Real Estate 101 – Renting vs. Owning
One of the common themes that get kicked around the financial blogosphere is the debate between buying and renting a place to live. Recently, there has been a rash of posts depicting the horrors of home ownership, warning others to avoid it like the plague. But, is this seasoned advice from people who understand the housing market? Or, is it bitter criticism from people who made an untimely investment? The truth is probably a little of both.
This is the first in a series of four posts on real estate.
Real Estate 101 – Renting vs. Owning
Real Estate 101 – Market Dynamics
Real Estate 101 – Purchase and Finance
Real Estate 101 – Investment Property
Disclaimer: I’m not a licensed broker or a real estate professional and laws change and vary by state. Before making any decision about buying a house, you should be aware of the laws or consult with a licensed professional.
How you Live is a Personal Choice
The decision to rent or buy is often based on personal reasons that favor one approach over the other. I never make blanket recommendations that people should rent or buy, because everyone’s situation is different. In life, most important decisions are made with the heart, not the wallet.
I’m a middle-aged guy, with a family and a stable career. I love where I live and have no intention of moving. So, buying a house was an easy choice for me. My brother owns a house down the street and the rest of our family lives within a short drive. My wife has pets, chickens, tropical plants and a vegetable garden. I have motorcycles, trailers, a truck and I want a motor home. We love our property and could never go back to renting.
On the other hand, I have friends who are happy renters. One is single and he often relocates for work. He is close to retirement age and most of his money is tied up in retirement accounts. It would be foolish to raise his cost of living and undertake a mortgage at this point in his life. Others I know have recently lost their houses and they no longer want the crushing pressure of debt.
Common Myths & Misconceptions
“I save a lot of money by renting.”
Unfortunately, it’s not that simple. The cost of a fixed mortgage stays the same, while the cost of rent continuously goes up. When I bought my house 15 years ago, my neighbors thought we were nuts to pay $500 more per month to buy, instead of renting. Now, they pay more to rent their apartment than the mortgage payment on our house. After our house is paid off, they will be paying a lot more than us. We are headed into an inflationary environment, which heavily favors owners over renters.
“When you rent, you are throwing money away.”
Shelter is a commodity, just like copper, oil or soybeans. Whether you rent or buy, you have to pay for shelter. For some people, it’s much more practical and efficient to rent. For others, buying is the only way to go. I don’t regret all of the money I paid out for the 13 years I rented. I was young and lived right on the beach. I wasn’t ready for the responsibility of a mortgage. My income wasn’t high enough to afford a house. So, I saved up money for when the time was right to buy. And, I never looked back with remorse.
“You should buy a house for the tax deduction”.
The mortgage interest deduction is a terrible reason to buy a house. In my opinion, it’s more of a scam than a benefit. This tax break is widely publicized by the mortgage and real estate industries. But, unless you pay a lot of interest, it doesn’t add up. The standard deduction is so high now it’s harder to itemize taxes. Even if someone can write off part of the interest, it’s like giving the bank a dollar to get a dime back in taxes.
Disclaimer: I’m not a tax professional and the tax laws change and vary by state. Before making any financial decision for tax purposes, you should consult with a licensed tax professional.
Who is a Candidate to Buy or Rent?
There are dozens of complex issues surrounding the decision to rent or buy. But, the decision can be simplified by using a few basic criteria that make the choice seem obvious. Which of these conditions apply to you?
Better Off Renting
- Have limited or sporadic income or employment
- Desire the freedom to move, travel or relocate
- Don’t want the expense or hassle of maintenance
- Don’t have many pets or need a lot of storage space
- Don’t have or want to invest a down payment
- Want to live in an area where you can’t afford to own
Potential Owners
- Plan to live in one place for many years
- Have a stable income and predictable expenses
- Have money put aside for a down payment
- Want the freedom to customize their surroundings
- Can absorb the cost of taxes and maintenance
- Want more control over their lifestyle decisions
Looking into the Future
In the short-term, renting has a lot of financial advantages over buying.
- Lower initial cost per month
- No down-payment required
- No property taxes or maintenance costs
- It’s cheaper to move, without selling a house
- Never owe more than a house is worth
In the long-term, the financial advantages shift toward ownership.
