Big Home, Big Investment?

Buying a home is a long-term investment that can be rewarding, but it also comes with risks. While it can be a good investment, it is not for everyone. It is important to weigh the benefits against the drawbacks and consider your own financial situation and goals.

One of the main advantages of owning a home is that it can build equity over time. As you pay off your mortgage, the value of your home typically rises, and you can eventually sell it for a profit. Additionally, homeowners can benefit from tax deductions on mortgage interest and property taxes. Owning a home also provides a sense of stability and the freedom to customise and renovate your living space.

However, there are also significant costs associated with buying and maintaining a home. Upfront costs such as closing costs and down payments can be substantial, and ongoing expenses like maintenance, repairs, and homeowners' association fees can add up. It is also important to consider the impact of the broader housing market, local economic conditions, and mortgage interest rates on the value of your home.

Ultimately, buying a home can be a good investment if you are financially stable, looking for a long-term residence, and willing to take on the associated costs and responsibilities.

Appreciation and equity building

Appreciation:

Appreciation refers to the increase in the value of a home over time. Real estate prices tend to be cyclical, and while homeowners should not expect drastic short-term gains, staying in the property for a longer period increases the likelihood of selling it for a profit. The location of the property is a significant factor in appreciation, with convenient access to transportation and proximity to good school districts being important considerations. The available land and the overall environment of the neighbourhood also play a role.

From 2010 to 2023, the median home sale price in the US increased significantly, showcasing the potential for long-term appreciation. However, it's important to remember that appreciation rates can vary across regions. For example, from November 2022 to November 2023, home prices in the New England region of the US increased by about 9.8%, while homes in the West South Central region only rose by about 3.1%.

Equity Building:

Equity building is a crucial aspect of homeownership and investment. Home equity is the difference between the appraised value of your home and the amount owed on your mortgage. It represents the portion of your home that you truly own. There are several ways to build equity in your home:

• Making a large down payment: A larger down payment instantly boosts your home equity as it increases the portion of the house that you own outright.
• Avoiding mortgage insurance: If you can put down at least 20% on the home purchase, you can avoid paying private mortgage insurance (PMI), reducing your monthly expenses and increasing your equity.
• Paying closing costs out of pocket: By paying closing costs upfront instead of rolling them into your mortgage, you keep the principal amount smaller, which helps boost your equity.
• Increasing the property value: Home renovations, upgrades, and regular maintenance can boost the value of your property and, therefore, your equity. Certain improvements, such as an upscale bathroom remodel or adding a wood deck, tend to offer a higher return on investment.
• Paying more on your mortgage: Making extra payments towards the principal amount of your mortgage helps build equity faster by reducing the overall debt.
• Refinancing to a shorter-term loan: Opting for a shorter-term loan or refinancing to one can help build equity faster as it increases the portion of your payment that goes towards the principal.
• Waiting for your home value to rise: Local housing markets fluctuate, and when property prices in your area increase, so does the value of your home and your equity.

In summary, appreciation and equity building are critical aspects of investing in a big home. By understanding these concepts and implementing strategies to maximise them, you can enhance the potential for your big home purchase to be a sound investment.

High upfront and ongoing costs

When it comes to buying a big home, it is important to consider the high upfront and ongoing costs that come with it. Upfront costs include the down payment and closing costs, which can amount to a significant percentage of the total loan amount. For example, closing costs can typically range from 3% to 6% of the loan value, which can translate to thousands of dollars.

Ongoing costs are another important factor to consider when purchasing a larger home. Bigger homes often come with bigger mortgages, resulting in higher monthly payments. Additionally, the cost of utilities tends to be higher for larger spaces, as more energy is required for heating, cooling, and lighting.

Maintenance and upkeep expenses also increase with the size of the home. Routine maintenance, such as lawn care, gutter cleaning, appliance servicing, and pest control, can add up quickly. On top of that, there are also the costs associated with major repairs and renovations, which are inevitable over time. For instance, replacing a roof or remodelling a kitchen in a larger home will inevitably cost more than in a smaller home.

