Renting vs. buying a home
khanacademy.org
khanacademy.org
Conventional wisdom is just that - conventional, and an important thing to teach people is that there are times when convention should be broken.
Back during the height of housing bubble (2006/2007), a friend of mine decided to buy his first home. It was so obviously a "bubble buy" that even before things started to get bad, it was visible from a mile away that he was making a bad decision: He was buying a new construction K. Hov. cookie-cutter apartment in Edgewater, NJ, which was just close enough to Manhattan to tempt those "I'm buying a NYC apartment!" types but just far enough away that there wasn't a real fundamental demand to live there. He got a terrible no-verification mortgage ("liar loan") that we all warned him was trouble. He paid way too much -- something like $600k for a 1BR condo (near Manhattan prices, not Edgewater NJ prices).
When our friends warned him of these issues, when we pointed out that he could rent a very nice 2BR apartment a few blocks away for $2500/month that he and his wife would be plenty comfortable in, when we pointed out he was likely buying at or near the peak of a heady real estate market, he didn't care. His only refrain - over and over - was the age-old:
"But I'm going to be a _homeowner_. You guys are just throwing away money towards rent every month. I don't want to do that."
Fast forward a few years: Not surprisingly, his interest rate reset, his apartment is worth about $400k, and he had to go through mortgage default to get a modification on his loan.
And yet he still clings to his decision - "yeah but I own my place, and it'll even out over the next few years."
Sometimes buying for the sake of buying just isn't the right decision, despite what "we were all taught."
"But prostitution is wrong!" So we make it illegal and cause prostitutes to get roughed up by pimps and Johns. They attract more diseases and end up straining our social support system.
"But drugs are bad for the community!" So we make drugs illegal and we have gang turf wars and a "fuck the police" vibe from the poorer areas of our cities. Tell me again, what was worse for the community?
"But I don't want to live in a city with lots of condos!" So we make it illegal to build new condos. Then a bunch of google employees start moving in and now the original votes are economically squeezed out.
"It isn't right that Wallmart's (or McDonalds, etc) employees require subsidies from the government!" So we raise minimum wage and (through perverse incentives and lobbying) cut welfare benefits to the partially employed. Minimum wage companies replace people with machines and the government gets higher unemployment and less productivity (since engineers are creating machines to replace the unskilled, instead of the skilled).
It's all the same thinking over and over again. An emotional appeal that has nothing to do with good policy. This is why Khan's video is so important. It reaches out to people and educates them without judgement. Talking to your friend he may feel like he needs to stick to his decision, otherwise his friends will see him as weak, but if he comes to these facts on his own maybe it will enlighten him.
When you take this modification into account, his investment might not look so bad.
But I agree with your general point. I was also taught the middle-class fuzzy thinking that paying rent is "throwing money away".
Renting will effectively (as the video outlined) leave a surplus of money in your pockets. Which you will use to buy the latest gadgets, to pay the latest cool service, to take fancy trips around the globe, to hunt the last ever living rhino in Africa or whatever else. BUT, thinking in perspective, after 20 years you will anyway have 0 cash in your pockets AND no house. Until your health and job keep up, this might be fine. In case of need you will just be f---.
What you are really doing, when you buy a house, is forcing yourself in saving a liable equity for you and your family. Not only it will free you from any rent after 30yrs, but you'll also have a tangible good and you'll leave something for your children and relatives. Not even mentioning that, in case of extreme need, you'll be able to sell it.
Not sure how the concept of "house" might differ between Europe and the US and i realize that if you buy a really crappy built house, my arguments might not be valid. But where i live, houses are built to last centuries and they are by far the best way to responsibly spend your money.
Doing a Khanacademy video advising people in renting vs buying is just SO wrong. The video itself is not only rounding numbers in a bad way (IMHO), but it's also giving a superficial and quite-not-always-true message.
Horrible.
The first thing that people like me need to understand is that we are not professional investors.
Normal people need to buy house on the following factors: is it affordable? what is chance of you or your significant other moving to different area? do you like location? do you expect to live there for next 30 years? are schools good? etc. The excel spreadsheet comparing costs of owning vs. renting should be also there as one of factors, but spreadsheet showing how you are going to be rich by "owning" the house should be ignored.
Even if you're not a professional investor, you can consider having a fraction of your savings on risky investments, such as stocks and real estate. I'm not saying it's easy, not saying it's for everyone, but I'm curious to know why you think a house is not a good investment.
Yes, there's a forced savings component, but it's expensive in terms of opportunity cost. It's not unlike insurance agents who want to sell you life-insurance policies that have "investment" components to them, when what you really want is to buy inexpensive term protection and put the difference in price into better-returning investments.
Remember that Sal Khan's comparison is of an interest-only mortgage versus renting. If you also want to build equity, well then, that's additional money out of your pocket (non-tax-deductible).
That will save you tens of thousands of dollars/euros in avoided interests over the years.
+ what is the total net value of the money you spend in each case, and
+ what is the total net residual value at the end of the period.
With term life insurance you get zero residual value at the end of the term; what you're paying for is nothing more than insurance protection, not an investment. Ditto with renting.
