My mother always told me I was a homebody. I would instinctively recoil when she would say that. What does she know?
“She’s just trying to plant seeds of thought in my head”, I always told myself. It was just her parental instincts to keep me close by, and make me feel that’s where I belonged.
In a sense, she was right that I am a homebody. I spent high school desperately trying to fit in, and beating myself up for not having an established circle of friends. I stayed home more often than not, but was too focused on my teenage angst to let myself appreciate or enjoy the things I was genuinely interested in.
When I went to college, I overexerted myself to make up for what I perceived to be lost time in high school. I sought out the people around me who liked to party, and made them my friends.
My freshman year of college was akin to handing presidential power to a buffoon. I had no clue how to handle all the partying, but I was presented with unfettered access to it. That’s a dangerous combination, no?
There were many out of control nights where people I barely knew had to take care of me. At the time, I thought I was fitting in.
“This is what happens in college”, I would say to myself as a justification for my actions. Amidst the many blackout nights, I was probably given life lessons by those around me who I still barely knew.
In the moment, I’m sure honest truths were dished out. I wasn’t in any state to remember them unfortunately, so they never stuck.
I zigged and zagged throughout college and my 20’s, alternating on a path between the peaks of responsible adulthood and the valleys of ridiculousness. These peaks and valleys balanced each other out; the straight line that could be drawn through them managed to produce a more-or-less respectable, balanced, and conventionally successful existence.
For me, early adulthood was like the stock market: it always goes up, but it’s not a smooth ride.
As I made mistakes and learned from them (in some cases years later), I began to get a clearer picture of my values and what I wanted out of life. I came to appreciate activities that didn’t involve being an enabler/being enabled, or constantly pursuing the next epic social adventure while simultaneously worrying about what might be happening in some place I wasn’t.
As it became clearer that the things I valued most centered on presence, it was fitting that I started to focus on the concept of “home”. My mom must have been on to something.
Time to stop throwing money away on rent
I wanted to redefine myself, and I wanted to do it in a way that screamed out “I’ve got my shit together!” to everyone I crossed paths with. So I decided to buy a house.
Buying a house seemed to be a no-brainer move for both my ego as well as my finances. There was certainly no one warning me to not buy a house. After all, renting is just throwing money away, as the conventional wisdom goes (though as I’ve learned through the years, conventional wisdom is pretty questionable in this case).
The truth is that owning a house, in my case, turned out to be a pretty significant financial mistake. Many reasons for this were self-imposed, given the somewhat rash decision making that lead me to buy.
The process of buying a house is complicated, especially when going through it for the first time. There’s a lot of technical jargon and terminology being thrown around, not to mention the stacks of papers that need to be signed or initialed.
Besides, I had a team of experts helping me through the process. Might as well defer to them. I more-or-less decided to limit my personal responsibility to signing when and where I was told. The experts could deal with the complications.
To be fair, signing papers presented enough of a challenge during this phase of my life, because I was hungover while signing them.
There are many things that suck to do while hungover, and signing papers is one of them. But that’s neither here nor there. Here are three key mistakes which lead to losing quite a bit of money on my home.
Mistake #1: Ignoring the downsides of an unfavorable loan
At the time I decided to buy a house, I was paying $600/month in rent to live with a roommate outside of the city. The mortgage payment on my new home would be more than double that. Due to this, I was motivated to lock into the lowest monthly payment amount possible.
The loan structure which offered the lowest monthly payment amount happened to be a ten year interest-only loan. This essentially meant that my first ten years of payments would go 100% to paying down interest.
In other words, after ten years, I would have paid down exactly 0% of the principle balance on the mortgage. Never mind the fact that I’d be paying the bank over $350k in interest over the life of the loan. And they call this home ownership? The only ownership going on here was the bank owning me.
Here’s the kicker: when due to start paying down the principle on the loan after the initial ten year period, my monthly payments would increase by more than $500 per month!
I assumed there was plenty of time within the first ten years to remedy the situation, so I justified the decision to go with the interest-only loan. I could refinance into a better loan that removed the interest-only downside. I was also likely to increase my salary as I advanced my career, which would offset higher payments in the future (very flawed logic in itself, but that’s for another day entirely).
To be fair, most of the shady loan structures and predatory lending practices that boxed people into such loans have been eliminated since the financial crisis. But there are still some unsettling practices happening today.
Mistake #2: Unwittingly viewing my home as an investment
One of the most widely proclaimed benefits of owning a home is that it’s an investment. It’s absolutely true that owning real estate can be a powerful wealth building tool. But for this to ultimately be the case, a reasonable understanding of market conditions, risks, and a clear vision for the future are necessary.
When I bought my home, I was lacking on all fronts. First and foremost, I was infatuated with the notion of becoming a home owner. I blindly believed that my home was an investment without a deeper understanding of the complex factors at play.
I also assumed I would be in the house for a generously long period of time (a decade or more). This was a bit unreasonable given that I was young and single at the time. Big life changes were likely to occur, and they did.
As a result, I ended up losing over $20,000 to being a home owner (more on this below). That’s certainly not a successful investment.
One reason I lost so much money on my home was a failure to keep my emotions in check. Upon moving into the house, I immediately felt personally attached to it. I wanted to make it mine, I was planning to be there for at least a decade, and I had some capital available to play around with. And, you know, something something something investment something something something.
