1 Crucial Mistake New Home Buyers Make

By Nathan Hamilton Markets Fool.com

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No doubt the stakes are high when buying a home, especially knowing that a mortgage payment is likely your single, biggest bill each month. It pays to know how much house you can affordso you can meet budgeting goals and better save for retirement.

With this in mind, Motley Fool analysts, Kristine Hartjes and Nathan Hamilton, discuss in the video below one mistake people make when getting a mortgage to fund a new home purchase. Listen in to learn why the house you've had your eye on may not be a great investment and how this impacts the size of your mortgage.

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KRISTINE HARJES:

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So here at The Motley Fool, we think a lot about what we do with our money. We're investors, at heart, and so we penny-pinch. We think about where each and every dollar goes. So it's crucial to consider what is often the biggest spend of a person's life, which is your home, and I think a lot of people out there consider a home an investment. But we want to talk to you today about why that could potentially be a huge mistake.

NATHAN HAMILTON:

Yeah, it's not to say that every home can't be a good investment opportunity, but the way that many people look at it is just the wrong way to think about an investment. [Think about it.] A former Motley Fool employee, Morgan Housel if you know him, has written for The Wall Street Journal. A super smart guy. And as he wrote in one of his articles before, a house is a large liability masquerading as a safe investment.

What does he mean by that? If you look at the long-term returns of the housing market, after inflation it's about 5%. If you're paying cash, you harvest that whole 5% when buying a home. But the majority of us don't. We use a mortgage. We have to take on debt. We leverage ourselves to get better returns. [The mortgage rate right now] is about 4.04%, so a long-term return is about 5%. You pay in interest 4%. Net to you, over the long term, is 1%. You can get that in a CD some places.

KRISTINE HARJES:

Yes. It's important to note that a house, as shelter, is necessary. I mean, it's not necessary to buy, but it is necessary to have shelter of some sort. So when you think about it that way, maybe a smarter way to think about a mortgage and a home is as a consumption vehicle.

NATHAN HAMILTON:

Yes.

KRISTINE HARJES:

This is something that you're putting money toward, like you'd put money toward clothes, or entertainment. It's something that you consume.

NATHAN HAMILTON:

Like I started with before, some houses can be good investments in certain markets, and they have proven to generate a better return than 1% per year.

KRISTINE HARJES:

But I think that kind of thing is largely hard to predict.

NATHAN HAMILTON:

It is. You never know, over a couple-of-year period, if the housing market in your specific area of the country is going to be hot, cold, lukewarm, anywhere in between. So you've really got to go at it and say, "What do we consider a good investment?" I would say (not just us at The Motley Fool, but in general), that a good investment earns an acceptable rate of return. Net 1% for the risk you're taking with a lot of debt, check the box? No. It probably doesn't fall into that category.

KRISTINE HARJES:

And the important thing to remember, too, is that sometimes people don't associate the word mortgage with debt.

NATHAN HAMILTON:

Oh, yes.

KRISTINE HARJES:

Even though that's what it is, and it is totally different than credit card debt or any other sort of very high interest rate debt. Still, debt is debt. It's an obligation.

NATHAN HAMILTON:

Think about it this way. If you're at a party with friends and somebody says, "OK, I got a mortgage to buy a new house," at that same party I'd never go and say, "Hey, I took on a lot of credit card debt to buy this new TV." It doesn't have the same meaning. And one of the most successful things is essentially calling debt a mortgage. It just has less of an impact. It doesn't sound as nasty as what debt does.

But continuing on what a good investment would be is it also increases in value without additional capital. A house is a consumption vehicle, as you mentioned. It depreciates in some areas. You have to pay utilities, upkeep, maintenance. All of that.

KRISTINE HARJES:

Fix the roof every once in a while.

NATHAN HAMILTON:

With a stock, you put money into it. Hopefully it appreciates in value from there. In some cases you actually earn a dividend as a return to you while you hold it. Check the box no, again. A house doesn't fit in there.

And then as we see it, at least at The Motley Fool, is not using a huge amount of leverage or debt to get those returns. And with a mortgage, as we've covered before, a mortgage is debt and the largest debt that many people will take out in their financial life.

KRISTINE HARJES:

And all of this is not to completely scare you out of buying a home...

NATHAN HAMILTON:

We don't want to be Negative Nancy...

KRISTINE HARJES:

...or getting a mortgage. It's just very important that you have that proper mental positioning when you go into this process...

NATHAN HAMILTON:

Yes...

KRISTINE HARJES:

...and as you mentioned earlier, the rates that you pay are very, very important. So if you're looking to get the lowest possible rate, something that's really important is boosting your credit score. How do you do that? Head to Fool.com/Mortgages and you can download our free report called "5 Tips to Increase Your Credit Score Over 800."

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