Unless your rental is rent-controlled, this is only true in the very short term. Most rents go up over time.
The payments on a fixed-rate mortgage do not go up. So the monthly real cost of the mortgage goes down over time. (This is even before taking equity into account.)
Renting for a long time is like having a mortgage that you refinance to a higher payment every couple few years.
(Edit: in the U.S.)
Short-term cash flow is not a smart way to evaluate rent vs own.
There are different markets, different economies, different lifestyles, and different situations. For some in some places, renting is wiser. For others, owning a home.
I sure delight in knowing that the home I bought in 2010 for $195k with 20% down and a $160k mortgage at 4.85% is not only worth $220k today, but costs me the same about ($1,200) for mortgage, insurance, and property tax as I used to pay just for my rent. And the place is 3,000sqft versus 1,000sqft of the apartment. And I get all the benefits of a home, such as a lawn, storage, nobody pounding on the floor because I'm listening to music, pets, a security system, and nobody else with a key to let themselves in whenever they feel like it.
In addition, that $1,200 I paid in rent started as $1,000 only four years earlier. In twenty years, it'll probably be at least $2,000+ while my mortgage will still be $850 (not counting insurance/tax). And, in the end, I'll have actual property that is worth something.
I see so many of these arguments back and forth and it always sounds more like people trying to convince themselves that they made the right decision than trying to convince someone else what decision to make. It's a lot like parents frustrated by their kids trying to convince other couples that they should have kids. Or a married couple always trying to convince their friends that they should get married.
It all comes down to individual situations and opportunities. Where that guy lives and with his opportunities in that market, his decision very well may be appropriate for him. For others, not so much. And that's okay.
After all, my next step is to buy more property. Real-estate is a dandy way to counter inflation and when I buy a couple more properties, I'm going to need people like the guy who made that video to be willing to pay me rent.
This is a key point for me, though I'd list different specifics. I've owned a house for ~5 years but was a renter for my previous (post-undergraduate) adult life other than brief periods when I was living with my parents.
The great horror of renting is the typical case of renting in a multi-unit building, and has to do with two things: i) neighbors, and ii) landlord or their agent running the operation. Having neighbors sharing walls, floors and ceilings with you is problematic because the neighbors are inevitably noisy (and in some cases there are other nuisance problems like cigarette smoke leeching in). I'm the guy who pounded on the ceiling who you had to deal with. But I also appreciate your desire to be able to listen to music without having to worry about annoying the neighbors. Neighbors tend to be inconsiderate, and I theorize that this tendency, or the perception of this tendency, has increased, perhaps due to: (a) an influx of young middle class renters who themselves did not grow up as renters but as children in suburban homes, so don't understand the norms of good neighborly behavior; (b) a race to the bottom in apartment building construction leading to poor insulation from noise from other apartments.
Then there's the other part, having to deal with a landlord or property agent. I've found that the rise of the class of mega rental property owning businesses, which I see in growing suburban and exurban areas as well as in cities, is a big problem - essentially slumlord-like unscrupulous behavior has gotten extended to middle-class rental unit property. There also seems often to be high turnover in management of such rental properties which also causes problems. For examples read your average negative Yelp or apartmentratings.com review of rental properties in this category. You'll hear the same types of complaints over and over -- failure to respond to renter complaints, imposition of fees and rental raises at any opportunity, a general culture of treating renters with high disrespect.
Some of these problems seem not to be present to the same degree in multi-unit dwellings that are structured as condominiums or (common in New York) coops. As a kid I lived in a coop in NY for a while and my parents later lived in a coop in Manhattan where my mother still lives. The contrast is significant, even though it shouldn't be overstated (my mom's building is probably higher quality than the average Manhattan coop). You get a different set of people in an ownership-structured multi-unit development -- fewer noisy young people who grew up in suburban houses and are straight out of college, a tendency to have middle-aged or older people, quieter, more considerate, less likely to move and with more of a stake in the maintenance of collective quality. I rented a condo in a multi-unit building in Seattle some years ago after having rented in the sort of rental building I describe above and the difference was notable there, if not dramatic.
When I grumble about aspects of my current situation (basically related to the fact that I'm in an exurb and not an urban setting) I sometimes remind myself of what I used to have to experience as a renter, and it makes me feel a lot better.
[Edited to fix a couple of typos]
Stick built houses are a plague upon the land.
Choosing to rent or buy on purely financial grounds must incorporate the length of time you will own the home.
Or if the neighborhood goes into recession for decades after your purchase.
There's a study floating around claiming that homebuyers flock to a region during a period of growth, buy homes at high prices and, when the local economy slows, are stuck forever.
jnardiello: "But where i live, houses are built to last centuries and they are by far the best way to responsibly spend your money."
- Centuries? Then you're not in the U.S. (nothing wrong with that but just want to clarify).
- Stocks do better than real estate historically.
-Building a home that lasts centuries is probably suboptimal. Who knows what the future holds? What will the local economy will be like in 10 years? What better, cheaper (e.g., energy-saving) building techniques will be developed in the next decade? We should all live in solar-powered eco-yurts!8-))
https://www.google.com/search?&q=eco-yurt
"A Home Is a Lousy Investment": http://online.wsj.com/news/articles/SB1000142405270230425930...