- The payment on a fixed mortgage never goes up
- It’s very cheap to live, after the mortgages is paid off
- Housing values usually rise with wages and inflation
- Owners can sell or downsize with tax advantages
- A property can be rented or mortgaged for income
- Owners can retire with predictable housing costs
The Bottom Line
The bottom line is that life is a series of trade-offs. Renting and owning both have their fair share. The decision to rent or buy has a lot more to do with a person’s goals and desires than with the math involved.
“The most critical factor subduing the demand for housing is that home ownership is no longer seen as the great, long-term buildup in equity value it once was.”
Mort Zuckerman – Real Estate Billionaire
Recommended Reading
Funny About Money – Real Estate: Catastrophic
Little House in the Valley – How Much will three Times my Income get Me?
Financial Samurai – Why I won’t Pay Off my Mortgage Until I Retire
This post was featured on the Carnival of Personal Finance over at Upside of Money. This is the Greatest Carnival on the Net. Check it out.
You make great points. I agree most home buying decisions are heart and not head directed.
The trend is toward smaller houses, and the glut of McMansions that will be on the market as us boomers start to retire is going to keep prices down.
I’m glad to see people moving away from the McMansions and the conspicuous consumption lifestyle. I love having a cheap gas and electical bill every month. I can’t imagine heating a bunch of rooms I rarely use and the expense of furnishing them.
Whenever I ponder this subject, it always makes me think of Al Gore and his 20,000 sf house. Carbon neutral, what a crock!
If you had posted this five years ago, you’d have been pilloried by a lot of people. Prior to the last real estate run-up it seemed as if most everybody was on the BUY bandwagon simply because owning was a “no-brainer investment.”
Of course, they were wrong on both counts. It was neither a no-brainer or an investment (My take is a home is a home – period!)
It’s always good to see both sides of the coin.
All the best,
Len
Len Penzo dot Com
Len,
You and I have been watching the California real estate boom and bust every decade since the ’70s. What’s amazing to me is how many people were blind-sided by it this time. The housing mania was so obvious that even Greenspan was warning against it.
As for presenting both sides of the coin, it’s something I believe in strongly. People who think in absolutes are often absolutely wrong.
My wife and I are currently in no place to buy a home. We would be stupid to think that we could tackle a mortgage at this point in our lives. We want to get rid of all debt, and then save up a down payment before we even consider buying a home. We want to find a house that we can live in for a long time and we are no rush to find it yet. Thanks for the great advice.
Matt,
I have three pieces of advice for you:
1. Save Money
2. Save Money
3. Save Money
I did a lot of stupid things when I was 21 years old. (Hey it WAS the ’80s.) But, the one smart thing I did was to start saving for a house. It paid off huge, because I was able to buy my house for a song within one month of the market low in 1996.
I believe we may still have a couple more years to go before housing prices hit bottom. And, if you have good credit, low debt and a down-payment, you will be in the driver’s seat.
I know you strongly want to get rid of your debt, but I recommend the 10-20-70 plan. Save 10%, pay 20% to debt and live on 70%. The percentages don’t matter. What is important is to save AND pay down debt.
You can search for the post on my site that explains the reasons to do both. Or, you can read about it in The Richest Man in Babylon.
Hi Bret, I think it’s a mistake to insist one solution fits all as you point out. I am very happy to have sold my house in early 2006 and rented. I’ve missed out on my home falling in value plus all the maintenance costs. I also don’t know that I will stay in Dallas long term so I don’t want to make a long term commitment, especially in this market.
As far as inflation goes, it’s hard to say that it will definitively help owners. If you lock in a low rate now and stay in your house for a couple of decades then I agree. However, if we go to hyperinflation, the Weimar Republic experience argues that landlords suffered. They could not inflate rents fast enough to keep up with currency debasement. Supply of housing also went up as people became homeless or took in multiple boarders to avoid sleeping on the street themselves.
Jennifer,
You are the only one I know who sold a house near the peak and started renting. Most of the people I know were convinced it was going to keep going up. I told a real estate agent I thought the home values were going to drop 30% and she looked at me like I had lost my mind. Then, it happened.
