Costs of home ownership
A house with a $200,000 mortgage on it has the following hypothetical, approximate expenses, per month:
|Mortgage (with very low interest rates of about 7.1%)||$1,350|
|Electric & other utilities||$400|
The monthly cost of renting an apartment is typically $800 or less. Usually the only required utilities payment is electric for most tenants. The total monthly costs are then about $900.
If you bought a house with all cash and no mortgage, the total monthly cost would be $1,100. This is because the mortgage payment tends to be the largest expense, but certainly not the only expense.
If we compare the three choices by total monthly cost:
Renting an apartment or small house: $900
Buying a home, with all cash: $1,100
Buying a home, with mortgage: $2,450
Clearly renting is the least expensive route and allows for the most funds to be put away for savings or investments. But a close second place is buying a home with all cash. If you have the saved money, buying a home with cash is not so bad. The difference in the cost with renting is little and can be made up with real estate appreciation. That is, when you go to sell your home the profit will usually cover that extra cost you had in owning rather than renting. If you must buy with a mortgage, however, there is little chance to make-up for the extra expenses of owning unless you live in a market where real estate appreciation has been through the roof.
It is dangerous to count on real estate appreciation, even though it can be quite regular. There are always times when real estate prices go up considerably. But as the saying goes, what goes up, must come down. If you buy a home and have mortgage payments thinking that you will get your money back because you are buying during a period of rapidly accelerating prices, think again. After you buy the prices could come down. Then you are stuck holding onto your property waiting for the market to rebound. Or worse yet, you may be in a position where you have to relocate and sell anyways, in which case you lose money.
In the above example of comparisons from renting and buying and monthly costs, there are other hidden costs even to the investor who paid all cash for his house. If you pay all cash for your house you will have a monthly expense of about $1,100 on a typical $220,000 home. What if you had invested that $220,000 cash that you had available? What if you could make about 8% return on some kind of investment, stock, or mutual fund? That 8% return would have given you $17,600 in its first year. That is real money that could have been in your pocket had you continue renting instead of paying cash for that house. So that becomes a hidden or unseen cost of owning, even when you pay cash and have no mortgage. Therefore, we must re-do the table of comparing the monthly costs:
Renting an apartment or small house: $900
Buying a house, all cash, minus lost investment opportunity: $2,567
Buying a house, with mortgage: $2,450
Now the difference between renting and buying is not so small. Either with all cash or with a mortgage, you stand to save plenty by renting. In fact, the $17,600 earned from investments as opposed to buying with all cash would cover all the costs of renting. The monthly cost of $900 with renting is $10,800 per year. If you earned $17,600 from investments, you would be able to pay all your rent from just the investment money that would have been used for the house and you would still have money leftover.
Q: But buying a home is the American dream. Why not participate in the American dream and feel good about owning a home?
A: Owning a home is supposed to make you feel good. The reality is that homeowners own only a small portion of the home, the rest is owned by the bank to which the mortgage is paid. After 30 years a family owns the home by completing the mortgage, however, by then the condition and style is so outdated that they need to buy a new one and start the whole debt process over again.
Q: How come so many people buy homes if it is so bad and not good economic sense to do so?
A: The advertisers, sales people, and banks all make good money by convincing us that we need to buy a house. Many people are returning to renting. Many former homeowners have sold their homes and return to renting when they realize the financial advantages of renting. Many elderly couples decide they do not need such a large space in a house when their children grow up and leave. They also like the idea of not having the responsibilities of dealing with landscaping and other expenses and hassles of house ownership.
Q: Home ownership has been called the greatest investment a person can do. Is this true?
A: No. Today, smarter financial advisors no longer call a house your greatest investment. It is your greatest liability.
A house drains your income. It is a money pit. It requires all kinds of expenses, which you do not have when you rent an apartment, such as, property taxes, insurance, landscaping, water bill, sewer, and repairs.
An investment is something that makes money, not drains your money. Sure, there could be some appreciation when you go to sell, if you sell, but then there are real estate commissions, escrow and closing fees, and transfer taxes. The bottom line profit rarely makes up for the added monthly cost you had in owning versus renting.
Q: Isn't it good to have the tax deduction of mortgage interest, which you get when you own a home?
A: A tax deduction such as mortgage interest is just a fancy word for LOST MONEY.
The government allows you to deduct from your taxable income line on your tax return money that you LOST, for example, mortgage interest that you paid to the bank that made the loan on your house.
For example, let's say that you paid $20,000 in mortgage interest in one year. You would get to deduct that $20,000 from your taxable income on your tax return. This DOES NOT mean that you get the $20,000 back. It simply means that you will not be paying taxes on $20,000 of your income. If you are in a 15% tax bracket, this results in a $3,000 savings. This is because what you really save are the taxes that you would have had to pay on the $20,000, which is deducted.