"Why owning a home is bad for you": http://www2.macleans.ca/2013/09/29/the-housing-trap/
"Is Home Ownership Overrated?" http://www.dailyfinance.com/2011/05/03/is-home-ownership-ove...
> - Stocks do better than real estate historically. Stocks are a bet. Slightly more scientific than going to casino, but still a bet. Ask lehman brothers investors, they might have an opinion on this.
Forced saving, and cost-benefit analysis are both factors that should be taken into account. Your claim that a person is entirely incapable of saving unless they have a mortgage is a bit extreme.
If I tied to mortgage payments, I am less likely to try financially risky startup.
If I tied to the house I own, I'm less likely to move for the better job opportunity (or just closer to work to reduce my daily commute).
Another disadvantage of owning house is that all major repairs have to be paid by house owner.
On the other hand, it's much less likely that anybody would kick me out from my own house vs chances of my landlord kicking me out of the house I rent.
Another advantage of owning house is that owners have more control over the house than renters have (paint walls any color, having pets etc.). Neighborhood composition tend to be different around houses that are typically for rent and houses are typically for owners only.
I think it is also wrong to generalize like that. There are renters who are disciplined enough to invest most of their "surplus of money" in appreciating assets. One can even invest in real estate without buying a home. Depending on location, a disciplined renter may well come out way ahead of the owner. IMO, that's a message that we should hear more often.
Wasn't that the thinking behind last bubble?
The risk here is your extreme need coinciding with other people's extreme needs (economic downturn, neighborhood deterioration, loss of a major area employer, etc.) at which point you and hundreds others try to sell with no one to buy, and property prices quickly falling further than outstanding payoff quote on the mortgage.
I didn't want to buy a house until recently, but now I want to buy one around here. Why?
For one thing, in the major cities the rents keep going up at a rate faster than what the government reports national inflation to be. Your (fix rate) mortgage shouldn't change over 30 years, but your rent will likely triple or more in that time in a city like Boston.
But the biggest thing? Customization. I like building and changing things. I'm so tired of landlords that won't let me rip down walls, replace sinks, get a new fridge, repaint everything, etc... not that they should, but I still want to change things. Buying my own place will enable me to do this.
Another thing I can do around here, is buy a place that has 5 bedrooms, and rent out the other 4. I've had several friends that do this, and it essentially pays for their mortgage by having roommates. Not a bad deal.
So far, my mortgage has been refinanced four times, each time reducing the interest rate (due to market conditions) and twice reducing the interest rate by reducing the term (20, 15, and now 10 years).
Being a landlord is a whole different proposition, and I would strongly recommend that you talk to current landlords before you go into that business. MA has excellent renter protection laws... which are not so great for landlords.
Is after tax take-home pay increasing at that rate? If not, or if its declining like in most areas, you can ask for whatever you want, but that doesn't mean anyone will line up to pay it... This is why as an international discussion on the internet, the topic doesn't make much sense. Nationwide, of course, rents will be declining because nationwide the line item on the budget for rent is in long term permanent decline.
Also be on the outlook for "grass is greener..." syndrome. I remember the glory days of the bachelor apartment and no matter how big the problem, the labor never exceeded a phone call to the onsite manager and the cost never exceeded one phone call. Someone else had the headache of the new hydronic heater unit for the whole building, replacing the garage door, upgrading the garage door opener to keyless from keypad, fixing the leaky water pipe, unclogging the storm drain, fixing the broken snowblower and the broken lawnmower, steam cleaning the hallway carpet, fixing the broken front door window, fixing the leaky roof, obviously not all at the same time, but I'd gladly trade all that away for "unable to paint the walls"
Also note you can do all that remodeling you're planning; it will never cost more than your security deposit. In practice the LL doesn't care as long as he doesn't find out and the work looks as good or better than he could do. So, sure, I painted.
Now that I've moved on and fully rented it, it's generating close to 2k a month in profit. Not bad since I got a FHA loan and only put 5% down.
Dealing with tenants can be a pain, but I have no regrets. Home ownership has certainly been a path to wealth for me, though I suspect most people who buy single families or condos with no rental income won't get any real returns.
S&P House Price index:
http://us.spindices.com/indices/real-estate/sp-case-shiller-...
Investing in a house is a gamble on house prices going up, which if you're going to make it you should do with a full understanding that historically there have been many house price crashes (typically caused by broader economic downturns), prices in an individual city can also collapse because of the local job market (Detroit) or natural disasters (New Orleans).
If house prices drop you can be stuck in negative equity whereby you owe more money on your house than it's worth which can easily bankrupt you. If you're renting that's obviously a problem you're not exposed to and you actually benefit from a declining market as your rent decreases.
If you are buying a home to live in rather than an investment you can ride out the odd declining market.
Seems like people have a lot of 'once bitten, twice shy' syndrome when it comes to housing. Market corrections like 2008 are exceedingly rare. I am not saying prices go up forever like so many idiots did around that time, but if you buy in a non-volatile market, it is a pretty safe bet that your home price will at least retain much of its value.