As for inflation, I was thinking more along the lines of the late 70s and early 80s, when mortgage rates shot up near 20%. I remember my parent’s house payment being $150 for a four bedroom house in So. Cal. They had a 5% fixed rate mortgage and they weren’t stessing about the inflation. Renters, on the other hand, were seeing double-digit rent increases for a couple of years in a row.
Bret
Hi Bret,
Great post. Happy to see that you are exposing the scam of the “mortgage interest tax deduction!” I would rather keep the whole dollar than pay a dollar and get back 25 cents.
I totally agree that it depends on your personality and situation. Most people are dependent on getting a job. Job don’t last forever. Usually they only last a few years. So what happens when the job ends? Are you going to join the millions of people who commute for hours each day and hate their life? Are you going to move to another city for a new job?
People think that they are going to keep their house and their mortgage forever. But times change. Finances change. Relationships change. Even our desire to keep doing the same thing each day changes. And, now technology is driving change faster than ever. The average mortgage only lasts 5 years. And that figure is going down.
Moving is expensive. Selling an house and buying a new one is incredibly expensive. Over 7% of the cost of the house. For a $200,000 house, that is $14,000. Most people could rent for a year or two for that much.
Another issue is mortgage interest. Most people refinance periodically and never pay off their mortgage. The payments only go up! Just like rent. I think it is silly to buy something and pay for it over 20 or 30 years. And even worse to never pay it off. I think that if you can’t pay it off in 5 years, then you can’t afford it.
Ultimately it is important to really think about your personality, desires and future. Like you said, it is all about stability. If nothing is likely to change for the next 10 years then it might be a good idea to get a house. Otherwise, maybe it’s not such a great idea.
George
George,
Thanks for your insight on the issue of moving.
I’m very fortunate that I live half way between two metro areas that provide a lot of tech jobs and are each a half hour commute (Irvine & Carlsbad, CA). Even luckier, I finally found a job in San Clemente and have a 3 mile commute right now. I believe this is one of the reasons the O.C. is so expensive to live and housing hasn’t taken as big of a hit. Houses are way cheaper elsewhere, but then you have a 90 minute commute.
People in many areas of the country aren’t so lucky with employment opporuntities and that is going to keep housing prices low in those areas, well into the future.
From what I read, the average person keeps a house for around 8 years, even though they keep a mortgage for five. I think both are way too short. I have been in my house for 15 years, with the original mortgage. I would do fine if I needed to sell. Instead, I plan to have it paid off in 5-6 years and stay in the house for a long time.
There are obvious reasons why some people are forced to sell or the neighborhood goes bad and that is unfortunate. But, I believe others move or refi too frequently, without considering the consequences. If someone’s house is mortgaged continuously, there is no advantage over renting. Paying it off should always be the end-game.
Bret
I guess it depends on how a person wants to live. I think George said it best when he related that people think that they are going to keep their house and their mortgage forever. But times change. Finances change. Relationships change. Even our desire to keep doing the same thing each day changes. And, now technology is driving change faster than ever. The average mortgage only lasts 5 years. And that figure is going down. Well said, brother!
Thanks for stopping by Hans.
I’m a little different than most people, especially in California. I’ve only had three addresses and two phone numbers my whole life. Twenty years from now, I will most likely have the same address and phone number. But, that’s just me. Everyone is different.
For people like me, buying a house makes all of the sense in the world. For those who crave change and excitement, it costs way too much to buy and sell homes frequently. They are better off renting.
It’s hard to know if someone is going to get laid off, transferred or divorced. There aren’t any certainties in life, except for death and taxes. I believe people should go for it, instead of worrying about what could go wrong. If it doesn’t work out, at least you took a shot. Then, you adjust to the changes.
I think you get to actually save when you buy than you rent the place. Buying is investing on assets which are valuable in the future. Renting is just like throwing away money into the trash. Yes, it’s spending money on something temporary. We got to think of the biggger picture.
I agree, except that owning is only better when you stay in a house longer than 5-10 years. People who move frequently are much better off renting.