Writing Your Money: The Missing Manual has been intense. I’ve spent a ton of time researching personal finance topics ranging from buying a car to funding a 401(k) to the relationship between money and happiness. My research has reinforced some of my convictions (index funds are the best investment for 99% of personal investors, for instance) but has toppled others. One of my beliefs that’s been set on its head is that Americans are better off buying their own homes. I don’t believe that’s necessarily the case anymore.
Advantages to renting
In 2007, Tim Ellis shared a guest post with GRS readers about the realities of home ownership. “It’s a real shame when people are driven to get into the housing market because of misplaced notions of imagined financial benefits,” Ellis wrote at the time. I didn’t pay much attention (because I was in London!), but I now believe he’s right. Yes, homeownership makes sense for some people. But there’s no shame in renting; in fact, for many folks, that’s the way to go.
The housing industry is huge, and it spends a lot of time propagating certain myths about homeownership, myths like:
- If you rent, you’re throwing your money away.
- Owning your home is a forced savings plan.
- Home ownership is a path to wealth.
My own research shows that over the long term, housing prices (and gold prices) barely outpace inflation. In fact, since 1926, home prices (and gold prices) have returned about one percent above the inflation rate. That’s hardly a good investment. (Stocks have averaged about 6.8% above inflation!)
There’s no question that buying a house makes sense for some folks, but mainly for non-financial reasons. Owning a home gives you stability (you’re not at the mercy of a landlord) and freedom (you can do what you want with the place). But financially, it’s not usually the best bet. (It’s true that you build equity, but you do so at a very high cost.)
In an editorial in the June 2007 issue of Kiplinger’s Personal Finance, Knight Kiplinger wrote, “It often costs less to rent. The annual cost of owning a property, be it a house or a condo, is usually greater than the cost of renting, after taxes.” And there are other advantages to renting.
For one, you have flexibility; you can move at a moment’s notice. For another, you’re not responsible when things go wrong. If the shower starts leaking before you leave for your vacation in Duluth, you don’t have to worry about it — you call in the landlord.
Still, this is a personal finance blog, so let’s look at some ways to examine the decision to rent or buy in a financial light.
Renting by the numbers
One way to tell whether it’s better to rent or buy is by checking out the price-to-rent ratio (or P/R ratio). This number gives you a rough idea whether homes in your area are fairly priced. Figuring a P/R ratio isn’t too tough. All you need to do is:
- Find two similar houses (or condos or apartments), one for sale and one for rent.
- Divide the sale price of the one place by the annual rent for the other. The resulting number is the P/R ratio.
For example, say you find a $200,000 house for sale in a nice neighborhood. You find a similar house on the next block for rent for $1,000 per month (which works out to $12,000 per year). Dividing $200,000 by $12,000, you get a P/R ratio of 16.7.
But what does this number mean? Writing in The New York Times, David Leonhardt says, “A rent ratio above 20 means that the monthly costs of ownership will exceed the cost of renting.” That’s \a little opaque, but what Leonhardt means is that the higher the P/R ratio, the more it makes sense to rent — and the less it makes sense to buy.
During the housing bubble, the national P/R ratio came close to 20 (and went far above that in some cities). In other words, you could rent a $200,000 house for $10,000 a year (or just over $800 per month), which is a pretty good deal.
The normal range nationwide is between 10 and 14 (meaning it would cost between $1200 and $1600 to rent a $200,000 house). During the 1990s, just before the housing bubble, the national P/R ratio was usually between 14 and 15 (about $1100 to $1200 to rent a $200,000 house).
Another way to gauge the cost of housing is to compare it to your family’s income. From 1984 to 2000, median home prices were about 2.8 times the median yearly family income. (In other words, the typical house cost about three times what a family earned in a year.) During the early 1970s, home prices were about 2.3 times median family income. During the housing bubble, this ratio jumped to 4.2.
These numbers may not mean a whole lot on their own, but they can give you some sort of idea whether housing is overpriced in your area. Plus, it seems safe to assume based on past figures that most families can comfortably afford a home that costs about 2.5x their annual income. (So, if your family makes $80,000 a year, you can afford our theoretical $200,000 house.)
Home sweet home
Despite the results of my research, I’m not about to sell our house. The thing is, there’s more to this decision than just the numbers. As I always say, money is more about mind than it is about math. Our financial decisions have more to do with our psychology than with the numbers.
Kris and I are happy in our drafty old house. We love the vast yard that gives us space to grow a vegetable garden, blackberry canes, and fruit trees. We love the uneven floors, the outdated kitchen (everything’s from 1950!), and the zillions of windows. It may not make the most financial sense, but there’s more to happiness than just money.
We’re not about to move, but you know what? If I had it to do again, I’d never buy this house. If we had stayed where we were, we’d now have just four years left on our mortgage. But knowing what I know now, I might even be inclined to rent. For most folks, renting isn’t a bad option.