Most mortgages are typically 30+ years, based on historic data you're almost guaranteed to see a house price crash sometime over a 30 year period.
(Although it's important to remember that the future isn't necessarily going to reflect the past)
I am not saying it is a safe /investment/ I am saying it is a safe(ish) /value store/. There is a big difference.
Your comment is the equivalent of saying "Saving accounts are not a safe bet. If it were everyone would be putting money into savings accounts until it stopped being a safe bet."
You have to pay so much to have a roof over your head whether it is through rent or through ownership. Even if a house is a loser, investment wise, it can be a winner value-store wise.
Now, you can totally mess that up by buying a home at the peak of a bubble and watch it tumble to near worthlessness, no doubt. But that is not the situation 99.999% of potential homeowners face.
The apartment I lived in Back Bay 5 years ago was $900 before, and now its $1350.
http://www.nytimes.com/interactive/business/buy-rent-calcula...
If you assume that Silicon Valley is going to be hot for even just the next 5-7 years, with both purchasing and rental prices increasing by 5% per year, then it very quickly becomes smarter to buy and sell the house within that 5-7 year window.
At some point it all just comes down to your prior belief on the growth rates of the two markets.
Who is paying 2.6% of their property value each year on those things? Who gets utilities for free with their rent. That calculator is very dishonest.
Nationwide the figure of a couple grand per acre is remarkably constant. Although property costs may vary two orders of magnitude or more, a firefighter gets paid "about" the same everywhere, ditto a new police car costs about constant, etc. So I would guess someone living where an acre costs about $200K would pay about 2.6%.
I would imagine in Detroit you could buy 50 houses for $100K but have to pay $100K/yr prop tax on them if the surface area adds up to enough acres.
The only utility bill I paid in my apartment was electric and it averaged about $10 over the course of a year. In a house you'll find its another order of magnitude plus of course all the other utilities.
In general, acreage is cheap. The millions of small lots with $X00,000 houses on them tend to make up for all the acres with nothing on them.
Depends on what you mean by 'utilities', but in New York City, landlords are required to provide heat and hot water to all tenants. Technically they are allowed to itemize this as a recurring surcharge on top of the rent, but in practice I have never seen this done.
Electricity is not included in most modern buildings, though it sometimes is for older buildings which cannot separate the meters per unit easily.
The property taxes in CA are lower than they might otherwise be if the home values weren't all so high. The government is going to get it's money one way or another.
From what I understand, property taxes in the north east are very very high though.
It'd be interesting to see a UK version of the calculator that took into account the local housing agreement rent prices, which are the maximum prices that can be paid for properties within an area by benefits.
http://www.bankrate.com/finance/mortgages/is-the-40-year-mor...
When you're modeling the rent vs buy scenario, the outcome is hugely dependent on regional factors (like average rent & purchase prices in your area), current economic factors (like mortgage rates), and also your estimates of future events (like long-term investment return, rental price growth, and home appreciation). Even small changes in these factors can make a huge difference in the outcome. If you're interested in going into more detail, I suggest downloading the model [1] that Sal was using for these videos and plugging in your own numbers:
Where I live, you can get a variable rate mortgage that's advertised at 3%. More than likely, the bank will look at your credit rating and offer something lower. Even if they don't, that's half of what the video is showing.
Likewise, a 4% return on investments seems unreasonable. The same bank with the 3% mortgage is offering a non-cashable GIC (which seems to be the Canadian version of a CD) which pays 2.3%. That's only a little better than half of what's shown in the video.
As for housing prices, it's very hard to find identical houses available for rent and for buying, but here's what I found:
For rent, a 3 bedroom, 1.5 bathroom, 1100 sq ft townhouse for $1500/mo. For buying, a 3 bedroom, 2 bathroom, 926 sq ft townhouse in the same area of the city for $225K. It's not apples to apples by any means. The one for purchase is smaller, plus it's a condo so there will be additional fees on top of the regular things you'd pay for in an owned house. In spite of the differences, $3K of rent does not equal a $1M house in my part of the world.
I plugged the numbers into the New York Times rent vs buy calculator that was mentioned elsewhere (http://www.nytimes.com/interactive/business/buy-rent-calcula...). With these two properties, with these interest rates on the mortgage and investment, with local taxes and utility costs applied, buying is better after three years.
That said, it might not be all about cost. If you like to move around a lot, maybe renting is better because not renewing your lease is easier than selling a house. Maybe renting is better because you don't have the savings for a downpayment or don't qualify for a mortgage. Maybe buying is better because you like to do the handyman type of stuff and rarely move.
There's all kinds of reasons that renting or buying can be better, which is why I don't buy blanket statements that say "renting is always better" or "buying is always better".
I am fortunate to live in a renters market, you can get some really great deals for long-terms rentals if you put in the work.
A house is not an investment for the average buyer, it's an emotional purchase.
>A house is not an investment for the average buyer, it's an emotional purchase.
