Whether to rent or to buy the place in which you live is a major decision. It doesn’t just affect how much money you have left at the end of the month, it also affects your lifestyle and the size of the savings you accumulate over the years.
Of the two options, the bias often veers towards ownership: It’s a big business for everyone from mortgage lenders to real estate agents to home improvement stores, so we are bombarded with the message that home ownership is the key to happiness.
But owning isn’t universally better than renting, nor is renting always simpler than owning. Consider the pros and cons of each to figure out whether renting or owning is best for you. Let’s start with useful considerations .
1. ILLIQUID ASSET
Real estate is the original illiquid asset. You might not be able to sell when you want if the housing market is down, and even if it’s up, there are significant transaction costs when you sell. The seller’s agent usually charges 5% to 6% of the home purchase price when the deal closes. If you live in a democratic western country, you may also face capital gains taxes in the profit from selling your home.
2. RENTING IS THROW AWAY MONEY?
First of all, you need a place to live, and that always costs money. Second, while it’s true that you aren’t building equity with monthly rent payments, you also aren’t building equity with much of the money you’ll put into owning a house.
Perhaps the biggest throw-away expense is mortgage interest, which can make up nearly all of your monthly payment in the early years of a long-term mortgage.
The overall cost of home ownership tends to be higher than the overall cost of renting, even if the monthly mortgage payment is similar to (or lower than) the monthly cost to rent.
Take this example: You borrow $100,000 at 4% for 30 years. Your first monthly payment will be $477.42, of which $333.33 is interest and $144.08 is principal. It will be about 13 years before more of your monthly payment goes toward principal than toward interest, and in total, you’ll lose $71,869.51 in interest. Despite the low value ($100,000), a real scenario will be explained below.
Let’s look at the numbers to buy a home valued at $1.4 million in US.
Mortgage – You would have to put down a minimum of 20%, which is $280,000. This would give you a mortgage of $1,120,000 at a 4% interest rate over 30 years. The payments for this mortgage (30-year fixed) would add up to about $64,160 per year.
Property Taxes – Tax rates vary widely among jurisdictions. In some jurisdictions, property is taxed based on its classification based on similar use: residential, commercial, industrial, vacant, and blighted real property. In Washington D.C. for instance property occupancy is incentivized by taxing residential property at 0.85 percent of assessed value but vacant residential property at 5 percent of assessed value. Taxes on my property example were $25,000. I assumed a 1.5% property tax rate.
Real Estate Transfer Tax – Is a tax that may be imposed by states, counties, or municipalities on the privilege of transferring real property within the jurisdiction. In Europe, rates between 2% and 4% are a general rate. In the USA, total transfer taxes can range between very small (0.01% in Colorado) to relatively large (4% in the city of Pittsburgh). Taxes on my property example were $28,000. I assumed a 2% real estate transfer tax.
Property Insurance – This was estimated at about $3,600 a year.
Heat – The estimate on heat was about $7,500 per year.
Water and Sewer – Average annual cost of maintenance and a new system was about $1,000 a year.
Electricity – This bill was about $4,600 a year.
Appliances – This was estimated at about $1,000 a year.
Home Repairs – I estimated it at about 1%, or $14,000 a year.
Lawn Care and Snow Removal – This can vary on the size of the property and the location, but I estimated it at about $4,500 a year.
By my accounts … wow, you’re screwed up buddy: $153,360 a year.
4. REAL ESTATE BUILD WEALTH
While home ownership is often touted as a way to build wealth, your home can lose value. Lots of value. The acceptable neighborhood you moved in could decline. A major employer can leave the area, causing a significant population decline and a surplus of housing, or there could be a residential construction boom – either of which keep prices down. You might buy a house for $200,000 tomorrow and in 30 years find that it’s still worth $200,000, meaning you’ve lost money after inflation. It is an improbable scenario, but it is possible. Do you know Detroit?
Even renovation projects don’t often increase the value of your home by more than what you spend on them. On average, you’ll get back 62 cents for every dollar you spend on a home improvement project, according to “Remodeling” magazine’s 2015 Cost vs. Value Report.
5. TAX DEDUCTION
Another bit of misleading conventional wisdom: Get a mortgage to get the tax deduction. True, the home mortgage interest deduction reduces your out-of-pocket expenses for mortgage interest early in your loan term (and the property tax deduction reduces property taxes), as long as you’re itemizing. But tax deductions are not a reason to buy a house. Here’s why: For every $1 you spend in interest, you might save 25¢ on your tax bill. You’re not coming out ahead. What’s more, as you pay down your mortgage and the proportion of your payment that covers interest decreases, so will the tax break.
5. NUMBERS DON’T LIE
A) The average American moves 11 times in their lives. Five of those moves occur between the ages of 20 and 40 and two of the moves occur between 40 and 60. In short, most home buyers won’t be able to reach the break-even point on home ownership.
B) Home ownership is also less cost-effective in the long term. Going back to the late 1800’s the inflation-adjusted return for the stock market is 2.03% per year, whereas home ownership is 0.33%. Both beat inflation, but over 125 years the growth of stocks was 12x whereas homes were only 1.5x.
C) Moving is expensive. A renter might pay $1000 for moving services, whereas the home owner has to pay $1000 plus ~6% commission on the sale, inspection costs, legal fees, etc. On a $1,4 M property just the commission would be $84,000.
D) Moving isn’t always predictable. People have more kids. People get divorced. People lose their jobs or better job opportunities might open up elsewhere.
E) A mortgage payment might be comparable to monthly rent. However the extra expenses like fees, taxes, insurance, property taxes and maintenance can contribute significantly to the monthly cost.
6. THE BOTTOM LINE
The biggest advantage of renting is the flexibility to relocate relatively easily. The situation in which you bought your home can change. Renting can offer a substantially greater number and variety of amenities than buying. For example, upscale apartment buildings can offer a swimming pool, tennis court, and on-site gym. The monthly rent is comparatively lower than a mortgage for a property with the same attributes.
Buying a house gives you the opportunity to choose a unique and distinct architectural style and to personalize it. An owner obviously has far more flexibility to make improvements to a home than a renter. But this freedom comes with the responsibility of keeping up with maintenance and repairs.
Rationally speaking, renting is the best option. But we’re talking about humans, damn it. Other considerations such as emotional, environmental, and flexibility can sometimes outweigh decisions that may not be financially justified.
Well… Now you have the data, information and opinion. Make the choices according to your goals. Make the odds in your favor.
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