What your house is really worth
There are several things you can do with a house that you own. During the housing boom, most of the attention was focused on two of those things: You could sell it, or you could borrow money against it. Now that the bust has arrived, it's easy to see the limitations of that particular model. Happily, there's a more stable, more useful way to value your house.
Until the housing boom distracted people with fantasies of easy riches, most people focused on the two other things you can do with a house you own:
- If you live in it, you don't have to pay to rent someplace else to live
- If you don't live in it, you can get paid rent to let someone else live there
Looked at this way, what is a house worth?
The financial analysis
Purely as an example, suppose you can rent an apartment as large as a small house for around $750 a month. (That's what a largish apartment around here might run).
Alternatively, suppose you owned a small house about the size of that apartment. You'd have a few expenses that the renter doesn't have: property taxes, insurance, maintenance, water, sewer, garbage, etc. If those add up to, let's say, $400 a month, then owning a house is worth $750 minus $400: $350 a month.
Note that this is true whether you've got a mortgage on the house or not. Just like having some credit card debt doesn't change the value of the clothes or TV or BBQ grill that you might have charged, the value of your house is unrelated to the structure of any debts you might have.
A financial calculator can crank out a value for a $350 stream of income. Depending on the value you pick as the relevant discount rate, that stream of income is worth around $60,000 to $65,000. (I used 6.5% as the discount rate. You also have to plug in a number for how long the stream of payments goes on, but the payments in the distant future are discounted away to a vanishingly small value--a stream of $350 payments that goes on for 100 years is only worth a couple thousand dollars more than a stream that only goes on for 50 years.)
Now, around here, a house comparable to a $750/month apartment (2 bedrooms, 1 bath, 1000 sq ft) could just about be had for $65,000--but only if it had serious problems. It would probably have a serious maintenance backlog or be in a bad neighborhood, or else it would cost more. (This is a big part of the reason that I rent rather than owning a house.)
You can't write in praise of renting without getting a lot of comments from people who think that renting amounts to stuffing their money down a rathole. You write checks month after month--possibly for years--with nothing to show for it. On the other hand, if you buy, you end up owning something. There's some truth to that, but it's worth being clear about what, exactly you do own. Specifically, you own the items listed at the beginning: You can sell it, mortgage it, live in it, or rent it out.
There are, of course, other advantages to living in a house: You have more privacy, more control of your living environment, more options in terms of size and amenities, and so on. But you don't own those things--those things you pay for just like rent. That is, the money you pay this month pays for this month's privacy and control. (Because, remember, owning a house also ties you to the neighborhood. If a creepy guy moves into the apartment next to yours, you can always move when your lease runs out. But if a creepy guys buys the house next to yours, you can lose a lot of privacy and control at exactly the same moment having that neighbor makes it a lot harder to sell your house.)
being tied into your neighborhood can have an upside as well--you're in a community. But, then, some apartment buildings have a community as well, even if most of them don't.
Principal and interest
Note that we haven't talked about actually paying the mortgage. As I said, that's really a separate issue. Your house is worth the cost of the rent that you don't have to pay, adjusted for the extra expenses that fall on a homeowner. The mortgage and interest are what you have to pay to get it. (In the United States the interest payment is tax advantaged, which makes the effective cost a bit harder to figure out, but that's just a detail.)
If what you have to pay is less than what the house is worth, it's a good deal financially. If what you have to pay is more than what the house is worth, it's a bad deal financially. It's that simple.
People seem to be strongly motivated by the idea that the money that goes toward their mortgage is going to buy something that they own, whereas money that goes toward rent is just gone. I think looking at homeownership that way just confuses people.
Your house is worth what it would cost you to rent an equivalent place or what you could get for it if you rented it out (adjusted for the expenses of home ownership). That's true whether you own it outright or have it mortgaged to the hilt. (Of course, if you have a mortgage you owe a large debt, but that doesn't affect the value of the house.)
Your apartment, of course, is worth zero. But if it's cheaper to live in an apartment than it is to live in a house--and it often is--then the apartment dweller has surplus cash to invest, and therefore can accumulate wealth.
One thing I've left out of this calculation is "appreciation" in the value of the house. If the price at which a house can be sold grows faster than other investments grow, then home ownership can win in a big way. But, as is now clear, there's no good reason to assume that such outsized growth can be expected.
No ratholes involved
Whether a house is a good deal financially or not is important, but it's not the only factor. The non-financial aspects are also important--in fact, they are often the determining factors in people's decisions to buy a house. If you want to buy a house because you find one you want to live in and can afford, then by all means do so. But if you've previously been misled by the fuzzy notion that money spent on a mortgage is money "invested" but that money spent on rent is money "down a rathole," now you know how to do a valid analysis.