More Money Is Just The Beginning...

I love having conversations with people that challenge my long-standing notions of wealth creation.  It happened just today with my friend Mark Charter of Re/Max Real Estate Concepts in Des Moines.

Mark and I were talking about some of the rental property mistakes we've made through the years and how it's had an effect on our net worth as a whole.  Specifically, our conversation focused on what to do if you found yourself in a position where it would take years for the property to regain enough value to make you money (in equity).  That led us to chat about some of the clients he was working with that wanted to sell their homes after living in them for 5 years or less and were shocked at the amount they'd be getting back (or NOT getting back) at the closing table.

Here's something we deduced that's going to challenge your belief that buying a home is the best way to build a large nest egg -- buying a home is a break even game for the first 6-8 years and it may not be right for you... yet.

That all being said, I still believe that buying my first home was a huge step in the right direction as far as wealth building was concerned.  However, with today's real estate market, even though there are some great buys out there, the homes you're looking at may not appreciate much over the next few years.  Couple that with the fact that the first 6 years or so of your mortgage payment are about 88% interest, you won't see a significant amount paid down on your mortgage until you've been there for 15-20 years.

Forty years ago, it was common for people to buy a home and stay there for a significant amount of time.  They were (mostly) in 30 year fixed mortgages and routinely held "mortgage-burning parties" to celebrate when their homes were paid off.  When was the last time you were invited to one of those?  Exactly.  It just doesn't happen much anymore.  On average, Americans are staying put for a little under or over 7 years and then trading up.  Considering that the majority of their payments are interest, the amount they're paying down on the principal is downright insignificant.  Then you throw 6 or 7% commissions to the realtors and another 3% in closing costs for the buyer and you're basically back to where you started.

Is it any wonder people are a little stressed when they finally realize how much (or little) they're going to get back at the closing table?

Here's a few ways to get more out of that first home purchase:

Additional Payments -- Even one extra payment a year can bring the principal down on your mortgage more than you might imagine.  When you prepay some of the principal it also affects how much interest is charged on a monthly basis.  The lower your principal, the lower your interest.  Makes sense, right?  (Making bi-weekly payments also does the same thing.  It essentially creates one more payment per year.)

Buy At A Discount -- There are thousands of homes on the market that are either in a short-sale position, have been foreclosed on, or have owners in a "distressed" position.  Your ability to buy a home at less than market value has probably never been greater.  I understand you want to have your dream home on the first go-round, but let's get real or let's not play.  You're better off spending less and doing a little legwork to make the home yours and build equity in the process.

Stay Put -- If the first 6 years of your payment are largely interest, then stick it out in your first home for 7-10 years before trading up.  Better yet, if you do decide to leave, make sure you're in a position that you can rent your first home out to someone and go find another bargain to buy for your move-up home.  My wife and I bought a really nice home (our 20 year home) after fixing up two other "starters" and the dream home we bought was a distressed situation.  A doctor and his wife had already moved out of the home and it had been vacant for 6 months.  We got a great deal and intend on reaping some serious gains from it in the future!

Maybe renting is a good option.

Ramit Sethi just had a great post on I Will Teach You To Be Rich where he talked about many of us using the wrong metrics to measure success.  Let's face it, when you're young and want to be able to travel, socialize with friends, and be nimble, maybe having a house and all that goes with it just isn't your bag.  Renting may be the best and most viable option for you instead of finding yourself back at square one 5 years from now when you're madly in love and wanting to buy a pad cozy enough for two and no equity in your place.

Just remember that the best way to build a substantial nest egg is to have a very long-term outlook.  If you're thinking, "this might be a nice house for a couple of years" you might want to  think again before inking the deal!