It is crucial to carefully consider your financial situation and ensure you are prepared for the increased expenses that come with owning a bigger home. Creating a detailed budget and testing it out before making a purchase can help ensure you are financially ready for the increased costs.

Tax benefits

There are several tax benefits to buying a home. However, it is important to note that the tax code related to homeownership is subject to change. For example, the Tax Cuts and Jobs Act reduced the value of owning a home by limiting mortgage interest deductions to $750,000 of total mortgage debt. This change is set to expire in 2025.

Mortgage Interest Deduction

You can deduct the interest you pay on a mortgage used to buy, build, or improve your main home or second home. The deduction limit is $750,000 for individual taxpayers or married couples filing jointly, and $375,000 for married couples filing separately. If you bought your home before December 16, 2017, the deduction limit is higher at $1 million for single filers and married couples filing jointly, and $500,000 for married couples filing separately.

Interest on Home Equity Loans and Lines of Credit (HELOCs)

The same deduction limits mentioned above apply to the interest paid on home equity loans and HELOCs. If the combined amount of your first mortgage and HELOC is less than the applicable limit, you can deduct the full amount of interest paid on both loans, as long as they were used to build, buy, or improve your main or second home.

Mortgage Interest Credit

A Mortgage Tax Credit Certificate (MCC) is a tax credit issued by the government that allows homeowners to reduce their tax bill by a certain percentage of their mortgage interest. First-time homebuyers, military service members, or those purchasing a home in an area targeted for development or revitalization may be eligible for this credit.

Mortgage Discount Points Deduction

You may be able to deduct mortgage points, also known as discount points, that you paid upfront when closing on your home purchase. One mortgage point is typically equal to 1% of your loan amount. These points can be deducted over the life of the loan or in the year they were paid, depending on certain tests outlined by the IRS.

State and Local Tax (SALT) Deduction

You can deduct certain taxes paid to state and local governments, including property taxes. The deduction is capped at $10,000 for single taxpayers and married couples filing jointly, and $5,000 for married couples filing separately.

Tax-Free Profits on Home Sale

In most cases, capital gains on a home sale are tax-free up to $250,000 for single filers and $500,000 for married couples filing jointly. To qualify for this tax break, you must have lived in and used the home as your primary residence for at least two of the five years before the sale date.

IRA Withdrawals without Penalty

You can use funds from your Individual Retirement Account (IRA) to buy a house without paying the usual early withdrawal penalty. Normally, withdrawing funds from an IRA before the age of 59 1/2 would result in income tax and a 10% additional penalty.

Tax Breaks for Green Upgrades

There are eco-friendly tax breaks available for homeowners who make energy-saving improvements to their homes, such as installing solar panels or wind turbines. The Residential Energy Efficient Property Credit ranges from 22% to 30% of the improvement cost, depending on the year the upgrades were made, and is valid until December 31, 2023.

Home Office Deduction

If you work from home or have a home-based business, you may be able to deduct expenses related to the use of your home as an office. To qualify, a portion of your home must be used exclusively and regularly for business purposes, and it must be the main location where you conduct your business. There are two methods to claim this deduction: the regular method, which involves calculating the actual expenses based on records, and the simplified option, which allows for a deduction of $5 per square foot, up to 300 square feet.

Rental Expenses Deduction

If you rent out all or part of your home, you may be able to deduct certain expenses related to being a landlord, such as mortgage interest, property taxes, insurance, utilities, and repairs. The rules vary depending on whether the home is used personally or solely as a rental property. This deduction can be claimed using Schedule E (Form 1040) to report rental income and calculate the deduction.

Liquidity and flexibility

Liquidity

Liquidity refers to the ease with which an asset or security can be converted into cash without affecting its market price. In the context of real estate, liquidity measures the degree to which a home can be bought or sold in the market without significantly impacting its price.

