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David Bach The Automatic Millionaire

David Bach, The Automatic Millionaire

Why Homeowners Get Rich and Renters Stay Poor

by David Bach

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Posted on Monday, February 13, 2006, 12:00AM

With my new book, "The Automatic Millionaire Homeowner," I aim to demystify the process of home buying and provide you with a common-sense way of looking at a real estate market that often seems crazy. If you're a renter, the book is meant to give you the motivation as well as the tools to make the dream of homeownership a reality. If you already own a home, it will teach you how to make it the foundation on which a lifetime of financial security can be built. What follows is a sneak preview of the book, which launches in March.

The Homeownership Dream -- and the Results

From 2001 to 2005, the average homeowner saw the value of his or her house jump by more than 50 percent. Many homeowners doubled, tripled, and in some cases even quadrupled their wealth in just five years because of exploding real estate values.

Imagine that. Buy a home, live in it, build your wealth, get great tax deductions -- and then retire rich. It may sound too good to be true.

Indeed, plenty of experts will tell you that the housing boom never happened. According to them, what we've experienced over the last few years was just a "bubble" that's going to pop any minute now. Others insist that whether it was a boom or a bubble, it's over. According to them, it's now too late to get in on the party.

The American Dream Is No Fantasy

I think both these positions are wrong. My view is that the American dream of building a nest egg by owning a home is no fantasy. Homeowners have been getting rich off their real estate for years, and they will continue to do so in the future.

How can I be so confident about the real estate road to riches? Well, U.S. real estate values have been going up steadily for nearly four decades -- an average of 6.3 percent a year since 1968, which is when the National Association of Realtors first started keeping track. According to Freddie Mac (a.k.a., the Federal Home Loan Mortgage Corporation), since 1950 U.S. house prices have never experienced a year-to-year decline nationally. Compare that to the S&P 500, a major stock-market indicator that has had no less than a dozen down years in the same period -- or the market for U.S. Treasury bonds, which has fallen in 17 of the last 55 years.

Of course, just because home prices have been rising for the last half-century doesn't mean they're going to continue doing so. But real estate's phenomenal track record is not the only reason you should want to become a homeowner. Here are five more.

1. Owning Is Cheaper Than Renting

People who say it's cheaper to rent than to own are simply wrong. Under certain circumstances in certain markets (where real estate values are overheated and rents are low), there may be some short-term advantages to renting. But over the long haul, renting simply isn't a good deal. If you don't own your own home, you can easily wind up spending more than half a million dollars on rent during the course of a lifetime -- and probably a lot more.

Assume you're renting a house for $1,500 a month. Now let's say you stay put for 30 years, during which the landlord increases the rent by 5 percent a year. Over those 30 years, you will hand over a total of nearly $1.2 million in rent payments -- and at the end, you'll have nothing to show for it except a bunch of cancelled checks. To add insult to injury, you'll now be paying $6,174 a month in rent!

Now let's imagine that instead of continuing to rent, you buy the same home for $200,000 (this is just an example, and prices will vary greatly from market to market, especially in big cities where homes are typically much more expensive). Initially, your costs as a homeowner are likely to total around the same $1,500 a month you would've paid in rent. But these costs won't balloon over the years the way rent would. That's because your regular mortgage payment, which represents the lion's share of your monthly outlay, is fixed (or, if you have an adjustable-rate mortgage, at least capped).

What will balloon over the years is the value of your house. Say it goes up by 6 percent a year, which is actually slightly lower than the national average. After 30 years, you will own a home that's worth just under $1.1 million.

2. Homeowners Get Leverage

Leverage is what you get when you use what is called "OPM," which stands for "other people's money" -- the other person in this case being your bank or mortgage lender.

Here's how it works. Let's say you buy a home for $200,000. With standard 80 percent financing, you make a cash down payment of $40,000 and cover the rest of the cost with a $160,000 mortgage from the bank.

Now let's say over the next year or two the value of your house rises by 10 percent. So now it's worth $20,000 more than you paid for it. If you were to sell the house at this point for $220,000, what kind of return would you have made?

If your answer is 10 percent, you're mistaken. You take the $220,000 you got for the house and repay the bank its $160,000. That leaves you with $60,000 -- or $20,000 more than the $40,000 original down payment. In other words, you made a $20,000 profit on a $40,000 investment -- which amounts to a 50 percent return.

As much as I like stocks, bonds, and mutual funds, there's little chance any of them will produce anything close to that return in such a short amount of time.

