New Money Rules for Financial Security - #5. Home Equity

[This post is written and copyrighted by FIRE Finance (http://firefinance.blogspot.com).]

Until recently it was almost always assumed that renting meant throwing away money. The golden money rule was to build home equity since real estate "always" appreciated. Thanks to the sub prime mortgage fiasco and the recession that emanated from it, the real estate bubble finally burst with a big impact.

Rule #5: Home Equity

Old thinking: You can expect your house to appreciate handsomely over the long run.

New rule: Your home won't make you rich. But it is an important savings tool.

Our take: We have always been of the opinion that renting is better than owning when we cannot stay at a place for a long time. Due to the volatility of our jobs we had to move four times in the past six years. Since we rent, it has given us the freedom to move to new cities with new jobs and higher incomes.

We did not have the headache of buying and selling houses at new cities. It saved us money since closing costs and a realtors fees can add up to about 10% of a house's market value. This is under the assumption that we could sell our house at each city.

Real Life Story: We have a friend who had a similar job hopping fate like ours. But she had a problem with apartments. She simply could not live in them since they appeared claustrophobic to her! In addition, her friend who was a real estate agent convinced her that home equity was one of the best all time investments.

So she purchased a house at Las Vegas where she was working. Then she moved to Dallas with a new job. Her Realtor in Vegas had convinced her that she would be able to sell her house with a big profit. That gave her the courage to buy a second house at Dallas. Unfortunately, around this time, the real estate bubble burst.

Till date she has not been able to sell her house at Vegas since the prices floored to rock bottom. Last Christmas saw her paying two mortgages! Finally she got lucky and could rent her house at Vegas which has taken care of a part of her mortgage. You could say that she is being forced to build home equity big time. But we feel that her money could have been better invested if she had not purchased houses and rented instead.

Advantages of Renting

» Renting frees us from paying property taxes, insurance and maintenance costs. Usually people overlook these pests when they look at their monthly mortgages and compare them with local rents. Also, don't forget the closing cost and realtors' fees involved in buying and selling a house. And if you get bored easily, there will be remodeling costs :).

» The money we save by renting can be invested to build our nest egg or an emergency fund.

» Renting gives us the freedom and mobility to look for employment in new cities in case of a job loss.

» Since a management team takes care of a rental property, we don't have to spend time and money for maintaining our apartment. This is a boon for busy professionals like us.

Having seen the advantages of renting, we still need to address a basic question concerning the appreciation rate of real estate after factoring inflation. Here are some interesting findings from Rober Shiller.

Yale University economist Robert Shiller looked closely in 2005 at the history of home prices since 1890, using a database he constructed. What he found was surprising. Except for two spectacular booms - the first after World War II and the second starting in 1998 - real estate appreciation has been unimpressive after figuring in inflation. As Shiller wrote in "Irrational Exuberance," technology has allowed builders to nail up more houses faster, ensuring that supply never gets too far behind demand (and often gets ahead of it).

If housing price rises cannot outstrip inflation in the long term, then building home equity may not be a worthwhile investment.

Question

What are your views and experiences about home equity with respect to keeping your financial security intact in the immediate present? We are looking forward towards your feedback.

Series

New Money Rules for Financial Security
» Rule #1 - Handling Risk
» Rule #2 - Building Cash Savings
» Rule #3 - Earning Potential
» Rule #4 - Handling Debt
» Rule #5 - Home Equity
» Rule #6 - Diversification
» Rule #7 - Retirement

Image Source(s): iStockPhoto

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