Note: This post contains bits and pieces that have been discarded (and some that haven’t!) from Your Money: The Missing Manual. My final manuscript was much, much too long, and we’re going to have to cut a lot of stuff. This makes me sad, but it’s not a complete loss. I’ll be able to share some of it here at GRS!
GRS is committed to helping our readers save and achieve your financial goals.Savings interest rates may be low, but that’s all the more reason to shop for the best rate.Find the highest savings interest rate from Ally Bank, Capital One 360, Everbank, and more.
This article is about House and Home
Disclaimer: This content is not provided or commissioned by American Express. Opinions expressed here are author's alone, not those of American Express, and have not been reviewed, approved or otherwise endorsed by American Express. This site may be compensated through American Express Affiliate Program.
Discover is a paid advertiser of this site. Reasonable efforts are made to maintain accurate information. See the Discover online credit card application for full terms and conditions on offers and rewards.
SEARCH FOR RECENT ARTICLES
We’re in the process of moving from a (small but decent) home that we rent for $200 per month to a (much bigger) home which we will be caretaking for free (but paying utilities, internet, etc). For us, renting is definitely the best option while we work to free ourselves from the constraints of debt.
loading....
JR (@99) — that P/R is CRAZYYYYYYYYYYY!!!!!!
My P/R is about 9.5 here in Columbia, SC… I purchased because my payment (including taxes, insurance etc. etc.) is $750 a month. Renting is actually quite higher than that.
loading....
Why not live rent free? How would your quality of life be if you did not have to pay for rent?
Why not buy a three bedroom house and rent the other two rooms to pay your mortgage? Think outside the box. Or better yet rent all three and live in the bastment, that way you have more privacy.
Do what other people are not doing, or do not want to do.
loading....
I think one element that is important is that, in my experience at least, people buy bigger places than they’d rent.
As a result, even if the prices would be comparable, they spend more buying than renting, because they go for a bigger place.
That can be a problem if they don’t actually need or want more room, obviously, but are just following the “bigger is better” they heard other people say.
Renting is definitely the way to go for me. I had a friend who told me “but buying is like renting, except in the end you’ve got a place! Even if you move out, you can sell it and make a profit!”.
That might work for her, but the way I see it, when you buy, you pay interest on a credit, on top of buying the place itself. Later, when you sell, you might sell for more, or less, or the same price, but you’ll have to find someone to buy. What if you don’t?
I like moving, I have never spent more than 3-4 years in the same place, and often much less than that. On top of that, I live with just my husband and we don’t intend on growing our family. And we like small places. So renting makes the most sense for us.
I can’t deny that if I could afford it (as it, pay upfront), I’d buy my ideal apartment… If it exists. It can be a pain dealing with some details, such as the fact that rentals here all seem to have carpet floors when lino is more practical to clean, looks better (in my opinion) and of course doesn’t give me allergies.
But every time I’ve looked around, condo fees were at least as high as rent, and that was on top of buying it. No thanks.
loading....
I’m glad you included the link to the 2007 CNN chart showing the rent ratio. After 10 years in Portland I moved to the Bay Area, in 2006. I figured I couldn’t afford a home in either place, so why not? It’s true that in 2007 the P/R for Portland was 20.7 and for the Bay Area it was 50, but unaffordable is unaffordable, no matter how you slice it. (Yes, my new salary offset the jump in living expenses.)
I am firmly attached to the 2.5x annual salary for an upper limit on housing price. I think it’s a very sensible rule of thumb, and it also means I may never be a homeowner, unless I move yet again – but I’m slowly coming to terms with that.
I can’t wait to read all the comments. Thank you for being another reasonable voice in the rent vs. buy debate!
loading....
JD, The problem with renting is that the money you spend on rent will never be recouped. Money spent on mortgage payments will most likely be returned with a profit. So even if rent is half the price of a mortgage, it is money that you will never see again. The only way you could possibly do better renting is if you were an awesome and dedicated investor who did not blow the extra money you save from not paying a mortgage. Tax deductions are also in favor of homeowners.
Additionally, when you rent you will never pay off your rent. It will only go up with inflation. You will never have an asset to sell. And, you most likely will have spent the extra money you could have saved by renting. A mortgage is a forced savings account. Most would not have the dedication to save as intensely as your mortgage forces you to.
Are there renters that are rich? Yes. But I suspect they would be wealthier if they were home owners. Despite the recent downturn in real estate, if you plan on living in your house for more than 10 years its a good investment. On average homeowners net worth is $166,000 dollars greater than renters according to Liz Pulliam Weston
http://moneycentral.msn.com/content/Banking/Homebuyingguide/P72655.asp
loading....
I’m with Theresa on this one. I live in suburban Washington, DC.
I rent a 725 sq ft 1 BDR apartment for $1056/mo. Assuming my rent goes up 4%/yr (which is what it did this year), in 30 years, I’ll have spent $710,708 in rent.
