Academic journal article Financial Services Review

The Impact of Housing Choice on Future Household Wealth

Academic journal article Financial Services Review

The Impact of Housing Choice on Future Household Wealth

Article excerpt


Is owning a home the correct housing choice for the average household, and, if so, how do we know? In North America, about two-thirds of households own their homes, and this figure is increasing after a period of decline. This paper provides a financial model that can be used to comprehensively analyze the impact the rent/buy decision has on wealth. The results of two case studies suggest that the financial impact of homeownership may not be as positive as perceived by the average North American household. The model can be easily adapted by users to reflect different assumptions. (C) 2003 Academy of Financial Services. All rights reserved.

1. Introduction

The choice of housing is one of the major decisions facing households and all must decide whether a home should be owned or rented? For a large majority of North Americans, ownership is the preferred choice, quite often a major life goal. In Canada, 64.2% and in the United States 67.8% of households now own their homes and this figure has been gradually increasing after a period of decline during the 1980s. For single families, the figure averages 75% but ranges over 90% depending on family income.2 Furthermore, in North America, surveys show that 86% of adults prefer to own a home and two-thirds of renters would buy a home if they could afford one (see Cisneros, 1995; Royal Bank, 2002).

A Royal Bank (2002) survey reveals a reason for the high incidence of homeownership: 84% of respondents believed a home was a good investment and a wise financial choice. For owners, the rate was 88%, for renters, 77%. In addition, governments and society encourage the achievement of this goal with many policies directed to current and potential homeowners. It seems society can be split into two groups: those who are homeowners and those who wish to be. For many one person households, renting is the only option given income constraints and the reduced need for living space.3 For the majority of North Americans, however, once household size reaches two adults, homeownership becomes a viable, usually desirable option. In North America it seems to have become accepted wisdom that buying a house is the intelligent choice when making the housing decision. Is this the case for the average household, however, and, if so, how do we know?

Given the major impact the decision has on family finances, it seems clear that a thorough financial analysis should be completed. This paper introduces a financial model that can be used by households and their advisors to comprehensively analyze whether a house should purchased or rented. A template, based on the model, is developed that displays the financial consequence of the choice. Numerous factors affect the decision and the analysis is quite intricate. With an information set regarding the choice of buying or renting a home, the expected financial outcome can be estimated and the household can decide if buying is financially wise.

Many North Americans innately believe that buying is superior to renting both financially and psychologically. While the financial aspects of the question can be modeled and analyzed, the emotional, social, and psychological reasons for owning a home are highly subjective and, in general, difficult to quantify. The output of the model presented in this paper, however, allows the user to implicitly value these factors. Even though the model's output may suggest that renting is the optimal financial choice, when the non-quantitative factors are considered, buying may be preferred. The implied value of the psychological reasons for owning may offset any explicit financial "cost" of ownership.

The remainder of this paper is organized as follows. The following section reviews the literature regarding housing choice. An applied model is then developed that can be used to analyze the housing question. The purpose of the model is to determine household wealth in the future assuming a home is purchased. …

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