Retirement

Is Your House An Asset Or A Liability?

By Charlie Farrell

Updated on: August 17, 2010 / 8:22 AM EDT / MoneyWatch

Over the last few years, many Americans found out that owning a big house was more like living the American nightmare, not the American dream. What got most people into trouble was they failed to realize that, on balance, a house is a liability, not an asset.

Now you might be thinking I'm exaggerating to make a point. But I'm not. On balance, a house is something you constantly pump money into, and for the most part, won't get out of it what you've invested in it. That sounds like a liability to me, not an asset. So before you buy your next house, you should ask yourself "what's it going to cost me," as opposed to "how much can I make off of it." That will help you keep your housing costs in line with your income.

I know most people have been led to believe that a house is an asset, which is why so many thought they should buy a huge home. The bigger the home, the bigger the asset. But it's not so. Think about this: assume you buy a home and don't put a dime into it for 30 years. You don't paint it, repair it, or update it. You just let it sit there. How much do you think that home will be worth at the end of 30 years? Not much.

You can get a sense of how quickly a home's value will decline if you don't take care of it by visiting a few foreclosed homes in your area. The value can fall 30% to 50% with just a few years' of neglect.

To maintain the value of your home, you have to constantly put money into it. A good estimate is about 2% to 3% a year of the cost of the home. If you bought a $300,000 home, consider that it'll cost $6,000 to $9,000 a year on average to keep it up. Now you won't spend that every year, but that's what you should be budgeting for the costs of maintenance. At some point, the furnace blows, the air conditioner dies, the water line breaks, the roof needs to be repaired, the windows need to be replaced, the kitchen needs to be updated, and the list goes on.

Then you have to pay taxes on your home. While tax rates vary by locality, a fair estimate is 1% a year. When you add it up, the house is costing you 3% to 4% a year just to keep. And over the last 80 to 100 years, housing costs on average have increased by about 3% to 4% a year. During some cycles they've gone up faster than that, and during others slower (such as now). If you look at the 60 or so years that you'll probably own a home, you're likely to get the average return, which is in the 3% to 4% range.

Of course, there are the exceptions to the rule. You could get lucky and buy a home in an area that's experiencing a boom in population and job growth. In that case, you may see the home appreciate faster than the long term rate. If that happens, great; but if you move, don't expect it to happen with the next house you buy.

So if your house costs you 3% to 4% a year to maintain, and it goes up in value 3% to 4% a year, you're at a wash; no real gain in the value of your investment. Then don't forget about all the interest you'll pay on the loan to buy that house. Unless you pay cash, that will be another 5% to 6% on whatever mortgage balance you have.

The basic return you get from a home is that someday you'll get the mortgage paid off, and you'll have a rent free place to live. That's a nice goal for your retirement years. But remember, if it's a big house, it will cost you a hefty amount just to maintain. That means less money to do other things you might find important during your retirement years.

Bottom line. Don't commit a huge percentage of your income to buying an "asset" that may turn out to be a liability.

Learn More: Want to learn about a simple way to manage your personal finances and prepare for retirement, investigate my new book Your Money Ratios: 8 Simple Tools For Financial Security, available in bookstores and at amazon.com The Wall Street Journal called the book "one of the best finance books to cross our desks this year." WSJ 12/19/09.

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