If I want to stay in my immediate area, a townhouse can be had for $350,000. Assume a 6% mortgage, and I’m looking at fixed payments of $2098/mo. Property taxes are assessed at $1.04 per $100. Assume an additional $200/mo in maintenance, HOA fees, and increased utilities. Assume all non-mortgage expenses (and the value of the home) increase with inflation — I used 3%.
In 30 years, my housing expenses will have totaled $1.07M, but my $350,000 house has increased to a value of $850,000. So, I actually have a net cost of ownership of about $227,000.
Now, if I have an $850,000 house in 30 years, I also have the money I wasn’t spending on home ownership. If I consumed it each year instead of saved it, I have about $366,700, putting me in the hole by about $344k.
However, if I were to invest that money in the stock market, that difference balloons to $1.8 million, putting me way in the clear by about $1M. Remember, buying that house cost me $227k.
As far as retirement goes, I’ll likely move somewhere much cheaper than the area that I live in now.
In reality, my wife and I do talk about buying that townhouse “someday.” But we also talk about what we would have to give up to pay that extra $1,000/mo, and right now, it’s not worth it to us. We plan to travel like that guy mentioned above… this year, we’ll be spending a month in SE Asia. I can’t say I’m willing to trade that for a house.
loading....
Am I the only one who thinks it’s silly to run numbers based on things 30 years from now? Depending on the assumptions I can show you when it’s better to rent and when it’s better to buy. Inflation of 5% for a decade, unexpected move, DE-flation for a few years, local factory/army base/tourist spot opening or closing, income tax laws changing (bye bye itemization), property tax laws changing, open-space laws changing…
There are so many things that will change. Some will be better if you’re renting, some will be better if you already own. You state your assumptions and decide for yourself. But that’s part of JD’s point, you have to consider the intangible and the mental calculations aren’t as straightforward as it often seems.
loading....
My boyfriend and I can’t imagine wanting to live in the same place for more than 5 years, ever. So owning just doesn’t make sense.
And those who say that ownership is a good idea and then use your rentals as examples, buying rental property as an investment is a TOTALLY DIFFERENT THING than buying your primary residence “as an investment.” A primary residence is a place to live, not an ATM.
loading....
I am glad you caught this too!
I was just talking about this with my brother a couple of months back. Buying a house financially just does not make sense for most people.
There is much more clever math that you can do to figure it out. Assuming that you monthly ownership cost is $2,000 and renting would cost $1,000 and if you have enough money, you could easily invest that $1,000 into the stock market or else where and eventually save up enough money to buy a house.
Another thing that you have mentioned that is true is this: mobility. You have none when you own a house, if you want to move you have sell it, which causes a ton of other issues and costs tons of money.
The only way owning a house makes sense is if you want to want to pass it on to your children, then you would be giving them a huge heads up in life. So it’s a great estate planning tool.
There are many more issues to consider when buying or renting a house and the great thing is that it all can be calculated
Anyways, thanks for talking some sense into people
Best,
Tomas
loading....
btw, many of the homeowners don’t seem to take into account transaction costs. Broker commission, inspections, and other costs are 8-10% of the sale price of the property (unless you do something unconventional like FSBO). That is why 4 or 5 years is typically estimated as a break even point, historical appreciation is ~2%.
loading....
@104 (The Broken Penny):
One thing that article misses is that correlation does not equal causation. The author’s premise is that owning makes people rich. But what if it’s the other way around? What if rich people own and poor people rent?
Take me for example… my income is borderline on the top two brackets. But I have a negative net worth. I don’t have a negative net worth because I rent instead of own, but I rent because my $400/mo student loan payments (which will jump to $650/mo or so in a year or two) take a big bite out of what I could put into a house. (If I didn’t have those student loan payments, I could either buy a house and establish some equity, or invest in stocks and increase my net worth that way.)
loading....
As a homeowner and as a real estate investor (who has tenants), it will be interesting to see how the post-bubble market plays out.
I think most people who visit GRS understand that tenants pay things like mortage interest, real estate taxes, insurance, repairs, upkeep, etc. but that they just pay it via rent. So renters really have similar costs they just don’t see them broken out.
loading....
I don’t understand all the people that posted that a house will put an end to their traveling lifestyles…
My husband and I are 26 and 27 respectively and have no kids and no plans for kids in the future. We own a home. We make $78,000 a year combined and live on $38,000 of that (including the mortgage and overpayments). We don’t spend our weekends slaving away on the house. We travel. Why would the house keep us from traveling?
Maybe I’m not understanding the posts…are you talking about vacation travel or about moving all the time? If you are moving all the time, then I wouldn’t want to own a home either. If you’re just vacationing, why would the house keep that from happening?
@TeresaA
The scenario you described had you saving at least $125,000 by owning a house. That $125,000 could have been invested in the stock market just as easily as the money you “saved” month-to-month by renting. You obviously don’t want to own a house, so why create the scenario to start with?
By all means, don’t buy a house. We are renting ours out once we move and will have another rental property by then too. I would love for lots of people to need rentals. I was just showing you that if you’re going to live in one place for 20 years and the housing market isn’t like NY or CA, you will save money by owning a home. That doesn’t mean that you should own a home, it just is what it is…
loading....
