Does it make sense to house if you intend to move every few years? Has anyone ever told you: “Since you never see rent money again, buying a house is usually the better financial decision.”
Most people do not think about the consequences of when you’re buying a home for a short time (less than 4 years). Just like rent, there is a lot of money going out the door when you own a home that you’ll never see again.
Is owning a home a good investment?
Traditionally, owning a home is pitched as a good investment, because you build equity in the home by paying off the mortgage principal. True statement. But consider all the rest of the money you have to shell out along the way to do that:
- Mortgage interest (this is usually the largest piece of the pie, especially early in the mortgage)
- Property taxes
- Home owner’s insurance (HOI)
- Flood insurance
- Mortgage insurance (if your downpayment was less than 20%)
- Condo or HOA fees (for those types of communities)
- Realtor/lawyer fees when selling (and sometimes buying)
- Closing costs (buying and selling)
Renting versus buying a home costs
In some cases, these can total to be more than what it would cost you to rent a similar place, especially over a short time horizon (less than 4 years). The reason for this is because the interest on the mortgage is the greatest amount when the principal of the mortgage is still high (i.e., early in the mortgage).
Taking a completely arbitrary example (but using realistic numbers), let’s say you can afford a $250K home, you have $25K (10%) to put on the downpayment, with a 30-year fixed rate mortgage at 4.50%. The property tax rate in your area is 2.00%.
If you put that info into a mortgage calculator, it will say your mortgage payment is $1140/month (which includes the interest on the mortgage, plus your principal payment). “Sweet!” you say, because that’s pretty affordable for a $250K home. But wait.
- Property tax = $4500/year = $375/mo
- HOI = $87.50/mo (Source: Zillow, $35/mo per $100K of home value)
- Flood insurance = cost can vary from $0 to a LOT (over $100/mo)
- Mortgage insurance = $93.75/mo (assuming 0.5% of borrowed amount of $225K)
- Maintenance/repairs = $2500/year = $208/mo (based on 1% of home’s value to use or save toward repairs)
How much you might spend on realtors, lawyers, and condo fees is completely dependent on the situation, and I won’t swag those numbers here. Hopefully I’m able to make my point without them—just keep those costs in mind if they apply to your situation.
Now, if you total all of that up, what you get is: $1904 and change per month to own. Plus, you’re building equity in the home! All the better. But if you take a closer look at that mortgage payment of $1140, there’s something important. How much interest are you paying versus principal in that $1140?
You can’t quantify this as a set number, because it changes every month. When you make a payment, part of the principal is reduced, so the interest on the principal is less the next month. But you can average it out over set periods of time.
In this example, with your very first $1140 payment you pay $844 in interest and $296 towards equity. Over the first year, you will have made $13,680 in total mortgage payments; $10,050 of that will have been purely interest on the loan. Only $3630 will have been equity in your home. After 4 years, the numbers are $54,720 total, of which $39,170 is interest and $15,550 is equity. In that 4 year span of time, the average amount you paid in mortgage interest per month was $816 ($39,170 divided by 48 months).
So, the final analysis has to be: once I tally all the money that goes out the door when I buy, is it more or less than what I can rent (which is also money out the door)? In this example:
- 816 (average mortgage interest over 4 years) +
- 375 (taxes) +
- 87.50 (HOI) +
- 93.75 (PMI) +
- 208 (repairs fund) +
- Any “other” costs (lawyer, realtor, condo, flood insurance, etc.)
Total = $1580, plus “other” costs. (Yes, I acknowledge some will say $200/mo for repairs is a lot, but you have to budget for repairs somehow, and a good rule of thumb is 1% of the value of the home per year.)
If you can rent a place that fits your needs for $1580 or less, you’re doing better renting the place than you would if you bought the $250K house in this example. You can invest/save what equity you would be building, plus you don’t take on the risk of owning the home (depreciation, unforeseen costs).
Yes, you never see your rent money again, but there’s a ton of money when you own a home that you never see again either. You need to make sure the dead money when owning is less than the dead money when renting. The NYT will help you do the math.
Other Reasons to Buy a Home Instead of Renting
I think the issue isn’t that there’s no reason to buy, it’s that a lot of people are under the delusion that you should buy because it’s inherently better financially and renting is somehow not as financially responsible. If you’re buying a house because you want to own a house, rather than because you think you’ll have more money if you own a house, then sure, do it for your own reasons.
Some people may, on the other hand, feel like there’s more value in having a landlord or management company deal with maintenance and emergency repairs for you, having a predictable monthly rent without worrying about surprise fluctuations when you have to deal with house trouble, and the ability to move much more easily. As you said, there are pros and cons to both. But financially, they’re on the whole equivalent, just different. People shouldn’t be pushed away from renting and into buying when they don’t actually prefer to own a house, out of a mistaken belief that that’s the financially better thing to do.
Thinking of a Home as an Investment is a Bad Idea
Thinking of taking a mortgage out on a home (that you plan to live in) as an investment is a very misguided approach to investing. For example, many people buy a more expensive home than they can afford because they see it as a good investment. They can no longer afford to adequately save for retirement, but they believe that their mortgage payments on their house will make up for it. If they take out a 30 year, $250,000 mortgage at 4% APR, they end up paying $429,673 (1,193 monthly) by the maturity of the mortgage. Let’s say the house appreciates in value by 20% over that time and is now worth $300,000, the “investment” you made in your house has yielded you -1.19% annually over that 30 year period. Now let’s say that they decided to instead put those monthly payments into their retirement averaging that same 4% that the mortgage cost you. By the end of the 30 years the value in your retirement would be $828,000. That “investment” that they thought was sound is only worth $300,000 as opposed $828,000 if they would have invested their money and received a modest return.
Theoretically, an investment in a tangible object, such as a house or gold, really only protects you from inflation. Houses have been appreciating in recent years for a couple of reasons. 1.) The low interest rates as a result of the dot.com bubble and the 2008 crisis have made taking out a mortgage much more appealing, thus increasing the demand. 2.) When real estate prices, it actually raises the demand for houses in some cases. People assume that the price will continue to rise and they will be able to make a profit. This same principle works inversely as well. If housing prices are decling, people become less likely to purchase a home for fear that it will continue to decrease in value. We have seen both ways in the past 15 years.