I'd say the house is an investment for the average buyer, even if the average buyer doesn't buy it as an investment.
http://diy.blogoverflow.com/2012/08/building-a-brick-pizza-o...
conversely, over the last 4 years, we've completely gutted and rebuilt this early 1900s house from all new electrical to plumbing, to insulation and windows. It helps to be handy (which I am) but it can be a money pit...
also it's not a fair comparison: yes with a mortgage at the beginning your payments are 99% interest, but in the last 5 years they're almost entirely principle, so you get to keep that money.
if you're still renting in 25 years 100% of that money is still going to the landlord, and your rent has likely gone up by a factor of 5 too.
ALSO over long periods of time real estate nearly always increases in value (more than inflation), so that's another thing to consider.
However, I think it was a good video because it does an apples-to-apples comparison and clears up a misconception that many people have about buying. In part 2 of the video he sums it up pretty well "You are not a home owner until you have no debt. Until then, you are a paying rent on the money you owe instead of the place you live - you are a money-renter".
Evident from the comments here on HN as well as the blog post, many people mistakenly believe that monthly payment in a buying situation all goes towards equity or "savings". But after 30 years, the buyer would still owe $1M on the house - he hasn't saved any money at all. Reading some of the comments, it's almost scary that people about to spend a huge amount on a home don't understand this!
Interestingly, it looks like on Dec 31, 2013 new video was added as 1 or 4 where Sal said he bought a house and now is neutral on rent. vs. buy: http://www.youtube.com/watch?v=JNL6f1xkie4
On the other hand, if what you want is a place to live that you can redecorate, remodel and change however you like then you can't beat buying. Where I live you can't do anything to the fittings and fixtures without the landlord's permission.
Given my local housing market I tripled my floor area buy buying for same monthly payment, but that's not true everywhere.
I'm from Australia (Sydney - one of the major capital cities) - and house prices here have basically been rising continually for the past few decades.
House prices are predicted to rise 10% per annum in most capital cities (less in smaller cities):
http://www.smh.com.au/business/property/australian-capital-c... http://smh.domain.com.au/real-estate-news/boom-time-sydney-h...
Hence, investing in a house is seen as a solid investment - most people will tell you to get a mortgage, and put your money into a house - to do anything otherwise is seen as silly, since the prices only go one way, and interest rates are incredibly low.
Occasionally, you'll get one or two people talking about "bubbles", but they're regarded as a bit kooky by most - and there doesn't seem to be any fundamental reason prices would shift.
What are people's thoughts on this?
Second, if I were to buy a house, I'd first go to my bank to check what kinda mortgage I could get, see how much that would cost me a month, and only then find a house.
Third, can't really compare rental homes with bought homes around here (netherlands); rentals are usually apartments and the like, while bought houses are... well, real houses.
Fourth, you get more house for the same amount, or pay less in mortgage/interest when you buy a house. I choose to rent for now, because the main advantage over renting vs buying is flexibility. I can give my landlady a one month notice and I'm outta here. Not so with buying a house; you've got to sell it, and hope that you can use that money to pay off your mortgage, or whatever. You're pretty much stuck on a 25-30 year mortgage if you get one.
As for having 250K in the bank-- if the house costs $1M, you have to make a down payment. In the mid-2000s, that may have been a smaller percentage, but these days I think 15-20% down is not unheard of.
I bought my place 15 years ago in San Francisco. It seemed like an unreasonable shitpile of money at the time.
My mortgage on a three story single family home plus land on top of Twin Peaks is three grand and change. I rent a couple rooms out and that covers a good part of the mortgage. A one bedroom apartment next door just rented out for more.
Granted SF is an unusual market, but California's population is forecast to nearly double, so the housing supply/demand imbalance is likely to only get worse, and if you don't live in a rent controlled unit, your rent is only going to increase in spades.
Plus I have the added advantage of being able to paint my house anyway I like, put pink flamingos and garden gnomes out front, and yell, "Get off my lawn!" when the mood suits me.
A couple things to add, house payments stay exactly the same over a very long time. They don't increase at all. The absolute dollar amount is fixed. So while rent in an area might triple over 30 years due to inflation and local housing market fluctuations, mortgage payments don't. It's a time-value of money idea. It's cheaper to buy now than later.
Most people buy or rent homes where the monthly payment is at around 1/3 of their take-home income. As a home owner, that percentage decreases as your pay increases (inflation, pay raises, promotions, etc.).
What makes the decision difficult is the cost of servicing a loan vs. just paying for rent. [1]
The problem is that, even with a low interest rate, you pay a lot of extra money towards interest. A $500,000 home with a 3% 30 year loan costs something like $750,000 in the end. You can effectively lower your rate by artificially paying down your principle. If you view the monthly payment as a minimum monthly payment, just pay extra and pay down the principle faster. One simple way to do it, as your income grows, just keep paying 33% of your take home pay towards your mortgage. If you get a big bonus, pay that as well. Most mortgages don't have a limit to how much you can pay in a month. Doing this will reduce the effective interest rate, lower the minimum required payment, and shorten the length of the loan. Even better, during months where you need lots of fluid cash, just pay the then minimum payment and different you were paying is now usable. It's like giving yourself a pay raise if you need one.