3. Homeowners Get Tax Breaks, Renters Don't

The best way to stay poor is to pay more than you have to in taxes. When you rent, you get absolutely zero tax breaks on your housing costs. But as a homeowner, you get the mortgage-interest deduction, which can effectively reduce your monthly mortgage payment by 30 percent or more.

4. Homeowners Can Earn Tax-Free Profits

Another way to stay poor (or at least middle class) is to keep letting the government take part of the profits you make from your investments. Buy shares of Google at $300 and sell them at $600, and you've made a bunch of money, but not as much as you think. This kind of profit is called a capital gain, and as with virtually all income, the IRS insists on taking its cut.

There's one asset, however, that you can sell at a profit without having to pay capital-gains taxes to the government. You guessed it: It's your home. Under current tax law, if you sell your primary residence, you don't have to pay any capital-gains taxes on the first $250,000 in profits -- the first $500,000 if you're married.

5. Homeowners Become Savers

Each time you make a mortgage payment, you're saving money. That's because with each payment you're reducing your loan balance a little -- and that, in turn, is building your equity. (This assumes you don't have an interest-only loan.) The longer you're in your home, the more equity you build, the more you save -- and the richer you get.

If You Want to Be Rich, Don't Rent

According to statistics compiled by the Federal Reserve, the average homeowner is 34 times richer than the average renter. If you're not a homeowner, this may depress you. But it shouldn't. Why? Because -- and this I can't emphasize this enough -- it's never too late to catch the real estate wave.

Everybody has to live somewhere, and someone owns every place where someone lives. Why shouldn't that someone be you?

Obviously, no investment -- not stocks, bonds, or real estate -- goes up in a straight line forever. But over the long term in America (which is to say, 10 years or more), most experts believe that homeownership is an exceptionally smart way to invest your money.

Remember -- as long as you're alive, you have to live somewhere. So does everyone else you know. And because of that, homeownership will continue to be a great investment.

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21 Comments

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  • the Dridis - Friday, August 31, 2007, 9:36AM ET  Report Abuse

    • Overall: 1/5

    Rents going up 5% a year for 30 years straight, and a home that only costs 200,000? These numbers are skewed to support this argument.

  • gepto - Sunday, June 3, 2007, 12:06PM ET  Report Abuse

    • Overall: 2/5

    if this guy's net worth is more than robert kiyosaki then he may be right otherwise ..... and what about interest, property taxes, insurance, it's all negative cash flow until you sell.

  • Yahoo! Finance User - Friday, April 27, 2007, 12:22PM ET  Report Abuse

    • Overall: 1/5

    This article is very one sided. The author himself said the average return on real estate is 6.6 % as opposed to 8% on mutual funds. He does not consider upkeep on the house or property taxes. In my neighborhood the rent on a house is $2200, and the mortgage to buy the same house is almost $4000 a month. Investing the difference appears to be the smarter option. But being a renter stinks, so I will probably buy anyway!

  • Yahoo! Finance User - Tuesday, April 24, 2007, 3:17PM ET  Report Abuse

    • Overall: 5/5

    I cannot understand why you people cannot see that what the author is saying is true. I am not sure all of his facts are right but in general he is right. I am a landlord. I make around 30,000 a year at my job. I make an extra 5600 a year from the rents profit. Plus I am building equity. I havent paid one red cent for my properties. So I hope that morons like you people stay stupid because I am ready to buy another property so that I can make even more money. Before long I will be living off of people like you. I wont have to use my income to make my own house payment. I will be able to afford nice cars on your hard work. I will be the person you see driving around in a big gas guzzling hummer when gas is like $10.00 a gallon and you will be the people paying for it all. So I short if you are dumb enough to think that renting is the best way to go please by all means come rent one of my properties so that I can get rich off of you.

  • Yahoo! Finance User - Monday, April 16, 2007, 4:42PM ET  Report Abuse

    • Overall: 1/5

    This is terrible. Do not take this advice. I thought it was a joke at first. In his second point, he doesn't even figure in the mortgage payments to the bank, of which the vast majority would be interest expense that you would never see again. Also absent is closing costs, which average about 3-5% (6,000-10,000 in the $200,000 example). So in point #2, when you sold the home for $220,000 after two years, you'd pay back roughly $160,000 (slightly less after factoring in normal payments, assuming a 15 year loan @ 6.5%). But your investment would include the initial $40,000, plus the 6,000-10,000 closing costs, and the interest costs you paid. After two years, you'd pay the bank approximately $146,500, leaving you with $73,500. Now take your initial investment of $40,000 closing costs of $6,000 (conservative 3% estimate) $20,000 of interest = a total "investment" of $66,000. This is an annualized return of only about 5.5%. If you have a 30 year loan, your interest payments are even higher, giving you a negative return over two years. Compare that to the historical annualized return of an ETF or mutual fund that tracks the overall market return: approximately 8% per year over the last 70 years. The bottom line is this: this article is way to simple to trust. There are too many factors that affect your net worth. If something seems very simple, don't trust it. I can't stress enough how misleading this article is. That is not to say that renting is better than buying, but a person's situation may be such that that could be the case. This is just plain garbage.