Homes are generally considered illiquid assets, as they can take weeks or months to sell, and there may be additional costs involved, such as broker fees. However, liquidity can vary depending on the specific real estate market and the demand for homes in a particular price range.

When considering the liquidity of a big home purchase, it's important to analyze the local real estate market. In a seller's market, with high demand and limited supply, homes may sell more quickly and at higher prices. On the other hand, in a buyer's market, with more sellers than buyers, it may take longer to find a buyer and there may be more room for negotiation on the price.

Additionally, the location and price range of the property can impact its liquidity. Homes in certain desirable locations or within a certain price range may have higher liquidity, as there are more potential buyers.

Flexibility

Flexibility is crucial when navigating the home-buying process. It's important to recognize that purchasing a home is both a personal and financial decision, and emotions can play a significant role. However, treating the process as a business transaction and maintaining a level head can be beneficial.

• Understand the seller's perspective: Consider the seller's financial situation, how long they have owned the property, their purchase price, and their reasons for moving. This information can help you design an attractive offer that meets their specific needs.
• Be open to negotiation: Recognize that an overpriced home may reflect the seller's honest belief about its worth. Provide a rationale for your offer and include comparable sales data from the neighborhood. Avoid making lowball offers without supporting information, as it may insult the seller and influence negotiations negatively.
• Avoid round numbers in offers: Offers with specific amounts, such as $401,650 instead of $400,000, can have a psychological impact and make your offer stand out in a competitive market.
• Separate contract negotiations from personal feelings: Remember that the buyer and seller often have opposing objectives. Be prepared for haggling and don't take it personally if the seller doesn't agree to all your requested repairs or concessions. Focus on the bigger picture and don't let minor disagreements deter you from a home you love.
• Choose inspections wisely: As a buyer, you have the right to request various inspections. However, requesting too many inspections may make you appear high-maintenance to the seller. Select the inspections that are most important to you and be mindful of the seller's perspective.

In summary, when considering the liquidity and flexibility of buying a big home, it's important to research the local real estate market, understand the seller's perspective, and maintain a flexible and pragmatic approach throughout the negotiation process.

Location, location, location

"Location, location, location" is a common refrain in real estate for good reason. When you buy a home, you're also investing in the land it stands on. While the house can be renovated or remodelled, its location is fixed.

Accessibility and Transportation

Easy access to transportation is crucial. Look for areas with good public transit options, such as bus stops, train stations, or bike-sharing programmes. Proximity to major roads and highways is also important, especially for those who commute by car.

Amenities

Convenience is key. Buyers generally want amenities like grocery stores, restaurants, entertainment, and gyms within a short distance, preferably a 5-10 minute drive. Being able to walk or have a short commute to these places is a huge plus.

Schools

The quality of local schools is a significant factor, especially for buyers with children or those planning to start a family. Good schools also attract more buyers and boost property values. Use resources like school rating websites and local community groups to research the school district.

Safety

Everyone wants to live in a safe neighbourhood. Look for areas with low crime rates, and consider the option of gated communities in cities with higher crime rates.

Development and Future Plans

Research any planned developments or construction in the area. New schools, hospitals, public transportation, and commercial projects can improve property values. Additionally, consider the city's expansion plans. Cities with limited room for growth tend to have higher property prices.

Neighbourhood Appearance

The look and feel of a neighbourhood matter. Well-kept homes, quality landscaping, trees, and community spaces like parks are desirable. A quick turnover of homes in an area is a good indicator of its popularity.

Proximity to Major Roads

While easy access to major roads is desirable, being located directly on a busy road or highway can decrease a property's value and make it harder to sell.

Lot Size and Shape

A larger lot is generally more valuable, and its value will likely appreciate over time. A well-shaped and well-situated lot is also preferable, as these factors are harder to change than the house itself.

Remember, location is a key driver of a property's value and desirability. By carefully considering these factors, you can make a more informed decision about your potential home purchase and future investment.

Frequently asked questions