Making The Right DecisionSo you see the title and you already know where I'm going with this, but stay with me. Math doesn't lie and I want to help people make the right decision with regards to renting or owning. 2018 has seen many families hit the pause button on home buying. The passing of the new tax bill hasn't helped as it has made the tax benefits to owning a home not as clear cut a winner as it was before. However, let's take a closer look and make the assumption that you want to own at some point in the future and there aren’t any foreseeable barriers in doing so. We simply want to make the right decision.
Major considerations when choosing to Rent or Own
Even with some of the tax benefits off the table, there are still several other considerations that are often overlooked. Here are just a few.
Factor #1 - Return on Investment (ROI)
Not many consider this, but your down payment directly affects the rate of return on your new investment, especially on a home purchase. Obviously, when you rent, you have no return on investment. There is no ownership, therefore no investment nor return. When you buy, you use the down payment (that’s your initial investment) and when you sell, you will have cash on hand (that’s your return). Now consider you put down 3% on a $400,000 home. That’s a $12,000 initial investment. Assuming at the end of 5 years, you walk away with $73,000. That’s a 608% ROI, or more than 50% per year. Imagine now that you bought that same home using a down payment grant, i.e. you put ZERO money down. What’s the return on your investment? The return is incalculable since you had no initial investment! You earned the entire gain on sale with no money invested. Now, let's say you put down $100,000, what's my ROI? I'm not going to do the math, but I think you get my point. The more money you put down on a home, the lower your ROI! Money does not grow sitting in the equity of your home and it certainly doesn’t help your financial plan having money sitting in the bank of your landlord!
Consumer Tip: Increase your ROI! Put as little money down as possible that still gives you a comfortable monthly payment.
Factor #2 - Ownership and Appreciation
This is where the rubber meets the road. Homes normally increase in value, but recently after the financial crisis in 2007, we witnessed a devastating time for home prices. It was the largest measure of home depreciation we’ve seen since the Depression. The financial crisis, the meltdown… it was awful. People who purchased homes in 2005-2006 and after the bubble burst saw a slew of foreclosures, short sales, etc. with the primary reason being the absolute collapse in home values. People were mortgaging their way to financial freedom and then decided to “let go” when home prices crashed. Some foreclosures happened due to a real “life event” but most homeowners just “let it go.” They bought and bailed adding further to the depreciation slide of home values.
I mention all this to set the stage to the fact that we are now SO regulated (I should know!) that this sort of financial collapse has very little chance of happening again. I’ve been saying for years that we wouldn’t see bank lending rates very high due to the regulation of the banking industry in 1987 and that’s held firm. Since the financial reform of 2008 every facet of the dollar sign as it relates to the consumer is highly regulated.
So, home prices are going up. Here is a great resource from the National Association of Realtors. Find your market and you will see that home prices are going up. In some parts of the country, you’re seeing 5-6% and up. In my area, it’s about 4-5%. On a $400,000 home purchase, 4% means a $16,000 increase in the home value! Factoring appreciation as a buying decision is important.
Consumer Tip: If you own now, that means that you may expect your home to grow in value which builds equity. Owning a home has always been considered one of the best investments one can make.
Factor #3 - Remaining principal on the loan
One of the most overlooked items in the consideration of buying a home is the paying down of your mortgage. Your mortgage payment consists of Principal, Interest, Taxes and Insurance. That “principal” piece is the only good part of your payment! If you look at an amortization schedule for a 30-year loan, you will see that more gets applied to the “principal” portion every month! This simply pays down your loan balance. On loanDepot's mortgage calculators you can input a $400,000 home purchase, borrowing $388,000 at 4.125% interest, at the end of just one year the balance is lower by $6,686. It’s a forced saving plan.
In other words, when you own, you are putting part of that payment into YOUR pocket. When you rent, you are putting ALL the money into your LANDLORD’s pocket. Personally, I choose my pocket for my money.
Consumer Tip: If you would like to get an amortization schedule for your current loan and see where all the money is going, you can use my mortgage calculators here!
The Dangers Of Not Owning
Now that we’ve discussed some of the major considerations regarding the decision to rent or own, let’s discuss some of the dangers of not owning. These are the final 3 factors as to why buying is better than renting. Note that before you make the decision not to own, you have to be OK with the following.
Factor #4 - Higher monthly payments
If you choose to rent, you could just be paying more, especially when you factor in rising rents vs. a fixed mortgage payment. Figure out the total amount of payments over your expected tenure in the home. Total payments over a 3 year period should be well in favor or buying. See below as I have a spreadsheet that proves this.
Factor #5 - Loss of equity
Remember that when you pay rent you aren’t investing in yourself, but rather paying your landlord’s mortgage. Every payment made on a mortgage reduces the amount owed on the loan. So really, whose debt do you want to pay down – yours or your landlord’s? Or rather, who would you rather invest in? Yourself or someone else?
Factor #6 - The Cost of Waiting
There is a cost to waiting. It’s broken down into (3) main areas.
- The cost of appreciation. When a home appreciates, you earn equity if you are the owner. If you are sitting on the sideline and not the owner, all you can do is watch the home go up in price. Every month… tick, tick, tick… making the same home more and more expensive.
- The cost of higher interest rates. When rates go up, payments go up and the cost for the same investment goes up. If you wait, it’s rolling the dice on interest rates. If rates go up, this will result in higher payments.
- Loss of purchasing power. The combination of appreciation and higher interest rates are the perfect storm. If you wait to buy and we have the expected appreciation and higher rates, the same home you are looking at today is not only worth more, but will cost more. To keep your payments in line with what you are looking at today, you would have to purchase a cheaper home. The question is, what does that cheaper home look like to you today? Well, that’s the home you may have to settle for if you wait until next year or down the road. That or else higher home prices and higher interest rates will force you to push your budget more than you may be comfortable with.
What about military families?
Of course, many military families are in a unique position because they need to move often—on average, three times as often as non-military families. Although it can be hard to predict where your career will take you and when, how often you move can be a good indicator of whether you should rent or own.
If you expect to move in less than two years, renting is probably a good option for the time being, because it offers flexibility. If you are more settled and will likely stay put for three or more years, purchasing a home could be the right move given everything we've covered already.
Those are the 6 Factors that I believe prove buying smokes renting. Although I do think it’s the best decision in most cases, everyone is different. Request my full blown Rent vs Own spreadsheet to see the numbers for your situation. Renting may be a good option and we would be happy to discuss a scenario that is specific to you. The spreadsheet will break down all the numbers… the pros and the cons. You can reach out to me at www.loanwithrick.com or email me at firstname.lastname@example.org.