Rent vs Own : And the Winner is …
Updated: Sep 3, 2019
“You are flushing your money down the toilet if you are Renting!”
How often have you heard that statement and wondered if you were just being stupid all along to not be able to see an obvious fact?
For ages, homeowners have shown immense pride upon acquiring a long term mortgage they call home. A person’s financial stability was often judged on the basis of whether they lived in a rental home or one they owned. It is surely a proud moment when you make that big decision to purchase a home, but are you fooling yourself when you call this home an asset?
While you may argue that you would rather pay the monthly rental amount towards a mortgage and build equity, it is not the only difference between renting versus owning. Without further ado, I would first like to point out the top 3 differences between renting and owning simply from a financial standpoint:
1. Costs, Fees, Charges and Anything Synonymous
You are super excited when you enter your new home and as you walk down to the basement, you notice an unpleasant guest – Mold. You can’t pick up the phone and call your landlord to have it fixed, because “Hey, you’re the proud owner of this home as well as the mold!”
One of the biggest expenses renters avoid are repair and maintenance costs, that can be unpredictable and involve a ton of stress. From leaky pipes, heater troubles to mowing the lawn, you are the new caretaker of each department.
While repair costs can be random, there are also other recurring expenses. HOA fees can be one of these expenses, that will show up each month. These fees will also increase over time with inflation and must be accounted for before you make that big decision.
Did you forget Taxes? Of course you forgot them, because you never paid them when you were renting your 3 bedroom apartment. Real estate taxes are a hefty burden that can vary by location. The average effective tax rate in USA is 1.15%, which is equivalent to over $3,000 in property taxes each year for a home worth more than $300,000.
Renters end up paying a fixed rental amount and low insurance and utility costs each month as opposed to homeowners who are prone to variable costs.
Not much of a big deal you say? But wait …
2. Down Payment
A 20% down payment is the ideal amount expected when signing for a new home deal. Basically for a $200,000 home, a down payment of $40,000 would be required in order to avoid a PMI (Principal Mortgage Insurance) This is a huge amount resulting in reduced liquidity.
Investing $40,000 in an index fund can yield an average 10% market return each year thereby making your money work for you. However when you use this amount towards a home purchase, this money is not going to make you any return on investment for a long period of time.
Renters on the other hand only have to pay a refundable deposit at the beginning of a rental agreement along with an application fee. Would you agree renters have more liquidity allowing them to invest their savings in a wide variety of asset classes?
Still not convinced? Here comes the eye opener …
3. The Asset Fallacy
The notion of buying a home is considered an investment in a profitable ‘asset’. Let us explore this with a simple example. You purchased a $200,000 home with a 20% down payment and 4% interest rate, and you pay your mortgage payments regularly, slowly building “equity” in your home.
Over a period of 15 years, you will have paid over $53,000 in bank interest alone and totaling over $264,000, excluding any costs, fees or taxes over this period. To calculate your payments click here. During this entire period while you were diligently paying all the bills and keeping your home in the best shape, your asset was not making any money for you. This makes it a liability. The only time this home can be called an asset, is when you get a return on investment from its sale.
Did you research the home price appreciation in your area before making the purchase? Did you compute the expected price after 15 years? The expectation of most real estate owners is a price appreciation over time, thereby increasing the value of their assets. However, most homeowners tend to ignore studying the market before jumping into the pool.
Renters will certainly not own anything at the end of 15 years, but for smart frugal investors, safe investments can amount to high returns over this long period. Renters can opt to build a portfolio of varied assets during this time, not having to rely on the volatile real estate market alone.
Now that we have some of the financial differences between renting and owning out of the way, let us get into the personal and emotional aspect of it.
You may not consider the financial differences a deal breaker and still wish to purchase a home. Here are the things you must consider to avoid any regrets in the future:
1. Are You Emotionally Ready?
Ask yourself this question multiple times because like marriage, owning a home too is a long term commitment.
Are you happy with the city you live in ? Are you in a stable job or business and wish to continue over an extended period? Does the prospect of added responsibility bother you?
Your life will enter a new phase and understand these implications, and ascertain your emotional well being will not be compromised with this new beginning.
2. Are you Financially Ready?
Making a buy decision solely based on the equality between a monthly mortgage payment and rental payment, without establishing an emergency fund can lead to increased stress. Don’t go all in when making that down payment, in turn reducing your liquidity to nothing. Your emergency fund must be enough to cover any unexpected expenses such as healthcare, job loss, repairs or a sudden economic collapse.
Carefully evaluate your finances and make sure your financial stability is not at stake for making this decision. You may also wish to read 4 ways to harbor your wealth from the next Recession
The Bottom Line…
The decision to rent or own is a personal one and while renting can save a lot of money over time, some find comfort in living by tradition and owning a home. Evaluate the financial as well as emotional elements with this decision to secure a future that keeps you smiling 🙂
Be Frugal, Be Smart, Be Rich!