What Your Home Is, and Isn't

The best reasons to own a home have always been psychological and social -- all about nesting and putting down roots. Financial considerations should be secondary. Now, with home prices flat to falling in many locales, it's a good time to restate the pros and cons of homeownership.

The benefits

A home is yours forever. As long as you can afford the mortgage and taxes, you don't ever have to move. There's no landlord to terminate your lease, raise your rent or deny you permission to make changes to the property.

Homeownership also forces you to save. If you have a traditional 30-year or 15-year mortgage, a small portion of each monthly payment reduces your indebtedness. And the amount that goes toward amortizing the loan increases over time. This can be very useful for people who lack the discipline to save on their own.

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Plus, paying that mortgage cuts your taxes. Uncle Sam subsidizes you by letting you deduct mortgage interest and property taxes -- benefits not available to renters -- and avoid taxes on some, and perhaps all, of your price gain.

You get decent appreciation. The operative word is decent. Sure, price gains in a few hot markets, mostly on the East and West coasts, outperformed Standard & Poor's 500-stock index over the past 30 years. But most local housing markets didn't come close. Nationally, home prices rose an average of 6.2% a year, exceeding the rise in consumer prices by just two percentage points a year and lagging well behind the S&P 500's annualized return of 12.3% since 1977.

In short, historical gains in housing prices haven't been dazzling in most regions. But they haven't been so bad, either, especially considering the psychological benefit and utility of being able to live in your investment. Using leverage -- in this case, buying a house with borrowed money and a small down payment -- can magnify your gains. But it can also deepen your losses in a housing slump.

What about price volatility? On this count, housing has a clear advantage over stocks. Yes, a few regions experienced long, deep slumps in home prices -- witness New England in the late '80s and early '90s, Texas after the oil bubble burst in the mid '80s, and Southern California after defense spending slumped in 1990, with the fall of Soviet communism.

But in most places over the past 30 years, a bad year for housing prices meant flat values or modest declines. Indeed, 2007 will probably be the first year since the Great Depression that the average home price will decline on a nationwide basis.

As any homeowner knows, a house can be a money pit. Sellers who crow about long-term gains usually don't factor in the costs of maintaining a house -- insurance, repairs, small improvement projects -- plus the after-tax cost of mortgage interest.

It often costs less to rent. The annual cost of owning a property, be it a house or a condo, is usually greater than the cost of renting, after taxes. It's the likely appreciation over time that explains an owner's willingness to pay more. Moreover, transaction costs are steep. Commissions, local transfer taxes and closing costs can run 7% of the sale price.

Temper your expectations

Big price gains are hardly assured. The strong price appreciation of the past few years was an aberration, vastly exceeding the rise in personal income. Future gains will probably look more like long-term norms.

My bottom-line advice: Don't over-invest in your home, either when you buy it or when you make subsequent improvements. Buy only as much house as you need. Plan to stay a long time. Don't view your home as your primary retirement savings. Instead, invest regularly in asset classes with the best long-term results -- the stocks and bonds of dynamic businesses, both in the U.S. and around the world.