  • thale138 - Thursday, April 5, 2007, 8:49PM ET  Report Abuse

    • Overall: 1/5

    yeah, i quit reading this garbage after the first four "points" he made. He seems like some slick shyster trying to sell a book to gullible fools.

  • franz - Thursday, March 22, 2007, 9:33PM ET  Report Abuse

    • Overall: 1/5

    The heading is ridiculously generalized. Look at the Forbes rich list. How many of those people got rich as a direct result of owning rather than renting? It is sometimes cheaper to rent - especially during mania stages where you can earn much higher Return on Invested Capital in alternative investments while renting."it's never too late to catch the real estate wave." - Tell that to Japanese home buyers who bought in 1990. I also remember hearing a similar phrase during the dot com bubble.

  • S. W - Thursday, March 15, 2007, 2:07AM ET  Report Abuse

    • Overall: 2/5

    I think you should do what's comfortable for you. I've been a renter and a homeowner (currently a homeowner). There are advantages and disadventages on both sides. I liked renting because I didn't have to pay for repairs/maintenance or make repairs, didn't have to pay property taxes or school taxes, didn't have to pay homeowners insurance (I did purchase renters insurance to cover my contents), and I still got tax write-offs for having a homeoffice. I rented a duplex for 2 years and my landlord never raised my rent. I rented a house for 4 years and my landlord never raised my rent. My first house I lived in for 2 years and had to pay all of the taxes mentioned previously and had to pay for all repairs/maintenance. I've lived in my current house for 8 years and have to pay taxes, pay for repairs/maintenance, etc. My property taxes have increased every year, which means the value of the house has increased. The increased value of the property is a good thing if I decide to sell the house if I sell it myself to avoid paying the 6% realtor fee. The tax write-off on interest isn't worth it to compared to the property tax I pay each year ( I could lose my house if I don't pay the property tax). I still get my tax write-off for having a home office. After I pay off the house I still have to pay property taxes until I no longer own the house, so I could still lose the hose if I don't pay the property tax (that sucks!). If I ever had an emergency come up and needed cash, assuming I have equity in the house, I could always get a home equity loan (assuming my credit is good enough for a bank to give me a loan). Just look at all of the pros and cons and do what's best for you.

  • Yahoo! Finance User - Monday, March 5, 2007, 6:36PM ET  Report Abuse

    • Overall: 1/5

    This guy sounds like he has a house for sale. He failed to mention that the government includes refinancings in its housing price indexes which helped overstate the bubble. Low interest rates, subsequent refinancings, home equity loans and sloppy lending were the leading factors in the housing boom. Watch prices return to 2001 rates plus slightly less than the inflation rate as history has always shown. 30 to 45 percent of today's prices are all bubble.

  • Yahoo! Finance User - Monday, February 26, 2007, 6:39PM ET  Report Abuse

    • Overall: 2/5

    I also think the article is biased. First of all, I don't think the house you live in should be viewed as an investment. That's not to say owning isn't a better deal than renting for most people most of the time. But the fact of the matter is that owning a home incurs lots of costs such as: real estate taxes that go up every year, maintenance costs, and commissions when you buy and sell. Also, articles like his aren't of much use for people who live in overpriced markets in the Northeast & on the West Coast. There comes a point of no return where the mortgage payment is just too much. As for me, I'm glad I'm a renter. Renting my studio apartment has kept my housing expenses to 20% of my income so that I can max out my 401k-type plan (which--I might add--I also get a tax deduction for). I'd barely be able to save anything for my retirement if I owned even a 1BR condo in my area. However, I would agree that it seems a lot of people who pay low rent tend to just spend the money instead of putting it in their retirement plans.

  • Yahoo! Finance User - Wednesday, February 14, 2007, 4:29PM ET  Report Abuse

    • Overall: 1/5

    There is too much left out. For example the capitol gains is allowed after living in the house for 2 of the last 5 yrs. and a big chunk of the profit is gobbled up in realty fees. I think real estate is a good investment but the 200,000 home i bought in 1998 was worth 155,000 in 1995 and when i sold it in 1997, 177,000. The market can and does go down. The comparison to the stock market is biased and incomplete.