@Dan (#105)
I appreciate how meticulous your calculations were, but you left out what rate of return you’re assuming you’ll be getting form the stock market over those 30 years. Can you provide that?
loading....
There are pros and cons to both. While I’d love to own a house, the only way I will do it is if I pay all cash. A personal mortgage is a big liability, I will stick to owning rentals instead (2 rentals).
My personal residence is rented, and I share the cost of the house with roommates which makes living very cheap (438/mo for my room/bath). That is a total no brainier for me right now so I can buy more rentals. Don’t have kids, so that makes it easy to be mobile.
loading....
I wonder where many of the commenters live? I live in one of the most expensive cities in the United States. I make an enviable income for someone my age. I cannot buy. It makes zero financial sense from a P/R ratio, even now. I could possibly buy a $450K house in a neighborhood with bad schools, but that’s about it (I’ve been looking, so I know). Or I could rent in an area with great schools for $2000/month and put the rest in my (future) kids’ college fund. And, even if I wanted to buy that $450K house, I can think of a lot of other ways to spend an upfront $100K downpayment/closing cost expenses.
I was obsessed with buying for several years, but JD’s link the the NYTimes rent v own calculator finally knocked me out of that desire on a pure numbers/value basis. Assuming incredibly favorable conditions, it would have taken 25 years to earn back my “investment” in the house. Math is an incredibly important factor that gets overlooked. My math says that my quality of life and the financial opportunities for my future family will be significantly improved if we rent. (And for those saying hyper-inflation will impact rent, I have a rent controlled unit, so it’s really not a concern.)
Oh, and if we lived in another city, say Houston where my fiance is from, I could buy a house with 30% down right now in a great neighborhood. I’d do it in a heartbeat. Context and math matter.
loading....
I bought a home in April of 2008, and don’t regret it at all. In fact, it was one of the best decisions my husband and I made.
I didn’t quite enjoy what sounded like elephants bowling with large boulders above me when I rented. Nor did I care for people blaring their music so loud that my cheap kitchen cabinets shook. May I also add I disliked smelling the cigarette smoke that floated through the vents? And I don’t miss the drunk college kids causing a commotion in the parking lot in the middle of the night.
Even if I rented a house – Which in my area would actually cost me more money than buying – I still wouldn’t have the freedom to do what I please with my living space. And I would still be at the mercy of a landlord who may or may not fix things needing repair in a timely manner.
Like others have mentioned, there is more to be considered with home ownership than just the financial reasons. But it even makes more sense financially for me to buy: I plan on being in my house 30+ years.
loading....
I’m monitoring and writing about both UK and Australian property prices based on price to income ratios as you mention. Both these countries saw a dip (now currently heading back towards the highs) during the global financial crisis however it was insignificant in relation to where the ratios have been in the past.
For that reason I’m still renting.
loading....
I am completely against renting if anyone can help it. I would rather build a nest egg and wealth by overtime, buying the house and owning it. From there I can rent it to someone else or hand it down to my children.
Sure there are arguments back and forth relating to this issue. However, I think all cent’s aside – home ownership is about feeling secure and having a roof over your head that nobody owns but you.
~ James
loading....
J.D. I appreciate your material, and ussually lurk via the googlereader and usually agree with you. Assuming the right conditions for ownership are met I think gina, Kevin, Joe, Jason, KevinM and DebbieM all appreciate, like me, the aspect of an inflation hedge, and this would end up powerful if things get ugly… ugly like as in hyperinflation.
loading....
@TeresaA, here’s how I see the math on your example:
Total cost to own a house for 20 years: 340K.
Value of house after 20 years: ~200K.
Total money wasted: 340K-200K = 140K
Total cost to rent for 20 years: 240K.
Value of apartment to you after 20 years: $0
Total money wasted: 240K – 0K = 240K
Extra spent for a house over 20 years: 340K-240K = 100K.
If you can invest 100K over 20 years so that it will grow to more than 240K, then renting gives you a higher net worth. If not, buying does.
@Avistew – I agree about condo fees being scary. You do have some say in them, but not much. Same with HOAs and HOA fees.
@Beth et al. – I paid 3x my income for this house, but I’m realizing I did things differently than normal people. When I bought my house, I went from paying $395/month in rent for a one-bedroom apartment to paying $610/month for a two-bedroom house, charging a roommate $305, and saving $100/month for inevitable repairs. I did go one or two months between roommates a few times, but could have afforded to do so indefinitely if I were very careful (though who wants to be very careful for 30 years?). I’m remembering that normal people do not want roommates once they get out of school unless it’s family.
Also, I plan to never have kids, so I don’t have to buy a house huge enough for them and then keep paying the huge bills after they leave or try to sell it the same time all the other boomers are trying to sell so I can switch to a small house. I got to start off with the small house (which they no longer build, so I got one built in the 1950s).