Also, when interest rates drop, you can refinance and otherwise change the terms of your loan to be more favorable. You can turn equity into large sums of cash almost on demand if you need to. You can't do any of that as a renter.
After a few years, if you run the numbers, you'll probably find that you can comfortably service a shorter-term loan, say a 15-year loan. Which also have lower interest rates than 30 year.
As a quick example, my "minimum" mortgage payment + amortized property tax is about $1500 less per month than the current market rental rate for a similar sized home.
In the end, once you finally own your house, all you are responsible for is upkeep and property taxes, which will be a tiny fraction of the then market rate for renting a similar sized property. You'll likely have more income coming in by then then you'll really know what to do with. Whereas if you had rented a similar sized property the entire time, you'll still be renting and have nothing to show for it and you'll be subject to the whims of your landlord.
I know a number of families who started out renting the house they eventually bought, but if they had just bought a house to start with would be close to owning the property instead of 10 years behind. Renting those properties bought them very little.
1 - Here's a fun experiment, let's suppose I buy a home at $500,000 with a 3.25% interest rate over 30 years. My monthly payment is $2176.03. Supposing I decided to stick with that, I'll pay $783,370 for the house.
Now let's say I rent the same property and I get lucky and it's an even $2,000/mo or $24,000/year. But let's say rent increases with the current rate of inflation (1.5%) for 30 years. Over that time you'll pay $900,928.40 for the same place. And the owner of the property will now own the place you live in and have made $117k off of you. Inflation rarely stays at 1.5% though, so let's say it's a more normal rate of 3%. Well now you've paid 1,141,809.977 for somebody else's to own their property. In other words, they'll have made $358k off of you and gotten a house of out it.
In fact, the property owner is probably just taking the increase in payment and paying down the principle even faster like I propose above.
2 - Here is an awesome tool that sort of shows my point http://www.nytimes.com/interactive/business/buy-rent-calcula... In my notional example, buying is better at around 6 years.
3 - and another one somebody else mentioned http://www.trulia.com/rent_vs_buy/ in my notional example, buying is almost 1/3rd cheaper than renting over 30 years.
1) Property Taxes Between 0.18% to 1.89% in the US. Let's assume the mean of the two for 1.035%. In the first year, that would be a payment of $5,175. Over 30 years, using the same 3% inflation to calculate the future value of an annuity, that works out to $246,202.78
2) Opportunity cost of down payment. Assuming a 20% down payment of $100,000, the future value of that money would work out to $100,000 x 1.03^30 = $242,726.25, or a gain of $142,726.25
Note that this is already quite a conservative return. A well-balanced portfolio over the last 10 years, even taking into account the disaster of 2008, would have easily exceeded 6%.
3) Maintenance/Upkeep At $2,000/yr and 3% inflation, the future value of the annuity would work out to $95,150.83
So, the cost of owning in your example is actually: $783,370 + $246,202.78 + $95,150.83 = $1,124,723.61
and the cost of renting is: $1,141,809.977 - $142,726.25 = $999,083.727
$26,112.36/yr * 30 years = $783,370 not 1,293,862. And then suddenly we're at $1,635,215? Where in the world did $341,353 come from?
Rent takes into account time-value because rent goes up, mortgage payments don't and it's very easy to make them go down. Mortgages actually stay fixed today and into the future at a worst case, and can actually become cheaper over 30 years, while rent almost never does.
edit are you comparing the cost of buying a home vs. the cost of starting an annuity at the same price as a home? If I had $500,000 to start with I'd just buy the house outright and not mess with a mortgage at all. Now I can pump up whatever investment instrument I want.
More importantly, you typically can't withdraw from an annuity until you hit 59 1/2. If you're at that age and have spent the last 40 years paying rent, you've already made some bad investment decisions.
You do have to take into account the time value of money with the mortgage payments still, because $1 today is worth much more than $1 30 years from now. It's the difference between nominal dollars and real dollars.
Conversely, even though rent goes up in nominal dollars, it stays the same in real dollars (or even goes down as a house becomes less marketable over time).
You never stop making rental payments.
Worth it.
Depending on the residual value of the building and the land value in 30 years, that may or may not be worth it. My point was just that the example was highly biased, not whether it's better to rent or to buy.
Note also that if you sell, you will have to pay realtor commissions and a capital gains tax on the nominal value.
15x what the original owner paid in nominal dollars doesn't give nearly enough context as to the real return. How many and which years was that over? What was the rate of inflation over this period? How did the Dow, S&P, or <insert stock market index here> do over that same period? And that's kind of beside the point.
Like I said earlier, I'm not arguing in favour of either owning or renting. I'm just making the same point as the submission, and that is to use full, accurate numbers to make informed decisions. If more people did (and everyone should), we probably wouldn't have such extreme bubbles and crashes.
Your return on your 'down payment' has to be well above average to make up for your otherwise 100% loss on rent.
And there is insurance you can buy at about $400/yr that will take care of most of your maintenance and upkeep.
Interest is 100% loss also, so what's your point? The cost of both are already factored into the calculations.
