Buying A House vs. Renting A House
This horse has been beaten to death many times over. Last time I researched this the conclusion I came to is that every situation is different. The people who will have the least regret if they did decide to buy are the ones that approach the house the way a real estate investor would. Regardless, a house you purchase to live in should and cannot be considered an investment. The reason I say that is because you have a lot of expenses that comes with it and you will live in it, which means you will “consume” it. For some people having their own home is really important for various reasons whether it makes sense financially or not. As an example, I am paying off my 2.75% student loans in less than one year even though it would be much wiser to keep them as long as possible and make the minimum payment on it. However paying off my student loans gives me a sense of freedom that to me is worth more than the money I could make had I invested the extra payments.
The $1Mill House
So here is the scenario… you are working with a group in an area where a house that meets your standards is $1,000,000. You make about $300,000 per year before tax and since you are married and have 2 kids you take home about $200,000. You feel that you are throwing your money away on rent and you see yourself settling down in the area for at least the next 5-10 years. You have enough money to give for a down payment without incurring a PMI which happens to be only 10% right now. So let’s play with the numbers. 10%*$1,000,000=$100,000. You pay the $100,000 down and pay another 4% to the realtor which is $40,000 and then you have some loan fees and inspection fees which is another $7,000. So you are going to be putting up $147,000 of your money towards this house. You will get a mortgage for the other $900,000 which comes out to $4,255/mo @ a rate of 3.92%. $2,940 will go towards the interest and $1,315 towards the principal with a total of $632,000 going towards interest over the life of the loan. It will take 17 years before your interest payments drop below $1,600/mo. And now for the property taxes, let’s say 1%, so that’s $10,000/yr or $833/mo for the taxes. Of course you are in a high tax bracket so you get to write off a good amount… we’ll say in total you will pay $2,641/mo just to own this material good. Your total expenses which will include property insurance ($1,100/yr) and home maintenance (1-2%/yr) will be $2,641+$91+$833=$3,565/mo.
$3,500 Spent On Rent… Money Thrown Away?
Many people say “I don’t want to throw money away on rent”. I think it’s important to correct this mentality. Unless you actually go “homeless” you must pay for the space you occupy on this planet. This planet is divided among countries and countries spend money protecting their border etc. You could potentially live out of your car, you could crash on a friend’s couch, travel the world through couchsurfing or sleep on public space illegally. Therefore, paying rent shouldn’t looked at throwing your money away. There is something you are getting in return… safety, weather control, place to store your belongings, peace of mind etc. So back to our example, you have a spouse and 2 kids and a cat and you want to be a in a good school district, relatively close enough to work and you need a safe neighborhood. Renting in that specific area would be about $3,500/mo. Wow, that’s a lot of money… and that’s money you won’t see again… even worse that’s money that’s going in someone else’s pocket (come on, you know how I feel about that last statement). What do you do? Pay that absurd amount of rent or purchase a home? Let’s do the math before you make your decision. As far as the monthly cost I would say the two options are sort of wash because you would pay $3,500/mo for your rental and you will have an out-of-pocket cost of $3,565/mo to own your home. Rent may even go up while you can expect your mortgage payments to stay the same even if we go into an inflation state in the economy. However, the $147,000 you paid is now tied up and we need to see what else you could have done with that money. Had you invested it the money it could be worth $477,000 if the economy does what it has done in the past. So you lost out on a potential financial gain of $330,000. The argument could be made that with that $147,000 you made an investment in the real estate and that it could go up in value in the future. What could it be worth in the future… that’s tough to say but let’s look at some numbers. Let’s say by the end of 30 years it was worth $2,430,000, how would you feel about that? Would you be pretty excited? Some of you know what I’m doing but the fact is that sadly you made $0 if the value only went up to $2.4mill because that’s just inflation. Which means that the house only went up as much as inflation. So in this example if the rent payment and mortgage payment were the same you would be losing out on $330,000 unless your house went up in value to at least $2.8 million at which point you would break even.
The Confounding Variables
Other factors to consider. What if interest rates go up and when you are ready to sell few people are able to afford that house? What if the housing market goes down again and you lose value in your property? At the same time what if that $147k that you would have invested instead dropped in value and what if the house goes up in value by a lot more than expected and you could cash out of the house… With a rental you have the choice to move whenever you want. But you could also get kicked out at the landlord’s whim (not quite that easy but possible). If you lose your job you are stuck with the mortgage payments unless you go into foreclosure or can sell it. If you rent, however, you can downsize if you needed to. But what if interest rates go up substantially, wouldn’t buying a home now in this low-interest rate economy be ideal? You should take advantage of a low-interest rate only when the purchase makes sense. After all, you wouldn’t buy a new car just because the dealer offers you a really low interest rate.
How did you make your decision?
Do you have a personal example that favors one choice over another?