What is an ‘Opportunity Cost’
Opportunity cost refers to a benefit that a person could have received, but gave up, to take another course of action. Stated differently, an opportunity cost represents an alternative given up when a decision is made. This cost is, therefore, most relevant for two mutually exclusive events. In investing, it is the difference in return between a chosen investment and one that is necessarily passed up. –Investopedia.com
My near future has a LOT of big changes coming. My student loans will be paid off soon. I will be moving out of my parent’s house shortly after. The beginning of my life with my girlfriend is about to start. While the future looks bright the past 4 years still haunt me. There is an obligation I feel to propel my financial situation forward to make up for that lost time. This how I got into studying investing and personal finance about ten months ago. When it comes to moving out, my goal of increasing my net worth will still be my focus. So where will my $25,000 best serve me? Any decision has its on opportunity costs associated with it. Using it as a down payment on a house gets me into a location where I could stay living and start building equity eventually. On the other hand, using it to make my first income producing investment could off set any net worth gains that I would be giving up.
What are coming opportunities?
In the future I want to be living in a house and looking at buying my first investment property. I get to pick one: Down payment on a house and then save OR down payment on a rental property to live in temporarily.
Down Payment for a house
The quality of house I can get for $1300 a month is much greater than what is rent-able in this area. Even at that rate, I should be able to save monthly for future investments. The sacrifice for this option is having a large amount of cash tied up in the loan and recouping that amount of capital will take longer than the initial time.
Down Payment for a rental property
With a 3-4 plex rental unit being the goal and using the same dollar amount down, I could do a high leverage debt on the property to get a good B-Class. The sacrifice for this option is having to live in the property for a year to get a lower rate on the loan and having to live directly next to tenants.
Is the house you live in an asset or liability?
Most people who do not read about personal finance regularly, might not be aware of this conversation. None of the millionaires I follow on YouTube and social media own their house; they are all leased. The reason is, “why would you want to own something expensive that doesn’t make any money?” This statement never resonated until now. Buying a house is not a wise choice to increase your networth quickly.
Your money was put down to purchase the house you live in. You are responsible for repairs. There are many more ways to spend money on your own house and some can even increase the property value. Other than forced appreciation, your house value is growing primarily at the rate of inflation. The house you’re living in, has an expected appreciation of the average rate of inflation of 3% per year. The stock market makes double that rate of return over the long run. Another option would be starting your first rental property. Both of the previous options are definitely assets.
Which side am I?
When people are not motivated to save money, I think putting a down payment on a house you own is a great deal. It is forced savings by earning equity. If you can save up for a down payment, make your monthly mortgage payment, AND save additional money for future investments, then you might be okay to buy. My next residence will be my home for more than the next 5 years. If I foresaw any reason I would be in that unit for less than 5 years, then I would only rent.
Making any decision and looking at the total opportunity costs takes time and understanding. My decision has to consider the person I am with and what she wants and needs. I personally need my significant other on the same page before anything is finalized. Anyone looking to make these decisions need to research and understand everything before hand. Paula Pant from Afford Anything has a great article titled ‘Should You Invest in This Rental Property?‘ that everyone should read to understand what ever choice they decide to make. My willingness to buy a permanent residence instead of jumping directly into a rental property is based on the trust I have in myself to save money once I get my house. This decision also gives me additional time to learn about deals and get even more familiar with the market. The future will still have my rental property when I am ready.