$400/yr insurance is not going to cover anywhere near the full cost of maintenance and upkeep.
The problem with the comparison of what you can invest if you don't buy a house is that you have to have the cash for plowing into other investments and still pay for a place to live.
The only money you really have to play with is the down payment and closing costs to make up for the month to month loss of equity and difference between renting and mortgage+incidentals (renting is usually still costlier since owners like to make a profit) in the rent-vs-buy comparison.
As for maintenance costs:
I've had my air conditioner, garage door, stove door, heater, and dish washer all fixed over the last couple of years.
Granted, you have to pay $80 for the repair visit but it is better than paying $1K to get my garage door repaired.
The only things it doesn't cover are normal wear and tear. So, yeah, it doesn't cover the full cost but it goes a long, long way.
A down payment is usually a significant chunk of money, and should definitely be factored in.
Also keep in mind that when you get a mortgage, you are effectively debt leveraging, which although magnifies your gains will also magnify your losses. So the idea that real estate is inherently safer is not necessarily true. Whereas most people think of buying stocks on margin as being insanely risky, they don't think twice about doing the equivalent with housing. And stocks have historically consistently outperformed housing.
That is true only if the alternative is doing something financially productive. In this case the alternative is spending the money.
You are seeing the house as an investment. Your analysis is spot on when talking about a house that is not the primary residence. But it fails when applied to the primary residence because the money is being spent on housing either way...
This analysis is specifically taking into account that money is spent on housing either way. Otherwise, we'd be comparing the ROI of purchasing a house and renting it out as a business in comparison to other forms of investment.
Because you have to live somewhere.
The only time this isn't true is if the owner has a very old mortgage or outright owns the home.
Everybody knows that. That's why you can take positive action to minimize interest outlay over the lifetime of the loan and reduce that loss. From refinancing, to shorter loan terms, to early principal pay down. You can't do anything analogous as a renter. Interest is only a small part of the total mortgage payments, while rent is a 100% loss always.
> $400/yr insurance is not going to cover anywhere near the full cost of maintenance and upkeep.
Maintenance and upkeep on my house costs way under $400/year.
A new roof and new coat of paint will already blow your budget. Your pipes will also need replacing after 30 years, as would your hot water heater, among a plethora of other expenses that come up.
Roofs last about 25 years except in very unusual circumstances that insurance covers, our appliances are 10 years old but work fine. I could probably do with a new washing machine, but it's okay. I won't pay more than $500 for one anyway. I'll cross fingers and hope that my hot water heater and heating a/c make it 20 more years. If not, it's not like the cost to fix comes anywhere near the 100% a month in rent I'd be throwing away so my landlord could replace everything with refurbished second rate equipment.
Nobody replaces pipes after 30 years except for leaks or lead.
But let's differentiate normal maintenance from repairs (just like with cars, oil changes from engine replacements). If I had to guess, I'd say my monthly maintenance on my house was under $50/mo? Amortize the repairs I've put in over the last 10 years? I've probably put in $1000 in work or less than $3/mo over 30 years. So I have a lot of room.
The smartest thing to do is buy a home under the condition that the previous owners do all that work right before you move in and absorb it out of their equity.
Look at it another way. You're already paying for this stuff built into your rent. If luck happens and nothing breaks, that's money the landlord pockets and you don't have anymore. If you own it, it's just extra money you can use to pay down your principle, reduce your interest losses and pay off your mortgage faster.
In other words, renters are likely paying these things, but it's all built into the rental price.
For example, I could comfortably charge about $1000-1500 a month more to somebody renting my house than what I pay for it right now. In a few years, when I pay it off, and it costs me nothing but property taxes and maintenance. I could move to another house and rent this one out and use their rental fee to cover most of the mortgage cost on my new house.
yes. this tool illustrates it perfectly. [http://www.nytimes.com/interactive/business/buy-rent-calcula...] it actually shows why the khan video is seriously flawed.
if you plug in the values he uses in the video: (which are stupid and no money manager in the world would tell you to buy a house like that)
- $1,000,000 house
- 25% down (all $250k? really?)
- 6% interest (ouch...)
- $3,000 a month in rent for 1600 square feet? (in the bay area!?!? hahahahahah)
now, let's change the numbers to something more reasonable.
- $1,000,000 house. (1600 square foot house in the bay area)
- 10% down. (that's all you need and this leaves $150k for investment)
- $4,500 a month in rent (according to zillow, that's what a 1600 square foot house rents for)
- 5% interest is more realistic.
still bad tho, huh?
yeah. because buying a $1,000,000 house in an over-inflated area is dumb.
now, let's look at something where it actually makes sense.
- same house.
- cheaper area -- not everyone wants to live in the bay area.
from some real numbers on a house i actually own (tho, i don't live in it - we're renting it out)
- $120,000 house.
- 10% down. (you have almost *ALL* of that fictional $250k left...)
- 5% interest
- $1200 a month in rent (again, zillow for that area)
if i lived in the bay area and didn't need all my intangibles (like, putting in new countertops in my kitchen or adding solar panels if i wanted to), i would totally rent.
if i lived in kirkland? i'd sure as hell buy.
