Conventional wisdom says that renting property is throwing your money away. This may be true in a sense, but homeowners are usually paying for the money they spend, right?
Some of our friends and neighbors are grappling with these decisions right now, and we wanted to offer a few thoughts.
The case for renting
One of the first things homeowners usually realize is that they pay plenty of bills that renters never worry about: property taxes, homeowner association fees, maintenance costs, and so on.
Then there is the matter of interest. Depending on the interest rate, an owner may wind up paying almost twice the value of their loan over the course of a 30-year mortgage. The interest is also frontloaded, so early payments are mostly applied to interest rather than equity.
An example may be instructive: if you take on a $200,000 mortgage at 5% interest, you would be looking at 360 monthly payments of $1,073.64—leaving you paying a total of $386,510.40 on your $200,000 loan.
Under typical amortization schedules, less than $250 of your first payments would be going towards your principal, so one could say that’s “throwing away” over $800 a month for the first few years on your mortgage payments alone. Between taxes, fees, and bills you might be out of pocket $300 to $500 or more on top of that before you even start to think about maintenance.
At this point the cost of renting suddenly does not seem so bad!
On the other hand…
Just like in traditional equity investing, however, time horizon matters. The upshot of taking on a mortgage when you’re ready is that if you are sticking it out, you will be losing less and less money to interest each month and accruing more and more equity.
It’s just that in the short run you may wind up “throwing away” more money buying than renting. You’re paying more for your home-owning money up front, so to speak.
Our example above is also a little conservative: with the Federal Reserve’s return to near-zero rates, many borrowers are going to be able to do a lot better than 5% interest. If you were so lucky as to cut your interest in half to 2.5% you would probably be losing far less money than you would if you were renting.
To buy or not to buy?
Even in making the case for each path, it’s hard to capture the full complexity. For instance, if the low rates get your heart racing, it’s worth remember that the low rates that create a good buying opportunity for you are also creating a good opportunity for everyone else, increasing competition and ultimately prices.
Each person’s situation will carry other factors that matter, too, and there’s no right answer that suits everyone.
It never hurts to keep an open mind when considering your housing options, though. While some people may be opposed to renting on principle, sometimes it just makes financial sense—and sometimes it does not. The important thing is to be willing to consider every angle.
Clients, if you would like to discuss how housing impacts your financial planning, please call or email us.
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