Even so, over half my net worth is still in my house. I keep adding to my investments, but they just aren’t keeping up with the growth of equity in my house. But if I sold my house, I’d have to earn 8% on the proceeds to be able to afford rent. I would like my net worth to be a bit more diversified.
@Budgie, I also see fewer bugs now that I have my own place. And when I do see one, I don’t have to use the horrible poisons my landlords used to use.
loading....
Interesting article,since I am single renting is the perfect option for me. I grew up in a nice 3 bedroom house with a nice yard, garage etc. It made for great childhood memories that I wouldn’t want to change. That being said I wouldn’t even think of owning a home unless I had a family and a job that payed enough to take care of all the little things that come with home ownership. Owning a home is big undertaking, things always have to be fixed, roof if it hails, toilet if it leaks, faucets leak etc. All that has to be maintained, and lets not forget the joys of property taxes! Bottom line if you buy a home it’s like a marriage, you’re committing to staying in that area for life if you’re just starting a family or at least 20 years or so till the kids grow up and leave. You better be sure or its money down the drain.
loading....
I always love the rent vs. buy arguments and some good ones are covered here but a few are missing. There is nothing wrong with renting but a whole industry that drives quite a bit of the economy makes sure that you feel like a scrub as a renter. I rented for a long time and was happy doing so and banked plenty of cash. I got rent down to the point where it was about 7% of income which makes it very easy to save. The problem for many people is that they don’t save money.
I’ve made numerous cases for why you should rent in my writings, but since JD took the renters stance, I’ll do the opposite.
Financial Reasons to Buy:
1) Every month you are paying down your mortgage and even in a zero price appreciation world, you are increasing your assets by reducing the debt on them. Kinda a forced savings plan for those not good at it. Don’t get overjoyed though, the principal payments in the early years are modest and it will take you 22 years to get rid of half your mortgage.
2) When you own a home, your retirement strategy becomes more secure: once you clear the mortgage, you’ll pay next to nothing in living expenses whereas if you rent you are going to pay rent for 20 to 40 years after you retire. This is one of the biggest factors that people don’t think about. With interest rates hovering at 2.5% to 3.0%, that $2,000 rent is going to require you to have nearly a million dollars in the bank.
3) In many places, especially with price declines and low interest rates, buying is far cheaper than renting. In Northeast and West Coast this is still not the case, not even close. But if you are in the Midwest, Mountains, and much of the South, housing is cheap.
4) Housing over time gives you financial options that you don’t have renting. If you need to borrow $25K because of an emergency, you can do it at 3% right now. Ideally you don’t have to do it, but its nice to know that you have that option.
5) Tax advantages: I’ll first state that the tax advantages of home ownership for the average family are overblown. But if you make good money, its ridiculous how good of a deal it is. Make big money and live in a high tax state and you’ll get your interest and taxes reduced by 45%. Then when you sell, you get a capital gain tax free up to $500K. Renters get squat, but your landlord does pretty well.
Comment on the Price to Rent ratios. I think this was pioneered by a Professor named Ed Leamer at UCLA. The problem I have always had is that they never compare apples to apples. 2 bedroom rental units and 2 bedroom townhouses are very different beasts. And when you get to houses, the gap is even wider. We looked at tons of rental houses in our area, none of which was less than $2,500 a month and all were crap. You needed to get to the $4,000 level before anything resembled what we would buy which meant that buying was about the same after tax benefits.
Of course there are tons of non-financial reasons for home ownership which I’ll skip. Bottom line, I would say that if you plan on staying in an area for 10 plus years, you want to have the security of fixed payments, the math on the monthlies is close, and you don’t mind doing lots of yardwork and other handy stuff, buying makes sense. If not, renting is the way to go and you shouldn’t be ashamed of it. Just make sure you save at least 15% of your income every month and invest it or you will have a serious issue at retirement.
loading....
Here’s an article worth looking at.
http://wwwp.dailyclimate.org/tdc-newsroom/2010/01/home-energy-efficiency
I’m not implying that anyone should move simply to get into an energy efficient home. I’m saying that one should seriously consider looking at Energy Star-rated homes IF one is looking to buy. Or at least consider efficiency upgrades to reduce your monthly energy costs.
(Disclaimer: to anyone ready to flame me for thinking I’m pushing a “global-warming-caused-by-man” agenda, I’m not! The reason I’m linking to this article is just to point out the value of checking out efficient homes, or even making efficiency part of the equation when remodeling. Irrespective of one’s views on global warming, one needs to consider the consequences of supporting dependence on oil just as one would consider the consequences of owing dept to a debtor. To state this another way, I’m pushing an “energy independence” agenda here just as many of us would want “financial independence”. Global warming has NOTHING to do with MY agenda in this comment!)
loading....
#7 It definitely varies by situation, but I’ve been renting out to friends for 3 years now, and it’s worked out great for me. Maybe it helps that I’m easy going, and it doesn’t hurt that the house splits up easily… and my roommates are pretty laid back as well!