  • Yahoo! Finance User - Thursday, February 8, 2007, 3:18PM ET  Report Abuse

    • Overall: 1/5

    Reasons to rent: A. You won't be ahead if your house doesn't appreciate. Remember, unless you are a realtor (C), you will probably pay at least 6% of the selling price to sell your house. B. Renters get tax breaks too, called the standard deduction. $10,300 for married filing joint. Of course, the mortgage interest deduction opens up all other itemized deductions, but the fact is you have to actually pay all that money to get the deduction. C. Mobility, when you get transferred for your job, or hurricane season floods your house, etc, you can get out. All i'm saying is there are definitely pros and cons to renting and buying, and it will totally depend on your situation.

  • The Donald - Wednesday, February 7, 2007, 6:04PM ET  Report Abuse

    • Overall: 5/5

    Those who rate this 1 star really need to be open-minded to rethinking your beliefs. Yes there are risks with real estate like everything. Buying more than one can afford or paying too much, not doing your homework, etc. Granted the statistic that a homeowner is 34 times richer than a renter on average is a meaningless statistic and has little merit as the top wealthiest 5 to 10% own 40 to 50% of the wealth in this country and most college students rent and are in debt so that can skew the data. Most of the wealthiest also hold their wealth in real estate. Coincidence? NOT For the guy who is paying $1800/month rent to live in a house that is worth $750k should ask himself why is the owner willing to do that? And the guy who worries about the $40k roof is paying for that roof with his rent payment whether he knows it or not. For $1800/month one can by a 300k house with a 30 year fixed mortgage with little money down. If after 5 years that house doesn't appreciate 1 penny you are still better off than renting for $1500/month. You get tax deductions. One can get tremendous leverage on a property for a few hundred dollars a month with a mortgage. $300k house after 5 years appreciation: 1.5%/year $300k after 5 years - $323k 3%/ year $300k after 5 years - $348k 6%/ year $300k after 5 years - $401k And you can improve the property beyond its simple appreciation. They guy who rented for 5 years got nothing but a place to live not even a tax deduction. You have to live somewhere anyway either by mortgage or rent or with parents. I started by saying those who rate this 1 star should be open minded and rethink their beliefs. I take that back. Please don't change your mind and continue to rent. I love renters they put cash in my pocket. Thank you for being a renter.

  • Yahoo! Finance User - Friday, January 26, 2007, 12:00PM ET  Report Abuse

    • Overall: 1/5

    Is the average homeowner 34 time richer than the average renter because they bought a home? Correlation does not prove or even imply causation. What is the average age of homeowners? Average income? Maybe they are wealthier because they are older and make more money. Take two individuals. Same income, same level of savings as of February 2006. Both were renting an apartment for $1200/mo. Person A reads Bach's article, and says, "yes, I plan to buy a house, but I'm not going to allow David's scare tactics to send me running to my local realtor, desperate to 'get in' to the housing market." Person B says, "holy crap, homeowners are 34 times wealthier?! I better get going." Person B pays $500k for a condo similar to what he was renting for $1200. He gets a 100% loan, and despite the loan to value, manages to find 6.5% financing. His mortgage is now $3160. Plus HOA, insurance and taxes. Yes, he gets a tax deduction on the interest, but it doesn't come close to covering his higher payment. Prices in most of the country, as we know, have not gone up, rather in many areas have gone down. Is Person B 34 times richer than Person A? No, because this is an actual apples to apples comparison.

  • Yahoo! Finance User - Thursday, January 25, 2007, 9:49PM ET  Report Abuse

    • Overall: 1/5

    While I agree that real estate is a solid investment option, this article is very poor and there is no way i would buy this book. Real estate is only smart if you can afford it, and that's why the majority of real estate sales now are by people that already own homes. So renting is more expensive than buying a home? What about the 1% property tax you will pay to the government each year? What about the $40,000 roof you will need to purchase at some point? Real Estate may always appreciate, but I don't see any real advice this book could give you after reading the summary above.

  • __A_YAHOO_USER__ - Sunday, January 21, 2007, 2:55AM ET  Report Abuse

    • Overall: 1/5

    I am a renter (for a reason), and I think this article is very biased. I pay $1800 rent for a house that goes about $750,000 - mortgage @ 6.25% comes to about 4500$ / month. Instead save 2700$ month on a tax deferred plan - it will soon become a decent saving. Another way to look at it: After 5 years paying the mortgage (650K @6.25), one would have hardly paid 30K towards the principal - the rest goes to making the lenders richer! Worse, the real-estate market does not have to crash - but even if it stays flat or below inflation, it will be a terrible loss!

Showing comments 6-21 of 21<< Previous

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