This is going to be a weird post. It’s a weird post in the sense that if you’re reading this, it is probably not relevant for you personally. However, FIRE pursuers tend to try and change other people. I notice that a lot on online forums (Facebook/Reddit). One of the common themes I noticed on these forums is something like: “My parents/friend own their home, wouldn’t they be better off renting and investing the money in index funds?”. If you agree with the quoted question, this post is for you. I want to make an argument for owning homes, especially for less-financial-savvy people. Ok, let me get to the point. I want to explain why most people should own their home, in my opinion of course.
Breaking down mortgage payments
As I explained in a previous post, mortgage payments are made of principal and interest. The interest is really an expense but the principal part is not, it’s savings.
Your net worth is the value of all your assets minus the value of all your liabilities. As the mortgage (debt) is a liability, reducing it increases your net value, just like increasing your assets (savings).
Got a headache from that last sentence? Let’s do an example.
A couple has £2,000 in the bank, a home that’s worth £100,000 and a mortgage of £80,000. No other assets or liabilities.
The sum of their assets is £102,000 and the sum of their liabilities is £80,000. Their net value is £22,000 (102,000-80,000).
If they reduce their mortgage by £10,000 (to £70,000), their net value will increase by £10,000 to £32,000 (102,000-70,000).
As you can see, decreasing the mortgage (liability) increased their net value.
Now, let’s assume their mortgage payment is £1,000 a month and the monthly interest is £200. This means that the principal payment is £800. Every month their net value increases by £800 due to the mortgage payment.
Now that we understand why a mortgage is partly an expense and partly savings, we can move on 🙂
Why I think most people SHOULD own their own home
We all know someone who spends everything they earn. If they get a raise or a bonus, they would spend it too. This behaviour is a lot more common than we would like it to be. It explains why people reach retirement age with very little money. A lot of these people get to retirement age with one significant asset- their home. If they rented, after 20-30 years they will still have close to no assets*. How do they manage to pay off their home if they spend all their money?
First of all, they save for a downpayment. This is not easy for them but they do it once in their life and get it over with, fair enough. sometimes it takes years or even decades and sometimes this money comes as help from family. However, most people save a downpayment of less than 25% of the value of the property. That means that paying the mortgage should be much harder as it’s a lot more money. But it isn’t, why is that?
It is (in my opinion) because mortgage payments FEEL like an expense. It is just another bill, you have to pay it (like rent) or you’ll be homeless. You pay it like any other bill, you don’t transfer the money to a savings account. Despite it feeling like an expense, we saw that it is also partly savings.
It is actually the fact that it FEELS like an expense that makes it “easier” to pay.
The fact that mortgage payments feel like an expense, but are (at least in our case) mostly savings is also why I think that most people should buy their own homes. Spenders are used to spending all their money on bills and other expenses. Spending (including “fake” expenses) is effortless, saving is hard (in the spender’s opinion).
I know this is a controversial topic. I know that financially, sometimes renting can make more financial sense, and it’s a legitimate debate. However, for people who aren’t into personal finance, it could be a really good decision to own their home (even if the yield is sh*t).
Imagine the peace of mind of having your main home paid off despite treating all of the mortgage payments as an expense for all those years. Now compare this to renting and then reaching retirement age with no significant assets, does that sound nice? Of course, it doesn’t.
If you are investing the money instead of buying your home, that’s fine. I’m talking about people who would just spend it all. For them, buying their own home and “tricking their own brain” could be the best decision they make.
You pay your mortgage each month and without really feeling it- you’re slowly buying more and more equity in your home.
I think that tricking your own brain works on financially savvy people too, we are all human. You know I’m all about automation, I love the fact that I HAVE to save (via mortgage payments) every month. You may consider it too.
Pensions follow the same logic. The default (you can opt-out, not recommended) is that the employers contribute at least 3%** of the employee’s salary to a pension and the employee contributes at least 5%**. This means that an employee saves at least 8% (total) of their annual to their pension. Thank god the government set this default setting. If they hadn’t, people would just increase their net salary, which would, in turn, increase the spending (not the savings). Oh, they also give you a HUGE tax to sweeten the deal.
Just like mortgage payments that feel like an expense, pension payments feel like a tax. It’s money that is deducted from your salary before you see it in your bank account. It doesn’t “feel” like you’re savings but you are. I love these ways to positively trick your brain.
Long live capitalism
I am a capitalist, I believe that you should take responsibility and ownership of your future and finances. This means that, in a perfect world, people shouldn’t be “forced” to contribute to a pension. However, I realise that this is not reality. Not all people are responsible enough and… this is gonna sound VERY condescending… some people need to be protected from themselves. This means that we have to accept the reality that people don’t save enough for the future and may need to be forced to do so. It is not an ideal solution but I see its benefits.
I am more than happy to debate the financial differences between renting vs. owning. The reality is that most people who rent don’t invest the money that would’ve otherwise been used to buy a home. If they can “trick themselves” into increasing their net worth by paying the mortgage payments, I think that’s awesome. The fact that it automates savings is just another bonus, which I explained in last week’s post. The same logic applies to pensions.
I know this is a controversial topic, feel free to disagree with me in the comments section, I just said “I am more than happy to debate” 🙂
*Besides retirement money which you are now “forced” to pay into and the employer is “forced” to contribute towards.
**These rates are from the GOV.UK website