The numbers are pretty close… my total expenses after rent income compared to my total expenses when I was renting. But…
It’s not at all apples to apples. I had a 600 sq ft one bedroom, one bathroom apartment. Now I have a 1300 sq ft home with a basement (half finished, the other half suitable for storage, workbench, etc). Even if I don’t count the rooms that my renters use (including my second full bath) I still have much more living and storage space, an extra half bath, dedicated parking, a fenced yard for my dog, etc…
There are a TON of factors. That being said… as a renter, I often moved every year or two. Moving isn’t exactly fun, but I could get it done in half a day. Just 3 years into home ownership, and the dreaded STUFF really has taken hold and anchored me to where I am.
Here’s to spring cleaning… may we purge ourselves of unnecessary STUFF!
loading....
JD,
As you stated above, money is more about mind than it is about math. I agree with you here, but I also think it’s so difficult to draw the line. To be able to look at yourself truthfully and say that despite the emotions the math can’t be ignored. How do you know if you’re fooling yourself? How do you know that you’re not merely making an appropriate financial sacrifice to secure your happiness.
Much to think about. Thanks for the great post.
loading....
We’re buying a 400K house in a nice, but not rich neighborhood, and for us it’s a no-brainer. Together we bring in a little over 200K a year, and since housing is a huge huge priority for us (much higher than vacations or “toys” and other big expenses), we’ve been renting a very nice house for 2400/mo. Our new PITI payment will be almost the same, but some of it will stay with us as equity, the payment won’t go up $100/mo every year like our rent, and we can start a family without worrying that 3 years down the line the owner will want to sell or occupy the house. And 10 years from now, after accelerating our payments, we’ll only be paying taxes, insurance, and maintenance. Buying is definitely the right move for us, especially in this incredible buyer’s market!
loading....
Des: I used the “trusty” 8%. But, my calculations suggest that as long as you get a 3.5% return on your savings, you’ve saved/earned back the $710,000 on your apartment. (Remember, with owning, I suggest that one has lost $250,000 at the end of 30 years with the numbers that I’ve used).
loading....
@104 (The Broken Penny) said: “Money spent on mortgage payments will most likely be returned with a profit. So even if rent is half the price of a mortgage, it is money that you will never see again.”
I’m a bit puzzled that a statement like this comes from a finance blog writer. In a typical 30 year mortgage, during the first year only a fraction of the mortgage payment goes toward principal. Something like 98% of the payment is interest alone. It’s the same as renting plus investing 2% of the rent. Instead of paying your landlord, you’re paying the bank. Yes, you will have paid off your mortgage over time, but if you rented and invested, over time you will have equity that generates enough interest to cover the rent. The outcome is the same, except that the renter is more liquid and flexible.
Of course there are scenarios and areas where buying makes more sense, see P/R ratios. JD is just trying to convey the point that buying is not always the better deal.
And yes, there are renters who save and don’t squander any money they have left over. Plus, they get to diversify their investment. Whereas buying a house, which is subject to neighborhood changes (think toxic waste dump in your backyard, or a night club next door), can be eaten by termites, develop severe mold problems etc., is like putting all your eggs in one basket.
loading....
We had to buy a house because our landlord didn’t fix anything and after 3 years some of the ignored repairs were coming home to roost. Less then a week after I gave him notice of our intent to vacate (we hadn’t had functioning sewer for 3 months)he tried to sue me for damages to the house!
Thank the lord I keep papers! I had enough documentation to enable an atty (I had to hire) launch a counter suite and then suddenly the land lord dropped everything. Now that I own a house & have had to make many similar repairs it disgusts me that he wouldn’t fix things when they were so simple.
We couldn’t find a rental to save our souls at the time because the housing market was “hot”. I regret owning this house but I’m making the best I can of it. The repairs are killing me – literally. I’m having to rebuild this house room by room. At least it’ll be sound & nice when I am done.
I don’t think I ever want to buy real estate in town again. I hope to buy a few acres back in my families home county with the next few years & make a weekend get away out of an abandoned acreage. Nothing fancy – just something cheap with a well (water) that I can grow a humongous garden on and be undisturbed when I go there. If I have to put up a tent when I go there so be it – as long as it’s all paid for I can always fall back on it as a place to land when life gets rough.
loading....
Buying was a better deal for me because I knew where I wanted to live long-term, and I paid cash. No wasted mortgage interest. As someone else pointed out, I only need to make a low wage to be able to pay my taxes, insurance and utilities, so it’s unlikely I’ll ever be forced out onto the street. And if things get really desperate, I can sell the property and rent a small cheap apartment.
loading....
If you are buying a house to leave to your kids (which someone mentioned as an estate planning move to set your children up financially) make sure they want it.
My boyfriend’s grandmother deeded her (paid off) house to her two children – problem is, it’s in the middle of NOWHERE, Illinois and also in need of EXTENSIVE remodeling/repair – both for aesthetic and safety purposes. There is no way they would be able to sell it because the town it’s in is so tiny, even if they could afford the renovations, which they can’t. They are going to be financially devastated by the burden of this once she dies, but they are too nice to tell her – they want her to believe the house means as much to them as it does to her.
loading....