Therefore, you LOST $20,000 because that is money that you really paid out in the form of mortgage interest. By deducting those funds what you really saved was $3,000. Therefore, you SPENT $20,000 to save $3,000. That's a net loss of $17,000. Don't be fooled, you need this deduction like you need another hole in your head.
Q: Is there never any good time to buy a home?
A: When a person or family has reached the pinnacle of their success, when they are no longer actively pursuing wealth and income and have all the resources they ever need, the time could be acceptable to buy. If such a family has all cash to buy their dream home and wish to do so, then they should do so. There may be some lost potential investment income as outlined above, but at this point the person or family may not care.
Further advantages to renting
Besides the above-mentioned economic advantages there are some other important advantages to renting. Mentioned briefly above is that renting gives you amenities that you do not normally have when you buy a home. This includes swimming pool, hot tub, tennis court, fitness center, and sometimes racquetball courts and other amenities. Only the very expensive homes with large amounts of land and price have amenities, which come standard at most apartment complexes.
Apartments tend to provide a greater security and community to home ownership. When you leave out of town on a trip, criminals can sometimes notice that you are gone in a development of houses. House sitters can be employed, but then you have even more cost to your home ownership. Because apartments tend to be clustered together there is typically more of a community. Sometimes there are social events at the clubhouse and usually tenants know at least all of their immediate neighbors. In a house development, few people even know their neighbors and when they do, sometimes petty fights breakout over insignificant things, such as the leaves from one tree going to the lawn of another. Condo ownership solves much of the issues mentioned in this paragraph. If or when you still decide to own, you will not be steered too wrongly by looking at condominium units.
Another very valuable advantage to renting is FREEDOM. There is little comparison to the freedom that apartment or condo rentals provide. The Home Owner's Association in a condominium building or the landlord / management company in an apartment building takes care of the day-to-day issues of exterior repairs, landscaping, amenities, and other repairs. If you are renting, the landlord is responsible for repairs inside your unit as well. You have the freedom to go about your daily business and errands without concern for these issues.
Another huge freedom in renting is the ability to get up and go on a whim. Typically apartment complexes only require a minimum six-month lease and some are willing to sign month-to-month agreements. This gives you the luxury to move rather easily if you so choose for a job promotion or business opportunity. If you own, it is not that simple. You must find a realtor who you feel is competent and you could make a mistake right there. After that there are showings, open houses, and other inconveniences. There are usually many showings before a real serious buyer even comes to see your house. Then there are the buyers who want to steal your home by making a low-ball offer. You may need to move fast for a job promotion and you become frustrated. You do not want to pay a home mortgage at two places when you can only live in one home at a time. The process becomes very frustrating and many owners sell too low just to get out of the problem. If you rented, you do not have this problem.
Some falsely believe that the appreciation on their home makes up for the cost and that they live free when owning a home. This is only true if the appreciation is very high which happens in some unusual markets such as California. Even then, as mentioned earlier, this does not happen all the time. Some markets have prolonged periods of no appreciation, where the home values remain the same year-after-year. Others still, see regular drops in their values. On average, a typical market will have some years of growth, some dips, and some stagnation. Over the long run, the average appreciation is about three percent per year. To illustrate with one more set of numbers, even in an average three percent appreciation you still lose:
|Home purchase price||$220,000|
|Home value after ten years||$294,900|
|Minus closing costs of||$23,592|
|Minus mortgage pay-off at sale||$172,186|
|Net funds at sale||$99,122|
After ten years the home is worth and sold for $294,900. There are closing costs of commission, escrow fees or closing company, property tax pro-rations, and transfer taxes. You are left with a good sum of $99,122. So you did good, right? Wrong. You must consider all the extra cost you were paying with mortgage payments and other home ownership costs over the ten years. Earlier it was shown that a typical apartment would cost $900 or less while home ownership costs $2,450 per month. This is a difference of $1,550 per month. This comes out to an additional cost of home ownership of $186,000 over the ten years.
The net funds of $99,122 minus the $186,000 comes to -$86,878 (negative $86,878). This means that you would have had about $86,000 more in your pocket if you had rented, even though you sold your home for a profit."Renting makes more sense for almost everybody. You would be wasting current and future money by buying a house."
This does not even take into account the do "Renting makes more sense for almost everybody. You would be wasting current and future money by buying a house."wn payment funds, which if invested would have produced more income for the renter. This makes the total lost by the homeowner, even with the above home value appreciation, over $100,000.