Living a rich life, with or without vast riches
To rent or to buy: That is the question.
At some time in your life, somebody probably told you that renting is like pouring money down a rat-hole. "You have nothing to show for it at the end of the day!" Of course, that's ridiculous. That rent gets you a roof over your head at the end of the day -- and at the beginning of the day and the middle of the day, for that matter. But what they're trying to say is that you don't build up equity in a rental, so you're arguably better off buying. Buying is a "good investment," these people contend. We'll get to the bad math required for this argument later. But, suffice it to say that buying a home is less like investing than it is like getting married. You do it because you want to -- because it appeals to you on an emotional level. You should know that getting in -- as every couple who has ever planned a wedding knows -- is expensive. Getting out can be even more so. Like marriage, it's tough to know at the outset whether it will be an economic boon or bust.
That said, if you're ready for the economic and emotional commitment
involved in buying a home, it can be a great way to spend your money and
time. If you're not, you'll find divorcing your house, like divorcing a spouse,
can gut your financial life.
So why am I so sure that a home isn't a great investment? Let's go through
Sad truth: Rent is almost always cheaper
A few years ago I wrote a column for CBS News called
detail just how bad you have to be at math -- or reality --
to make the argument that buying is a better investment
than renting. The full story is linked above and, if you're
considering buying a house, you really ought to read it.
But, I'll give you the summary version here: Renting is
cheaper, even when the cost of rent is slightly higher than
the cost of a mortgage.
Why? Let me count the ways.
But home is where the heart is....
By now, you're probably thinking, "Okay, killjoy. I want the house anyway. It's cool. I want to hang pictures and paint the walls whatever color I want; and plant in my yard and live there forever....Happily. Ever. After... Don't mess with my dream!"
Okay, then. Here's what you need to be in a position to buy.
Aren't homeowners better off in the end?
Some past studies have shown that people who owned homes
accumulated more wealth that people who rented. However,
that's probably not because they made a fortune on their home.
A home isn't a great investment. It's a great forced savings plan.
If renters were forced to sock an equally large portion of their
disposable income into, say, the stock market, they would probably
end up far wealthier than homeowners in the long run. But they're
not. So good number of them probably spent all or a portion of the
money that they didn't have to "invest" in their homes on things like
boats and vacations and dinners out. You would probably do things
like that too, if you weren't stuck under the sink fixing the plumbing.
(But, hey, you are getting good at it. It's a new skill that you wouldn't
have if you weren't a homeowner. There's always a bright side.)
Don't believe me? Let's run through the math. Let's say you bought the $200,000 home mentioned above; financed it at 4%; remained there for 30 years; and then sold the home for $600,000. You made a 300% profit, right? Not so fast.
After putting $40,000 down 30 years ago, you made 360 monthly payments of $763.86 each, or $274,991 total. Add that to the down payment and your total investment in the home is $314,991. Still, you say you almost doubled your money? Again, not quite. You also had to pay property tax, insurance and all of those home maintenance expenses that the renter didn't have.
But let's even set that aside and imagine, for example's sake, that a similarly situated renter paid almost exactly the same monthly payments as you, at least averaged out over time. Chances are, his payments started lower but he had to deal with rent increases over the years. We'll imagine that those rent increases added up to what you were paying in property taxes, insurance and repairs each year. (They probably were a lot less, but let's give the homeowner every advantage here.) Anyway, so now the only difference is the down payment difference. If this renter took the $38,000 difference between his rental deposit and your down payment, and invested that in a broad basket of stocks and bonds in a tax-favored retirement plan. Over the 30 year period he could reasonably expect to earn 9% on that money. He ends up with $559,762 -- a $521,762 profit compared to your profit of $285,009.
But what about the tax breaks?
In a higher interest rate environment, the tax breaks can be substantial. In today’s interest rate environment, the tax breaks really only help people with big mortgages. Again, it’s important to resort to a little math to illustrate. Let’s say you bought the $240,000 house with a $200,000 mortgage. Your monthly payments are $898. You get to deduct the interest portion of that payment, which you can find by using the handy “amortization schedule” at BankRate.com. On this loan, your annual interest payment adds to $7,511 in the first year. (The total will drop incrementally in subsequent years, so this is as good as your mortgage interest deduction is going to get.) You also get to deduct the amount you pay in property taxes, which we will estimate at 1.5% of your home’s value, or $3,600. Total home-related deductions: $11,111.
That’s good, right? Only if you’re single. The reason? The tax code already allows you to take a standard deduction. You only itemize deductions if your itemized deductions amount to more than the standard deduction. In 2016, the standard deduction for married couples is $12,600, according to the IRS. The standard deduction for a head-of-household – essentially a single person with a dependent – is $9,300; for singles without children, the standard deduction is $6,300.
So….If you’re married, your standard deduction is higher than your housing-related itemized deductions, so you get no tax benefit at all; if you’re a single parent, the itemized deductions exceed your standard deduction by $1,811. Assuming you pay 25% of your income in federal and state taxes, that saves you a whopping $453 annually. If you are single, assuming the 25% combined bracket, you save about $1,202 in tax.
So why buy?
So why would anyone buy a home? Because it's not about who
has the biggest pile of cash in the end. It's about who is living the
best life. Savvy money management is about using money as a tool
to get the things you want. If you want to settle down, you want
to plant in your own garden and paint your own walls -- even fix
your own plumbing -- awesome. Do it. Don't do it because you
imagine your home is going to be a wonderful investment. Do it
because it makes you happy. That's what your money is for.