3 Common Myths About Buying a House

shutterstock_122051806Buying houses is very popular in America: about 65 percent of us own houses and 85 percent of renters say they would like to own, according to a recent New York Times-CBS poll. But, while there are some good reasons to own a your house (protecting yourself from rents increasing, being able to renovate and decorate as you like), our new research shows that buying a home is often a bad strategy to build wealth.

There are three persistent myths about buying a house that real estate agents, lenders, and homebuilders repeat to convince us that buying makes financial sense. These myths are: 1) renting is throwing money away; 2) homeownership leads to big tax savings; and 3)homes are great investments. 

  1. Renting is not just throwing money away.
    Although buying a house can help people build equity over the long run, owning means a lot more costs such as property taxes and maintenance. And, even with low-interest loans, mortgage payments for the first few years go almost entirely to service interest charges rather than paying down the loan, meaning buyers have little equity in their homes.


  2. Homeownership doesn’t lead to big tax savings.
    75% of homeowners get no additional benefit from owning. The reason is that the standard deduction, which everyone can claim, is often higher than the “itemized deductions” homeowners have the option of claiming. And, families must choose one or the other: they cannot itemize and claim the standard deduction. This also means that families that itemize lose out on the standard deduction and the net tax benefits from owning can be quite small for middle-income families. For example, over the first 10 years of homeownership in one large U.S. city, we expect a family making $50,000 to save just $5,200 total in federal taxes. In contrast, a family earning $100,000 could expect to save almost 10 times more—$50,700 in taxes—over that time!


  3. Homes do not perform as well as a typical mixture of stocks and bonds a family might invest in a retirement account such as an IRA or a 401k.
    Homes have typically appreciated much more slowly than a typical investment in a mix of stocks and bonds. For this reason, investing in a 401k is often better than buying a home. Some of you may be saying, “but homes are purchased with leverage, which magnifies returns.” But, once we account for the extra costs of owning a home, we find it is still often better to rent and invest the savings, even if the home was purchased with credit.

So, how should you think about buying a house? Consider the cost of renting a home relative to buying, or the “rent-to-price ratio,” which is the cost to rent for a year divided by the purchase price of a home.

If the rent-to-price ratio is 5% or less, potential homebuyers are generally better off renting and investing than they would be buying. (The current average rent-to-price ratio is about 5%.) But, if the rent-to-price ratio is 7% or higher, we find that buying is generally better than renting except in a few cities. For in-between rent-to-price ratios, whether to buy or rent depends on the specifics of a city’s real estate market and tax structure.

In sum, buying may be the right choice for you. But don’t believe that buying is always a good idea. Consider how much it would cost to rent a comparable home, how much money will be tied up in housing, and the extra costs that come with owning before you buy.