Is it always better to buy than to rent? Turns out, no.
This afternoon, me and the hubby were at a block party organized by one of our neighbors. We live on a quaint street, and it was nice to meet the neighbors and get to know them, but to me, one of the most interesting aspects of the shindig was finding out how many of them rent and how many of them own their homes. (Spoiler – lots of owners).
You see, renting is something that is generally held in contempt in the United States. The US is a country of homeowners, and everyone assumes that the goal should be to own your home. Homeownership is widely seen as an investment, and renting as a waste.
The idea, of course, is that your home will appreciate in value over time. Sure, goes the thinking, you’ll be paying more than the sticker price because you borrow the money to buy, but over time, the increase in your home’s value will repay you for the interest, plus a healthy return to boot! Obviously, this hasn’t always worked out (remember the mortgage crisis? Yeah, that happened), but the dream of homeownership remains a core part of American financial DNA.
But is this way of thinking correct? Is owning a better financial decision than renting?
The answer is obviously quite complex, because there are so many factors at play. For a start, figuring out how much a house costs is no simple matter. The total cost of your home includes what you pay for the house, the interest you pay on your mortgage, the cost of repairs, improvements and maintenance, property taxes, and closing costs. Then, houses appreciate to varying degrees – some homes gain value, some lose it (depending on your timing and your location) and that feeds in to how worthwhile buying is. There are also opportunity costs at play – the money you spend on your mortgage can’t be invested in the stock market, say, so by tying money up in your house you prevent it from deployed elsewhere.
With renting, your major cost is your rent, plus renter’s insurance. Obviously, when you’re done renting a place you don’t really have anything to show for it, except for your security deposit, but if your rent is lower than the cost of owning a home, you could be investing the difference in the stock market. There is also, obviously, an opportunity cost – the money you spend on rent can’t be spent elsewhere.
Let’s look at an example, using elements of the handy dandy New York Times rent vs buy calculator. Let’s start with the assumption that you have saved up some money to buy a house – say $25,000 – and you’re about to make the decision to rent or buy.
First, let’s imagine you take the buying route. Let’s figure you’re buying a home that costs $250,000. You take on a 15 year mortgage, with an interest rate of 3.5%, and pay a $25,000 deposit – which means you’ll be paying $1,608 on your mortgage each month. We’ll assume 1.5% property taxes (check out your actual rate here), which works out to $3,750 in the first year, and rises with your house’s value, and that you’re paying a marginal tax rate of 20% (fair, if you’re buying a house you probably have a decent income). You’ll also be paying upfront closing costs of 4% when you buy your home – another $10,000. You’re also spending about 1.5% of the value of your home on maintenance and remodeling etc. over the 15 years, which is $3,750 in the first year, and 0.5% on insurance ($1,250 in the first year), plus $150 a month on utilities.
At the end of the 15 years, you’ll have spent a total of $503,895. At that point, you sell your house. We’re going to imagine that house prices will increase by 5% a year (generous, by recent historical standards), and that selling costs you 6% of the selling price, which is quite typical. You’ll sell your house for a net of $488,548. That leaves you $15,347 out-of-pocket over the period.
Now, let’s say you go with renting. You stick the $25,000 you saved up into an S&P 500 ETF, and find a place to rent that costs you, say, $1,134 a month including utilities (this is the amount the NYT considers breakeven, which is why I’m using it), plus renter’s insurance that works out to 1.5% of your yearly rent ($204 in the first year), and one month’s rent as a security deposit. At the end of 15 years, you’ll have be out $248,761.
At this point, it looks like buying is clearly better – over the 15 years you’ve spent WAY less than the renter, if you sell your house and count the proceeds against your spending.
Remember that the renter put the $25k into an ETF. The stock market has returned an average of just over 9% a year since the Great Depression with dividends reinvested, so let’s assume you earned 9% a year on that money, and reinvested the dividends. Over 15 years, you’re $25k would grow to about $91,000.
And then, here’s the big one. Let’s say that the renter decided to invest the difference between what she spent on her rent and what the buyer spent on her home. Remember, the buyer spent $255,134 more than the renter over the period. If the renter had invested that money in the stock exchange, the renter could conceivably have built up an account of around $600,000 (making a lot of assumptions that I don’t want to discuss here because BORING). That would leave the renter with a $690,000 nest egg. Less her spending on rent and the $255k she invested, she’d be ahead about $180,000, while the buyer would be $15,000 in the red.
Suddenly, renting doesn’t look so bad.
You see, every month, the renter is spending about $1382 a month on housing (over the full 15 year period), while the buyer is spending closer to $2800 a month, when you count up all the costs. If the renter invests the difference (about $1400 a month), she will come out WAY ahead in the end.
Now, if you poke around the NYT calculator, you’ll notice that some of their calculations are different to mine –they assume the renter hasn’t saved up the lump sum to invest, and they make different assumptions about opportunity costs (that is, the cost of spending your money on rent instead of investing). I’m assuming that you don’t just spend less, but that you invest the difference.
If you spend much less on rent than you would on a comparably comfortable house (or just live in a small house – I do and it works just fine), and invest money in the stock exchange, you will probably be better off, in the long-run, than someone who buys a house.
This is obviously not always true, but at the very least it should make you seriously consider whether buying a home is the only smart financial choice.