A house is probably the most significant purchase you'll make.
It comes with a lot of advantages but it also decides where you're going to live, how much money you'll have to earn consistently, and what risks you can afford to take over the next 15-20 years. A house is also where most of America stores its wealth: Families that own homes have 40 times the net worth of renters and twice the median household net worth in the US. The higher your income level, the greater the chances that you own a home – and more than 70% of homeowners are over the age of 45.
On the other hand, rents are also rising, and it can be hard to decide whether to rent or to buy. If it costs just a little more to buy a house than rent it, is the decision worth it? I'll break it down step-by-step and cover all the pros and cons so you can decide.
How much does buying a home really cost?
Sure, buying a home is slightly more expensive than renting, but at the end of it, you at least have an asset to your name – so you might as well buy a home, right? Think again. The costs of buying a home don't stop just with the mortgage payments.
The median home in the US costs about $400,000 today. The down payment on a house can be as low as 1-2%, but most lenders need at least 10% down to qualify you for a loan. Next, the interest rates on your mortgage determine how much you pay: With rates currently going from 7 to 8%, you would lose that much to monetary policy every year. But it doesn't stop there:
These are the explicit costs out of your pocket. But the $40,000 you put down for your down payment could also have been invested in the market at an average of say 6%. That brings an opportunity cost of about $200 every month. But with a 1% net appreciation every year, your house will also gain in value by $330 per month.
But there are things that work in your favor too. As you pay down your loan, you build equity in your home like a "forced savings account". That translates to about $304 per month in this case. You would also qualify for a write-off by deducting the mortgage interest you pay – which brings the average tax savings to $2,450 a year or $204 a month (I'm leaving out state tax deductions because only 30% of Americans use it).
The total cost calculation works out like this:
So after taking into account everything, a $400,000 house will cost you about $2,825 per month. Next, let's take a look at renting.
How much does renting cost?
One of the delightful things about renting is that the financial cost is so transparent – the price you pay is the price you pay. If you want to really look into the "opportunity cost" of your 1-month security deposit of $3,000, that's about $15 per month. That doesn't make a big difference. So, can you rent a house for less than $2,825 per month?
The answer is: Yes. In all but 4 major American cities, renting is cheaper than buying.
What's more interesting is that you get much bigger and better homes for rent that would cost more if you were to buy them on a mortgage. For example, here's this Las Vegas house that costs $400,000 to buy:
But this one down the street is almost double the size and it just costs $2,600 to rent:
This isn't a one-off example. In almost every city across the country, $400,000 homes pale next to the options you have for a similar rent.
Why renting makes sense for most people
Buying a house is an investment, and with investment, there always comes risk. What makes homeownership tricky is the sheer number of variables – interest rates, property taxes, insurance rates, expenses, inventory – over which you have no control. For most people, here's why renting is better:
The downside is that renting leaves you at the mercy of your landlord, and there's very little protection against rental increases. You are subject to the whims of the market, and it can be difficult to plan your housing budget long-term. You can't customize your house according to your wishes either – so if you want to break a wall and remodel, or redo the landscaping, then you'll have to wait till you own a home.
When does it make sense to buy?
Long-term, home ownership has been shown to be a better choice, though the market could decline temporarily. Locking in a home gives you predictability about exactly how much you're going to pay for at least the next decade, and if you've decided on settling, it could make sense. Still, with interest rates as they are, there's a financial cost to this.
In what situations would it make sense to buy a home? Consider this:
Unless you plan to live in an area for 10 years or more, renting is the cheaper option. But for longer periods than that, owning a home probably makes more sense. Just be aware that you'll be tying up a lot of money in your house, and it's not guaranteed that your area will go up in value. When you buy a home, you're locked in for better or worse. Even a 5% decline could leave 200,000 households underwater on their mortgage – that would make moving difficult without taking a loss.
There's one advantage that comes with buying a home that isn't financial: it's the psychological feeling of ownership and safety. Owning a home brings value and stability to your life, and you won't need to answer to a landlord anymore. If you want that sort of control and plan to stay in the area for at least 10 years, see if the calculations make sense for you – buying a home might be the way.
My personal preference here is to buy something that needs work and to fix it up so that it's worth more than what I paid for. In the event I need to sell, it's a buffer against paying out of pocket.
If not, for most people, renting is the superior option just because it's cheaper right now, gives you the flexibility to move at short notice, and lets you manage your cash flow without taking a sizeable hit.
That's it for this week. I hope you enjoyed this article. Let me know your thoughts by responding to this email - I read every single comment :)
Stay safe, stay invested and I will see you next week – Graham Stephan.