I think you’re missing one point. When I retire, my house will be paid for. In retirement, I will not have any housing expenses accept property taxes and maintenance, property taxes being deductible. That’s one less expense I need to save for.
loading....
@132: Or, when you retire, you could have $300,000 in the bank instead of owning a house of the same value, which generates a tax free $1,000 per month (when invested in a conservative muni bond fund) which in turn pays for the rent. That way, you wouldn’t have to worry about maintenance and such, and could move south easily on a whim if it gets too cold in the winter.
loading....
@132: Correct me if I’m wrong, but your property taxes are only deductible if you itemize, correct? Without the mortgage payment, are you even going to itemize? Second, in retirement, you’ll be at such a low tax bracket that the deduction won’t be worth much.
@133: $1000/mo in 40 years is about $357 in today’s dollars. I’m not sure that I want to rent something that cheap.
loading....
Out of curiosity, how many of you move on a whim? That keeps coming up and I really don’t get it. Even if I rented, I HATE moving. I don’t have a lot of stuff, but furniture is heavy and dishes suck to pack, and something always seems to get broken…it’s one thing when you’re 20 and live with milk crates instead of tables and chairs, but at 30? And when you’re married and/or have kids moving can become a logistical nightmare, especially if you’re moving cities. It can be done but takes so much planning that you aren’t going to do it often.
It’s interesting how many home buyers over estimate how long they’ll stay in a house, and how many home renters underestimate.
loading....
I am 30 and the longest I have lived in one place since moving out of the dorms was 4 years. I have also lived in 3 different major cities during that time (Orlando, Tucson, Phoenix). My boyfriend and I anticipate a cross-country move sometime this year. We do not want to have kids and part of the reason is that they would inhibit our ability to move on a whim.
loading....
Courtesy of my mortgage, I’m ‘throwing away’ a months worth of rent in interest every month.
It would be far cheaper to rent, but it’s not for us.
loading....
@137:
The longest I’ve lived anywhere other than with my parents was 2.5 years. But up until recently, I always “knew” I couldn’t commit to where I was.
Now that I’ve truly started my career and got married, I believe I’m more likely to stay put for awhile. But the question is how long? I have a great job, but who knows how long it will last. (That’s not stopping me from buying. The sheer cost is.)
loading....
I do commercial real estate, so studying property as an investment is nearly second nature.
Looking at a true return on investment is the best way to go. I think the own vs. rent scenario is TOTALLY dependent on where you can/have to live (read: the market).
You need to look at things from an investment perspective. Residential brokers will seldom give you any of that perspective. If you were going to buy a house, what COULD you rent it for? Whats the IRR and CAP rate.
I don’t look at anything with less than an 8% Cap.
Cap=Net income (after taxes, maintenance, insurance, brokerage fees, vacancy factors, etc.) divided by purchase price.
i.e. 10,000(income)/$100,000(purchase price)= 10% cap.
loading....
Thank you for posting this.
My husband and I have been renting our entire adult life and we’ve been told time and again we should buy. We enjoy the freedom from maintenance, snow removal and lawn care. We don’t have to stress about home repairs or the cost of our investment tanking.
We would like to rent a home to have a yard for our son to play in but we’re happy with where we are at. For the amenities we have vs. what we’d have to compromise on to purchase just don’t add up to us.
We also live in a state that allows us a partial deduction for our rent so while we’re not getting the federal tax breaks, we do get state ones.
loading....
I wanted to thank YOU J.D. for posting this article.
As a young individual (24) who is approaching his “debt-free” status, and is debating this exact scenario this year, I can truly relate.
I personally can see the benefits of both sides, and have grown up in households of both natures, so I completely agree that many many factors really do come into play during the decision-making process. (I also appreciate most readers on here for keeping an open-mind given the historical, and almost “patriotic” association with home ownership.)
The most profound and intriguing comment I read of dozens was:
#23 Alexandra << She stressed that while you can save money while renting opposed to buying, YOU MUST ACTUALLY SAVE THE DIFFERENCE TO COME OUT THE VICTOR. I believe this applies to both renters and mortgagers alike, as most of us desire the most satisfying AND affordable place to live so that we can SAVE MONEY, but how many of us actually SAVE much of the difference??? Hmmm…
I believe it would make an excellent article worthy of much discussion.
loading....
I live in Sydney, Australia (the world’s second most expensive city to buy a home in according to a report that came out yesterday). Hubby and I are saving for a house at the moment. Despite the fact we are both professionals and earn quite decent income (about double the median household income for Sydney) we know there is no way we can afford to buy a home comparable to the one we live in now (which is on the small side, let alone if we have kids soon- which we want to). The stats you mention in the article have just confirmed that Sydney is far too expensive!
We rent and an identical house next door was sold 2 months ago so I have a pretty good idea of what ours is worth. Our price-to-rent ratio was 45.4% – way over the 20% mentioned in the article. Comparing the price to our median income I get 6.2, also way over the recommended 2.5.
