Friday, August 22, 2008

The Risks & Disadvantages of Buying a House

The Risks/Cons/Disadvantages of Buying a House/Condo/Co-OpAccording to, at the depths of the 2008 housing crash "A record 5.4 million American homeowners with a mortgage of any kind, or nearly 12 percent, were at least one month late or in foreclosure...."

In addition, according to, "21.8% of all U.S. homes, representing more than 20 million residences, were in a "negative equity" or "underwater" position...."

Risks and Disadvantages of Owning a Home (whether Single Family Home, Condo or Co-Op)

The many advantages to buying and owning your home have been well publicized. However, the above statistics make it clear that owning a home is not without risk. To form a complete picture, you, the prospective buyer, need to consider the potential risks and disadvantages of home ownership as well. Understanding these disadvantages beforehand will give you a better chance of minimizing their impact and avoiding the fate suffered by these homeowners. 

Less Flexibility

A mortgage is a long-term legal and financial obligation. More than likely, yours will be for 30 years. Suppose two years from now: You have a great job opportunity, but in order to accept it you need to sell your house and move; or, you want to get married, or unmarried, and your new home is no longer appropriate; or, your financial situation has changed (e.g., what if you lose our job?) and you would like to reduce your home-related expenses. Because a mortgage is a long-term obligation, picking up and moving on short notice, for whatever reason, will be significantly more difficult. In fact,
the impact of selling your home could be devastating.

Risk of Losing Money

There is a chance that your new home will lose value. Luckily, in general, the longer you own your home, the less likely a loss becomes. Loss of value is typically a short-term problem, possibly due to the local or national economy, and prices normally recover. (Note: for a look at the long-term history of U.S. real estate prices, see 100 Years of U.S. Housing Price History and 100 Years of Inflation-Adjusted Housing Price History.)

However, even in the best of times, some neighborhoods experience price declines. The value of your home could also decline because of a rash of foreclosures in properties that potential buyers might consider as an alternative to yours (i.e., not just foreclosures in your immediate neighborhood). And if someone decides to build a landfill nearby, or your town’s largest employer moves or goes out of business, for example, it could be a long time before you are back to break-even. If you have to sell, for whatever reason, before the market has recovered, you could be in serious trouble - as explained in my post discussing the risks of 3% - 5% down payment mortgages.

Risk of Foreclosure and/or Bankruptcy

Foreclosure, the repossession of the home due to non-payment, is often caused by an unexpected decrease in income or increase in expenses. Typically, the decrease in income is caused by an accident, unexpected illness/disability, or loss of job by even one (not necessarily all) of the owners. Unexpected increases in expenses can be caused by, for example, unpredictable medical bills, divorce or separation, or unexpected major car or home repairs. Since the consequences of foreclosure are more severe than falling behind in your rent, the risk of foreclosure is an added risk of home ownership.

The ultimate risk is that of bankruptcy, the least favorable outcome of all. This could occur as the result of a foreclosure because you have been unable to keep up with your payments. However, bankruptcy can also be a risk even if you are current on your payments! This could happen, for example, if you have to sell in a down market when you are "underwater" or "upside down" -- i.e., when the proceeds of the sale are not enough to pay off your mortgage.

If you want or have to move when you're underwater, you're potentially in serious trouble. You'll not only need to come up with additional money to pay off the mortgage, but also money for closing, moving, etc. -- as explained in the post mentioned above. Typically, the desire or need to move is the result of a job change/loss, divorce or separation. It can also happen when there is the recognition that, while there is no imminent threat of foreclosure, the long-term ability to make the mortgage payments is in doubt (as is the case, for example, with some people who have adjustable-rate or interest-only mortgages).

Increased Monthly Expenses

If you are currently living in an apartment, there’s a good chance you’re going to buy something larger. More space usually means a larger monthly payment, or increased commuting expenses (if the additional space is obtained by moving to a cheaper area further away from your job) -- or both. More space also means your new home will be more costly to heat and cool. In addition, you may have new expenses such as water, sewer and lawn care.

Potentially Significant Start-up Costs (after closing)

More space also means you may find that you now need another TV or sound system, additional furniture, a lawnmower, curtains…

Less Predictable Expenses

If you rent, you know what your housing expenses are going to be from one month to the next. Renters don’t have to worry if the hot water heater, or the roof, springs a leak. Maintaining and repairing a home can be amazingly expensive and/or time consuming. A plumbing or electrical problem can easily cost you $250-1000, or many hours doing things you may not enjoy. If you are also responsible for maintaining the exterior of your home, painting the exterior, or replacing the roof is even more expensive; at some point, you may need to do that too.

Minimizing the Risks & Disadvantages of Buying a Home -- by PLANNING

My intent is not to disparage home ownership. Rather, it is to add some balance and objectivity to the home buying decision-making process, especially for first-time homeowners. The reality is that buying a house has not only advantages, but disadvantages as well. However, these disadvantages can be overcome! Having a good understanding of both the pros and the cons of buying and owning a house will decrease your chances of being added to the statistics at the top of this post, and increase your chances of becoming a successful homeowner.

The risks and disadvantages of home ownership can be overcome by planning. Else, what should be one of the most satisfying decisions in your life could become your biggest mistake. The next post in this series, Planning To Buy a House, discusses planning, and managing the risks, from an income & expense perspective. The Planning to Buy a House Calculator post provides an interactive tool to help you estimate your total cost of ownership and reduce some of these risks.

Related Articles:

8 Signs You Should Not Buy a House from Morningstar
100 Years of U.S. Housing Price History: for some insight into the economics of home ownership.
Risks & Disadvantages of 3%-5% Down Payment Mortgages: Explains how the leverage involved in 3% - 5% and no-down payment mortgages increases the risk of these mortgages.
Planning To Buy a House: Some ways to reduce homeownership risk.
Planning to Buy a House Calculator: An interactive home purchase planning tool.
Your Responsibilities as a home owner, from the Freddie Mac web-site. 
The Homeownership Obsession from August 4, 2008 edition of Newsweek
Housing vs Stock Market Growth Revisited 
Shiller: Mr. Worst-case Scenario July, 2007 interview with Robert Shiller, co-creator of the Case-Shiller housing price index, covering, among other things, the historical performance of residential real estate.
The picture is from Public Domain Pictures.
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