For a $120000 house like yours, I expected a monthly rent of about half. Your area seems like a great place to own a property, so it looks to me that buying is definitely the way to go there.
Baltimore has high rents (relative to prices) because of Hopkins, for example. There are many wealthy people from the Middle East who come here for treatment. Many places, price/rent ratios are under 10 years. If you can buy and will be in the area for a while, you should.
In NYC and San Francisco, price/rent ratios can reach absurd numbers: 40 to 50 years. Why? Emotional bullshit, a sense of prestige, et cetera. Buying only makes sense if you expect apocalyptic increases of housing prices (see: Tokyo, especially in the late '80s).
Some of the hardest-to-predict relevant variables are (1) what you expect housing to do, and (2) whether you think your career needs will favor (or disfavor) a move. There are a lot of sociological factors that no one can predict. But most people, when they buy, are betting money they can't really afford to lose.
Yeah, that's certainly true. I'd call those outliers in the same way that I'd call places going through huge economic crashes where you can pick up a house for pennies outliers.
In typical markets, and even ones close to those outliers, over the long run (30 years), buying an equivalent property nearly always makes more sense.
- I'm currently paying $2,300 for a $500k house. I think his rental rates are way off.
- In a free market, rental rates are supposed to adjust to make it such that an individual is indifferent between renting and buying. If it was that much more expensive to own than to rent, the landlord would never rent the house out!
I don't quite agree with that. If you're renting out, the apartment owner must pay for the risk of you destroying the apartment. If you instead buy the apartment you don't need to pay for the risk, assuming that you don't yourself destroy it.
I have a sizeable deposit (20-25%) but I would still need a large mortgage. I want to buy because I know rent is going to through the roof as this tiny island becomes more and more populated.
However, I don't want to be tied to a job/location. Commuting to London for work is always an option but it comes at a cost of £350-450/mo in travel. Not to mention the time involved. I want the flexibility of renting but I also want a paid-off house when I'm in my 40s/50s.
AFAIK most mortgages (non buy-to-let) do not permit letting out your property, so I'd need to re-mortgage to do that.
My advice: rent and be a fanatic about investing the difference in the mortgage payment for a property exactly equivalent to what you'd been thinking about buying. Over the long time horizon you're planning for you should be all right.
The big difference is my interest is tax-deductible and I will always get at least something back from my investment. From a finance/economics perspective: Owning home > renting. Obviously.
At least that's how it works in the UK, fixed rates are hardly worth it.
http://www.nytimes.com/interactive/business/buy-rent-calcula...
Even if we assume that the rent & the house price remains the same of 30y, after 30y you end up with a house that worth $1M & spent ~$15K more per year. Over 30y it's $450K in cash vs owning a house of $1M, meaning buying the house was the right decision.
Where is my mistake?
In his video, Sal Khan did an apples-to-apples comparison: He compared the net out-of-pocket costs of (i) an interest-only mortgage in which you build no equity, and (ii) renting, where you likewise get no equity.
If you also want to build equity in your house, in addition to merely paying the interest, then that's an additional out-of-pocket cost (which unlike the interest payment is not tax deductible).
That's not to say his numbers are realistic approximations. But his basic approach to comparison seems sound.
At the end of a rental period, if you want to buy the property you are going to pay the current price.
That delta can be significant over long periods of time, and is a benefit of purchasing over renting.
The amount that he was paying monthly goes towards paying off interest on the loan, property taxes, etc. only.
Owning a home makes people feel safe. Renters know they can be priced out at the end of a lease cycle. (Most of the yuppie "luxury" buildings, because they target people who work obscene hours, pack an automatic 15-20% increase in the first year, just because people hate moving.) Owning may be a worse deal on average (expectancy) but it doesn't pack as much volatility.
The error is in the idea that homeownership provides protection. As the OP points out, a mortgage is just renting from a bank. If you have a catastrophic income loss, you're just as exposed to eviction. This can even be true if your mortgage is paid off-- if you lose the ability to pay property taxes.
I don't like being an involuntary renter (read: I made too many bad calls in my 20s) but homeownership in a city is almost always a bad idea. It's an investment that (a) you cannot move and (b) other people can fuck with by, say, building ugly things near it. The obscene cost of housing in most cities has far more to do with NIMBYism than natural supply/demand issues, when the real problem is just that urban homeownership is a pretty raw deal.
This analysis didn't even cover upkeep and transaction costs, or (even worse) the career-altering loss of geographic mobility. Urban homeownership is entirely about prestige and emotion; it makes no sense otherwise. But it's an enormously expensive hobby, making boats and cars look like childrens' toys.
Renting is throwing money away, but so is owning in most cases. The best we can do is to make housing a commodity (what suburbia originally intended to accomplish, but at horrific costs) or, more accurately, to accept the fact that that's what it is. That is, we need to tell the NIMBYs to choke on a dick and build high-rises (i.e. solve the supply crisis that is making housing more expensive than the natural $125-175/ft^2 level-- price of new house construction-- at which it belongs) yesterday.