Revealing the Dark Side of Homeownership: Why Buying a House Might Ruin Your Finances
Just a few days back, I was talking with my friend who kept trying to convince me that renting is an absolute waste of money.
According to him, you are basically burning money if you decide to rent.
You would be paying the rent every month to the landlord, which would be used to pay the landlord’s mortgage.
Why would anyone begin to do that rather than taking a mortgage and outright owning a home even if it means waiting for 30 years.
Honestly though, I can’t wrap my head around how flawed this logic is, even if you assume that renting is really cheaper in the long run, spoiler alert, it might not be!
When you rent, you are not wasting money, you see, you are getting a service in return.
As an example, when you call for an Uber, you don’t get the car, nor are you getting the driver, and neither are you getting the company itself.
What you would be getting is a service, the Uber is going to take you from your office to the mall, which is the whole purpose of the car.
Purpose Of Renting
Same thing goes for renting, the point here is to have a place to stay, not to own the house.
But you would always need a place to stay in for your entire life, which is why many people automatically think of renting as wasting money, especially when the alternative is to buy a house and own it for the same amount of money.
And that’s when the misconception starts.
Oftentimes, people don’t compare apples to apples when it comes to the cost between buying a house and renting one.
What they do is they will just take the usual price tag of buying a house and compare it directly to the cost of the rental.
In this article, we’re gonna break down a fair view between renting and buying a house.
And how you can potentially end up with several hundred thousand more if you rent a house compared to buying one.
Cost Of Buying vs Renting
First things first, let’s make it clear that whenever I talk about buying a house in this article, I am not talking about buying a house to invest in as a real estate investor, what I am referring to is buying a house as a primary residence, or as a place to live in.
So let’s say my friend that I mentioned earlier decides to buy a house because renting is burning money according to him.
Let’s compare his net worth with another person who decides to rent 30 years later assuming everything else is constant.
As an example, the house we are talking about is valued at $300,000 dollars and it can be rented for around $1,800.
So if you take a 30-year mortgage, assuming the interest is around 4.5 percent, your total monthly payment would be roughly $1,216.
This is your total amount which includes the principal plus the interest.
If you only look at a surface level based on these 2 figures, then a mortgage is clearly cheaper.
However, that is not the whole story, as there are other expenses not being accounted for yet.
If insurance and property taxes are factored in, then the cost of buying would increase from $1,216 to $1,707.
At this point, buying is catching up to the cost of renting, but buying is still cheaper.
Cost Of Upkeep For A House
However we are not quite done just yet, the other expenses to be included would be the cost of upkeep for a house.
These costs would include the repairs and maintenance of the home, which would usually be taken care of by the landlord or the homeowner.
Depending on the age of the property, the rule of thumb is to budget for 1% of the property’s value each and every year to go towards repair and maintenance.
Now obviously this depends on the location of the property and it doesn’t apply to high cost of living areas where most of the property’s value is tied up in the land’s value and not the home value itself.
Regardless, maintaining a house can be extremely expensive, sometimes even more so when compared to the property’s value, since we are talking about a long time frame of 30 years.
The land under your feet might appreciate, but everything else starts losing value.
The kitchen might need to be replaced every 10, 15, or 20 years.
Every piece of furniture has an expiration date; that couch, let’s face it, it’s not gonna last for 30 years.
You gotta change the roof every 10 or 15 years.
And the bathroom needs to be replaced every X number of years or so.
So, if you ever owned a house, you know that maintaining a house is not cheap!
On the flip side, you won’t have to bear any of these expenses when you rent as I said previously.
Although we budgeted the cost of maintenance to be 1% of the property’s value, let’s just assume a higher value to be safe at 2.5%.
This would equate to a monthly maintenance cost of $625 dollars averaged out over the course of 30 years.
This brings the total cost of ownership up to $2,332 a month while renting is still $1,800.
Cost Of Buying vs Renting (Continued)
Even though buying has a slight premium over renting, it still seems like a better choice.
And that’s because at the end of the 30 years, you would end up with a house under your name that is fully paid for, while the person who’s renting all this while would have nothing.
But is that really true?
Let’s run the numbers and take a closer look.
Assuming your house appreciates by 3% a year, the future value of the house would be $728,179 at the end of the 30 years.
This is a safe estimate as anything higher would not be realistic.
Now here’s what most people would miss, the opportunity cost.
People just don’t think about this when they buy a home, how much is your down payment worth to you if you just invested it instead?
If you put a 20% down payment on your house, which is $60,000 dollars in this case.
This money could have been invested in the stock market, or used as startup capital for your business venture.
The thing about buying a home is from a financial standpoint, having all your money tied up in a home isn’t usually the most profitable thing to do.
Let’s illustrate how this can happen if you had taken the money and invested it in the stock market instead.
And since we are talking about a period of 30 years, it’s fair to say that we can expect at least an 8% annual return, since the S&P 500 has returned 10% over the long-run.
Your monthly mortgage payment is $2,332, but renting a similar house is $1,800, so there is an opportunity cost of $532 every month.
So if you invest the difference as well, this would be an upfront investment of $60,000 which is the down payment and monthly contributions of $532 a month.
With the power of compound interest, this would grow to a value of $1,326,959.43 assuming the 8% annual return over 30 years.
That is a huge difference, if you chose to buy the house, your house would be worth $728k dollars, but if you chose to rent and invest the difference, you would end up with a sizable portfolio of $1.3 million dollars, which is almost double.
So which would you personally prefer?
The $1.3 million dollars worth of liquid assets or the house valued up to $728k dollars?
Things become very different when you look at it from this perspective.
Other Factors To Consider
However, even this is still not the most accurate numbers you can get, some things that we didn’t look at is maybe a 3% rent increase annually, and the same applies to the cost of your repairs and maintenance as inflation does its magic.
Buying a home can also bring you some interest deduction which you otherwise wouldn’t have enjoyed.
If we look at personal factors, one can be frugal with their house and spend less than 1% of the property’s value on maintenance cost each year.
Or let’s say you have a renovation expense coming up, and you didn’t have enough of a cash buffer to pay for it, so you put it on your credit card, for example, and pay a huge interest on top of the actual payment itself.
There are so many moving parts but the point is, buying a home isn’t always the best investment and renting isn’t always a waste of money because it gives you an opportunity to invest elsewhere, especially if you are planning to live there for just a few years, since the cost of selling that property and getting a new one would easily make it even more expensive.
Now none of this video is meant to dissuade you from buying real estate, because long-term owning a home could end up making you a significant amount of money, not to mention the psychological benefits and peace of mind that you get from having total control over where you live, but it is meant to get you thinking why you were buying in the first place and to get you to think about running the numbers beforehand to make sure it's really the right choice for you.
The idea that renting is just throwing your money away is complete nonsense.
And depending on the situation and how long you plan to be there for, renting could just be the smartest financial move you make.
All of that really just comes down to determining the true cost of ownership for all the things you didn't think about and then running the numbers to see which would be the best choice for you.
- Ivan