The result is that I paid for multiple additions and renovations to the house, which I failed to recuperate when it came time to sell. Sure, the additions helped the resale value, but they didn’t come anywhere close to paying for themselves.
Additions and renovations included:
- Construction of a roof-top deck with harbor and skyline views of the city ($6,000)
- Conversion of an existing bedroom and common area into a master suite, complete with a brand-new bathroom and walk-in closet ($18,000)
- Complete gut/remodel of the house’s original bathroom ($8,000)
All said, the additions and renovations totaled up to more than $30,000. I knew I wouldn’t see a full return on these costs when selling the house, but emotional attachment and desire to improve my home won out. When the time came to sell, this also made the process much more challenging from an emotional standpoint.
Mistake #3: Overestimating my home’s equity
Net worth is the total value of the assets you own minus your debts/liabilities. When it comes to owning a home, this is known as equity. It’s common to factor your home’s equity into your overall net worth, but there are some caveats that need to be kept in mind to ensure it’s accurately calculated.
When I owned my house, I calculated equity by taking the current estimated value and subtracting what I owed on it. At the time I put my house on the market, it house was worth $285k and I owed $250k on the mortgage. On paper, I had a $35k equity stake in my house.
Real life is not lived on paper, though. The flaw in assessing equity based on the estimated value of an asset is that there’s no guarantee someone will actually pay that amount for it.
When it comes to selling real estate, perhaps the market will be strong for sellers, and an even higher asking price can be commanded. On the flip side, it could be a buyer’s market. This may dictate a lower asking price or the need to accept costly concessions in order to get someone to bite.
Market conditions are difficult to predict and impossible to control. The market conditions at the time of selling can have a serious impact on bottom line. On top of market conditions, there are additional costs to be factored in when selling which will eat away at your total return. These include:
- Any work to be done in preparation for marketing the house to buyers. This includes painting, repairs, cosmetic changes such as new floors, and staging.
- Agent commission (typically 6%)
- Concessions that the buyer may negotiate as part of the final sale (for example, help with closing costs or any repair needs that may arise during the inspection)
Ultimately, I sold the house as-is for $275,000. There was no one willing to offer more than that without costly concessions, and I had plenty of feedback from buyers to feel safe arriving at this conclusion. The market simply wasn’t going to allow me to command the $285,000 estimated value for my home.
After paying my agent’s commission (6% of $275,000 = $16,500) and paying off the balance of my mortgage ($250,000), I was left with $8,500 in my pocket ($275,000 – $16,500 – $250,000). Way below that $35,000 equity stake I foolishly believed to be mine.
All told, when factoring in the costly renovations made, I lost over $20,000 in my home. I sunk $32,000 into renovations while I was the owner, and walked away with an $8,500 profit when I sold. For those keeping score at home, that’s a loss of $24,500.
The previous owners who sold the house to me? Turns out they owed a handsome $27,000 at the time of settlement, according to the records I have. We both lost significant money owning that house.
Maximize upside, minimize downside
Becoming a home owner has many potential upsides. However, the downsides need to be understood and (when possible) avoided. It is crucial to be driven by well-informed decision making, rather than an abstract idea that buying a house is just another rung upwards on the ladder of success. Don’t buy a house just because of the cliche belief that renting is throwing money away. I can attest to the fact that it isn’t.
There are many mistakes I made along my journey of owning a home. Given how things have played out in recent history, I am confident in saying that many others have made similar mistakes. A key component of the subprime mortgage crisis was shitty loans that people failed to understand, or didn’t want to understand.
The mistakes I made proved to be very costly, and offset the upsides of owning. If I choose to buy a house again in the future, I will surely avoid the costly mistakes I made the first time around.
This comes at a perfect time for me. I was just talking to mom and dad about buying a home. Not seriously but I was just curious as to what all went into it.
So all said and done, had you not put those rennovation into the house ($32,000), what do you think the selling price would’ve been ($275K down to maybe 265K or less)? I gues then you still would have lost money, but not as much. What do you think?
So what type of loan would you recommend (obvioulsy not the 10 year all interest)? Name me one that would be considered reasonable and fit for the home buyer.
The sale price most likely would have been around $260k-$265k had I not put the renovations into the house. Hard to say, really. It’s all so subjective. But the additions I made were definitely high-quality and much needed to move the house out of the realm of being a “starter home”.
I’d recommend a loan with a fixed interest rate (typically mortgages are 30 years but if you can afford aggressive payment amounts you can do a 15 year loan and save a bunch on interest). Interest rates are low (though they appear to be going up as the fed raises them) so locking into a solid rate would be the best move. Much less attractive options are loans like the interest-only loan I originally had, or worse, an ARM (adjustable rate mortgage) where the interest rate for the first X number of years isn’t locked in, and the rate can change (meaning it can go up significantly) after the first few years, sometimes to the point of doubling your mortgage payment.
This is actually what lead to the housing collapse in 2008. People who weren’t able to afford homes were handed loans that looked appealing due to the low rate up front, and then they foreclosed on their house when the rate would adjust and they couldn’t afford the payments any longer. And this happened in a widespread fashion. Fortunately ARMs aren’t nearly as widespread now.