Renting vs buying a home isn't just about the numbers
Should you rent or buy a home? What are the numbers behind the decision and which makes more sense?
In this video, I’ll show you those numbers but I’m also going to reveal two reasons why you need to ignore the numbers. I’ll show you how to make the decision based on your personal needs and what to consider.
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Is it Better to Rent or Buy a House?
We’re talking about one of the biggest financial decisions of your life today and as a real estate investor, one that I get a lot. Should you buy a home or is it smarter to rent and just invest the difference.
So as a big bow-tie nerd, you know I have to go into the numbers first, look at the pros and cons of buying vs renting but then I’m going to reveal two reasons why you might want to ignore the numbers.
I’m doing this video along with Kelly of Freedom in a Budget, a good friend of mine here on YouTube. I love the idea here. I’ll share my perspective in this video, why I think you should buy a home instead of rent, but Kelly is going to do her best to convince you otherwise. She makes some great points about renting so click through to the YouTube channel and check out her perspective.
Now you might expect as an investments guy, I’m going to say rent and invest the difference. In fact, I’m going to start by looking at those numbers, looking at your home as an investment and showing you why Kelly might be right.
Then we’ll get to those two reasons that have nothing to do with the numbers and everything to do with making the right decision.
Numbers Behind Renting vs Buying a Home
So I’ve put together the investment returns on buying a home and we’ll talk through this chart. Understand there are some assumptions here and home ownership is local so your returns might be different but I’ve used national averages to make these estimates.
First, the S&P CoreLogic Case-Shiller National Home Price Index shows an increase in home prices of 3.7% over the 30 years through 2017. That’s the pink bar here and about a percent over the annual rate of inflation over the period.
Now a lot of people like to say home prices don’t rise beyond inflation and they may be right for very short periods of time and in some places around the country but we see that overall, your home’s value does provide a positive return just on the price itself.
Back into the numbers and we can estimate about a 1.15% benefit from being able to deduct mortgage interest from your income taxes. That’s from the interest paid on the median loan amount of $200,000 and at a 4% interest rate.
Finally on the positive side, you save about 5% a year from not having to pay rent. That’s going to depend on your local housing market but it’s around the average home buyers save instead of renting.
Of course, there are extra costs for owning a home so we can’t ignore those. The national average for property taxes is 1.4% of the home’s value, so you’ll have to pay that. Estimates for maintenance and insurance average another 3.2% of a home’s value each year.
Take these positive returns against the costs and you get a return around 5.25% a year for owning your home. That’s going to vary a little depending on your taxes and local property prices but I feel confident in saying it’s going to range between 4.5% to 6.5% for most people.
Now if you consider the return on most investments, and here we’ve got research on 20-years of returns by JP Morgan, you see that almost all of these beat that home ownership return.
You’ve got an investment in real estate investment trusts, REITs, so investing in companies that own and manage commercial real estate, that’s produced nearly a 10% annual return over 20 years. Stocks have produced a 5.6% return and even a 60/40 split between stocks and bonds has produced a return about on par with home ownership but without the hassles of fixing your air conditioning when summer hits in Phoenix.
So just looking at these numbers, it seems like a no-brainer. Rent your home, save that $20,000 down payment and invest it to make the difference…
Reasons to Rent instead of Buying
But now I’m going to reveal those two reasons to ignore the numbers. Two reasons to make a financially-dumb decision and buy your home instead of renting.
Again, home buying is always going to be a personal decision so I want to cover a few reasons or circumstances why you might rent instead of buy. Then I’ll show you those two reasons that most people don’t think about and mean you want to consider buying even if it’s a terrible investment.
So if your job isn’t very secure or maybe if the city where you live has an unemployment rate that’s much higher than the national average, you might consider renting for that flexibility to pick up and move to where the jobs are.
According to the National Association of Realtors, it takes an average of 68 days to sell a house, and that’s in a pretty good market this year. When jobs get scarce and a recession hits, it can take years before you get out of your home and can take a job offer somewhere else.
Another reason to rent instead of buying could just be personal preference. Remember it takes about 10 years for the numbers to come out on home ownership so if you’re not ready to stay in one place for at least a decade, it might be better to forego those closing costs and fees of home buying.
Finally, if your credit score isn’t going to get you an affordable rate. So if you’re only getting mortgage rate offers that are a few percent above the advertised rates, maybe you want to consider renting while you increase your FICO and then get a cheaper loan.
Reasons to Buy a Home instead of Renting
Now it’s time for those two reasons that scream buy instead of renting, two practical reasons why I think home buying is best for most people.
First, that five and a quarter percent return we saw in the home ownership example, that’s a solid return and actually beats what the average investor makes in the market. Research is by DALBAR, which studies the actual returns investors make each year. We see that despite the stock market averaging a return of 7.4% annualized in the decade through 2013, the average investor earned just 2.6% a year on their money.
That’s not just cherry-picking a bad set of ten years. DALBAR updates this research regularly and the results are the same each time. The average investor earns between 3% to 5% a year on their investments, well below the return on stocks and even on safer bonds.
Why? Because investors are horrible at…well, investing! We make all the bad investing decisions like jumping in and out of hot stocks, panic-selling when prices fall and just everything else that eats away at returns.
The result is that 2.6% average annual return, far below what we would get on home ownership.
So yeah, that 5.25% percent return on buying a home might seem like a bum deal against a market posting higher returns, but many investors aren’t getting those sweet stock returns.
The other reason to consider buying versus renting goes to that idea of saving your money by renting and then investing it.
I had a Master Sergeant in the Marine Corps that liked to say, “Show me an income and I’ll show you how to live above it.”
It’s true isn’t it? It’s true whether you’re a grunt corporal making $2,300 a month or a Hollywood actor making $55 million per movie. We always find ways to live beyond our means, spend more than we have and then have to face the financial consequences.
People just don’t seem to be able to save. A Bankrate survey shows 57% of households don’t have enough savings to cover a $500 emergency expense.
So real life is that instead of taking the extra after paying rent to invest, most people are going to spend it on that mocha-coca-chino latte or on avocado toast.
But buying a home is a forced-savings plan. You don’t have the excruciating decision of whether to buy those new iPhone ear buds or invest the money, you’ve got a mortgage payment that forces you to save.
Think about it this way. Buying a $200,000 home with a $20,000 down-payment and financing at 4% a year over 30 years means a payment around $860 a month. Within ten years, your homes value will have increased to approximately $288,000 and you’ll have paid the loan down to $142,000 with regular payments.
That’s $146,000 in equity, nearly a hundred and fifty grand you’ve saved. Considering the average American household has just over $200,000 saved for retirement, I’d say buying a home is a pretty good start and a darn good financial decision.
The numbers may not come out exactly on the buy vs rent a home decision but sometimes you have to ignore the numbers. Take it from a numbers nerd, sometimes you have to go with the decision that's right for you, right for your heart and not your head.