Buying Vs. Renting (A Home Buyer’s Guide, Part 1)
A Home Buyer’s Guide
There’s a lot of advice out there about buying homes and getting mortgages. Some of it is good and some of it is deeply flawed. In this guide, our focus is on how to buy a house that helps you build long-term wealth, not to provide detailed real estate advice.
Renting vs. Buying
In most cases, it makes more economic sense to be a homeowner in the long run. Studies and census bureau reports reveal that home buyers are better off than renters, with average net worths many times higher than renters. Information from the Federal Reserve indicates that home owners have net worths that average 36 times higher than renters.
While you can argue that wealthier people are more likely to own homes, the data also shows that when other factors are the considered – such as income, age, race, location, almost nothing raises a person’s level of wealth more than home ownership! Most people cannot afford to purchase a home free-and-clear, and even if they can, it may not be the best decision. Yet by simply making mortgage payments over the term of a mortgage, a home buyer ends up with a valuable asset they can leverage for other investments, rent out for cash flow, or sell for cash.
Homeowners are consistently wealthier than renters – even with mortgages and home maintenance to worry about – because of one simple fact: it’s difficult to build wealth when throwing money down “the rent drain.” And just as the homeowner’s house tends to appreciates over time along with inflation, so does the renter’s rent. Using an appreciation rate of 4%, we see that the rent would increase a surprising 42% in just a decade – from $1,000 to a payment of $1,423 per month:
10 years of renting at 4% inflation:
What about 30 years of renting? Your $1,000 rent payment will more than TRIPLE to a whopping $3,119! Sound unrealistic? From Portland, Oregon to Portland, Maine, cities are reporting rents increasing at least this quickly. See now the payment climbs over the next 20 years at the same 4% inflation:
As expensive as renting can be, when a potential home buyer sees the “TIL,” or Truth-in-Lending Disclosure, it can be a shock. The TIL details how much they’ll pay for the home over time. This number can seem enormous to buyers, creating anxiety and even cold feet when it comes to signing the escrow papers. And yet, to put the TIL in perspective, a buyer must consider how much RENT they are expected to pay in the next 30 years… and what they’ll end up with.
Taking the rental example above further, if we begin with a $1,000/month rent that increases 4% each year, the renter will wind up spending $673,019 – with absolutely nothing to show for all of their payments.
So if it will cost $673,019 to rent a home for 30 years, what will it cost to buy the home?
A home buyer who makes the leap from renting a home for $1,000/month to purchasing a home for $200k at a 5% interest rate will see on their Truth in Lending Statement that their mortgage loan will actually cost them $386,512 in principle and interest. Plus, they’ll have additional costs such as insurance and oftentimes mortgage insurance worked in to the payment.
As rents creep up with inflation, the principle and interest portion of the homeowner’s payment stays the same. After about 10 years, our renter is likely paying just as much as or more than our homeowner… without building equity!
In summary, renting a home beginning at $1,000 a month could cost as much as $673,019 over 30 years. At the end of 30 years, the landlord has a paid-off home and the renter has nothing.
In contrast, a homeowner might have paid approximately $622,067 – that’s $386,510 in principle and interest, as shown above, plus an additional estimated $235,557 in property taxes, insurance and maintenance (assuming our starting figure of $350 and accounting for 4% inflation each year.)
Not only does the homeowner pay nearly $51k LESS than the renter over time (because the principle and interest payment remain unchanged while the renter’s entire payment will keep inflating) but they own their home at the end of 30 years! At 4% appreciation, a $200k home would be worth an approximate $662,700 30 years later. The homeowner in our example comes out ahead of the renter by a whopping $715,652.
Becoming a homeowner saves you from paying rent for decades and having nothing to show for it. It gives you a chance to keep your housing dollars in your personal economy rather than transferring them to your landlord’s personal economy. And it allows you to purchase, over time, a significant asset.
Even better, as a home gains equity through either appreciation or the paying down of a mortgage, you’ll find yourself with greater options for the future. You’ll no longer be at the mercy of landlords. And you’ll have greater options for the future, such as:
- leveraging your equity to purchase a second property;
- improving your property to increase its value;
- renting out your home (or a portion of it);
- paying off your mortgage completely;
- taking a reverse mortgage;
- selling the home for a nice tax-advantaged profit. (The first $250k, or $500k for couples, is income-tax-free if you have lived in the home for 2 of the last 5 years, according to current tax laws.)