Is a Home Your Best Investment? Four Reasons It Feels That Way

For some households, a home is the largest thing they own and can feel like their best investment. That feeling can come from several different forces working at once, and each depends on conditions. A home can help build wealth, and it is also a costly, concentrated and hard-to-divide purchase that comes with risks other holdings do not.

Key takeaways

• A home can build wealth through price growth, mortgage principal payments and a fixed rate, but each of the three carries conditions.
• Paying down principal turns cash into equity without changing net worth on that day.
• A purchase with 20 percent down magnifies price changes, so a 3 percent rise or fall in value moves the owner's stake by about 15 percent before costs.
• A home is one property in one place, which makes it concentrated and hard to sell in pieces.
• Part of a home's value is the use of living in it, which no price chart captures.

Four reasons a home feels like an investment

Price growth. Homes can rise in value over long stretches, and a rising value adds directly to what the owner is worth. Prices are local, though, and they can also fall. The Consumer Financial Protection Bureau cautions that if home prices drop, an owner may owe more than the home is worth, which can make it hard to move.

Savings built into the payment. Part of each mortgage payment reduces the balance owed. That steady paydown works like a habit that is hard to skip.

A fixed payment against changing prices. With a fixed-rate loan, the interest rate is set at the start and does not change. Meanwhile, the Bureau of Labor Statistics describes the Consumer Price Index as a measure of the average change in prices paid by urban consumers, and many everyday prices drift up over time. A payment that stays put can feel lighter in later years, even though taxes, insurance and repairs may not stay put.

Use as well as value. A home shelters a household and gives its members control over their space. Part of its worth is the daily experience, which no price chart captures.

What each reason leaves out

The savings idea is the one most often misunderstood. When a household pays $1,000 of principal, cash falls by $1,000 and debt falls by $1,000. Net worth is the same that day. The paydown moves wealth from an easy-to-spend form into a hard-to-spend form called equity, and it can be valuable in building toward a debt-free home. It is not, by itself, a gain.

Price growth, meanwhile, has to be weighed against the costs of holding the home: interest, property taxes, insurance and maintenance. Those are real outflows in the years when prices rise slowly or not at all, and selling costs reduce whatever gain exists when the household moves.

Leverage cuts both ways

Most buyers borrow much of the price. Here is a hypothetical. A household buys a $400,000 home with $80,000 down. If the value rises 3 percent, that is $12,000, or 15 percent of the down payment. If it falls 3 percent, the loss is the same $12,000, again 15 percent of the down payment. Because the loan is a fixed amount, changes in price are magnified relative to the owner's own money.

This illustration leaves out selling costs, interest, taxes, insurance and repairs, all of which would make the outcome less favorable. It is not a forecast, and actual changes in value vary a great deal by place and by year.

Concentration and limited flexibility

A home is one property in one location. Diversification, the idea of spreading holdings among many things so that one problem matters less, is hard to achieve with a single house. A job change, a local downturn or a neighborhood shift can affect both the household's income and its largest holding at once.

A home is also hard to use in pieces. Savings can be drawn on in small amounts. Equity generally requires selling the home or borrowing against it, and both carry costs and risk.

Questions to ask about your own home

1. How much of our total wealth sits in the home compared with accounts we can reach quickly?
2. If values were flat for several years, what would we have gained and what would we have spent?
3. How long do we expect to stay, and what would selling cost?
4. Is our cash cushion separate from the equity in the house?
5. What does the mortgage cost each month, and does that leave room for other goals?

None of this argues against owning. It separates the parts of a home that act like an investment from the parts that are simply living, and that makes each easier to plan for.

Common questions

Does paying down a mortgage increase net worth?

Not directly. Each principal payment lowers what is owed and lowers cash by the same amount, so net worth is unchanged on that day. Net worth rises when the home's value rises or when other debts and costs are managed.

Can a home lose value?

Yes. The Consumer Financial Protection Bureau notes that if home prices fall, a homeowner may owe more than the home is worth, which could make selling or moving harder.

Why does a fixed mortgage payment feel smaller over time?

With a fixed-rate loan the interest rate is set when the loan is made and does not change, while many other prices in the household budget can rise. Taxes, insurance and repairs can also change, so the full cost of owning does not stay flat.

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