.
However, for those who do choose to rent in their 20s, you do not have to commit to renting forever.
Instead, those in their 20s may choose to rent until they become financially able to buy or can take advantage of the intrinsic value of owning a home when they have a family.
If you have a substantial nest egg saved in addition to a down payment and you simply want to buy, owning your home could be a viable option. However, putting your money into your primary residence may not necessarily be the best “investment” due to all of the additional costs people tend to forget about. After all, you could be better off investing the cash in the market and earning a higher return with less hassle.
Alternatively, if you do want to own a home in your 20s, you could consider “house hacking” by renting out spare bedrooms or finding roommates. If you are single, this could be a happy medium that makes your primary residence a hybrid between an expense and a cash flow producing asset.
In the end, you must decide if you are ready to give up the flexibility renting offers and take on the additional expenses of owning and maintaining a house of your own.