James d. Gwartney

Video:
Availability Bias
Video:
Loss Aversion

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Video:
Home Country Bias
Video:
Herding

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258
Reduce Your Risks
The purchase of housing is one of the most important decisions most of us will confront during
our lifetime. For most, a home purchase will be their largest investment, at least initially.
Buying a home you can afford in a desirable location and keeping it well maintained can be a
good investment. But, as is illustrated by the housing crisis of 2008–2009
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in the United
States, there are potential pitfalls. Examination of the following factors will help you avoid the
worst problems.
First, carefully consider the “own versus rent” option. Many people immediately
conclude that purchasing is a better option than renting because purchasing can build equity.
They reason that their money is wasted on rent going into the landlord’s pocket when it could
be put to work creating equity, helping to build the homeowner’s net worth as the mortgage is
paid off and the market value of the property appreciates. During the first few years of a
mortgage, however, almost all of the monthly payment is for interest and very little is actually
building equity. So if you sell the home within three years, for example, you will have
accumulated little or no equity. You’ve simply paid the bank interest instead of paying rent to a
landlord.
Second, buying and selling real estate is expensive and therefore it is not a good idea to
purchase a house unless you expect to live in it at least three years. You will need to pay
realtor commissions
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plus VAT
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levied on commissions, which vary across countries (in
Austria, 3 percent: Croatia, 3 percent; Italy, up to 7 percent).
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Closing costs on a mortgage
are typically several thousand dollars. If you sell the house within a few years after the initial
purchase, the transaction costs are likely to be greater than your equity.
Third, do not buy a house (or flat) until you have saved for a down payment. In the
United States, this should be at least 20 percent. If your down payment is less than 20 percent,