Our house is by no means big, or flash- it is a terrace (i.e. thin and long with shared walls on either side), it has a backyard which is about 4x4m, it is 130 years old (which is very old by Aussie standards) and could do with a new kitchen, bathroom, paint job, etc. On the upside, it is relatively close to the city and it is handy to public transport.
Your article has just confirmed to me that for now, it is much better for us to be renting (so long as we are saving or investing the difference between our rent and a possible mortgage) than it would be to buy. When we do buy it will probably not be in Sydney as it is just not affordable for the average Australian family anymore.
loading....
@112 (Dan): You make a good point. It could be that home owners were wealthy and because of that they bought a home. But if that is the case, then the wealthy must see home ownership as a good investment?
@130 (Lars): The fact that I am a personal finance blogger does not make me an expert, but I do know this. In my first year of home ownership at 5.5% interest rate I paid 80% toward interest. After tax deductions are applied that percentage comes down to 55%, which if far from 98% that you mention. That is also without making any additional payments toward principle, and in the first year of a mortgage, which as you mentioned is the worst for interest. That’s lot better than the 100% of a rent check that goes down the drain. Your argument about a home being subject to neighborhood changes, is the same risk you take when you invest in stocks. A house is an investment just like stocks, and both are subject to variability. You cannot make the argument that a house can become “toxic” without acknowledging that a stock investment can also become “toxic”.
I see the point that JD is making, but I disagree. I am not saying that home ownership is for everyone, but based on my analysis most people do better financial by owning, than renting. I also stated in my first post that I believe a renter could become rich if they are good savers and investors, but the truth is that most do neither. If you don’t believe me please review page 16 of the Federal Reserve’s February 2009 bulletin on Family holdings of financial assets, by selected characteristics of families and type of asset. There is not one category of investment in which renters outpace home owners.
http://www.federalreserve.gov/pubs/bulletin/2009/pdf/scf09.pdf
loading....
We have done both, rented and owned. We loved the home we owned in FL. We had acerage, horses, could paint the walls any color we wanted, replace crappy old stuff with nice functional stuff, but at the end of the day, we ended up with a house that was worth about 2/3rds of what we paid for it 5 years ago. We are upside on this house, currently have it rented out for a major hit on our cash flow each month, but we are just trying to get by through this time in the economy. The place we rent right now is nice, clean, the landlords are great people, but we still have those limitations on pets, ability to change things in the house, can’t sublet for a roommate, etc etc. There are pro’s and con’s with each, but I think after we are done traveling and we retire, we will certainly plan on buying a house. We have a savings account set aside for this purchase in 10 to 15 years, so maybe it will be in cash and we won’t have to fool with the mortgage part of it. I enjoy renting for the freedom it offers us as a military family, but once retirement comes and we are in a more permanent place in life, I will be happy to take the plunge again, have property, build another barn, and start it all over again because that is what makes us happy.
loading....
Thank you so much for this article. Though my husband and I really want to purchase a house soon, this relieves some of that pressure off of us. I have been thinking that we were idiots for not owning a house sooner. Many of my family members, who live in less expensive areas, all own homes. I’ve sort of felt like the odd man out for not owning. I worked out my P/R based on a $275,000 house (what we could afford and really the cheapest homes in our area) and it is a little over 12. I think that means we should continue to rent, right? I will also check out that NY Times links too. Thanks again!
loading....
Thank you. A co-worker (who is younger) and her husband just bought a house. I’m really happy for them. I want a house for a zillion non-financial reasons. But when I weigh them against what a lousy financial decision home ownership would be for me right now… well, I’m gonna stay a renter. I just re-ran the numbers while pouting about how come I can’t buy one and they looked just as bad as the last time I ran them. Ahh well.
loading....
I haven’t read all of the comments… but JD, I think you’re disregarding 3 important points:
1) If you buy a house, you’ll one day be free of house payments. All things being equal, that means freedom. My parents are nearing retirement age, but didn’t save much to retire on. Most of their SS will go to their rent, which they’ll have to pay until they die.
2) Your return on mortgage payments, as with any loan payments, is guaranteed. If you rent to “save money” and invest the difference, there’s no telling what will happen to that money.
3) Do you know the percentage of millionaires who own their homes instead of renting? It’s something over 90%, IIRC from The Millionaire Next Door. There’s probably a good financial reason for that.
loading....
We’re about to start building a home, but it makes a lot of sense for us because we have no plans to move from it. We’re near family, we love the acreage, and I’m head over heels in love with the plans. In fact, even if I won the lotto tomorrow, I’d build the same house–just pay for it in cash.
I like the feeling of owning and investing time in making my home beautiful, with gardens and landscaping, and I really hated that when I rented, people had access to my apartment at any time.
It’s not for everyone, though, and if you need the flexibility or just don’t want to deal with repairs and such–renting is the way to go. Do what’s right for you in your situation.
loading....