To Rent or Buy?

Many people in their twenties are renting, including Jenn and me.

The traditional American culture says that you grow up, graduate from college, get married, buy a house, have some kids and then retire. While I have a lot to say about all of those things, I'm going to just comment on the "buying a house" part.

Common House buying advocates cite the following as great reasons to buy a home:

• Tax Deductions
• Pay yourself instead of paying your landlord
• Build equity (good long term investment)

What I want to do is just compare renting vs. buying for a married twenty-something who might move in say 5 years. You'll see ads for, "Own for what you're paying in rent!"

I'm going to have a quick little table on a 30 year fixed mortgage for a $200,000 home. This might be a 2 or 3 bedroom single family home with 1 1/2 or 2 baths in some parts of DuPage county (Carol Stream, Lombard, Glendale Heights) where I live. I'm not say that this is your price range or mine, but it's a nice round number and something we can use for a conversation.

Step One is that you're now borrowing money from the bank. Let's assume you're a good little saver and you put 10% or $20,000 down. Good for you! Now you'll need a loan for $180,000. Fortuantely, you have good credit, because you're not only a saver, you're good at paying off credit cards on time. You have some student debt, but hey, you're 20ish.

A $180,000 loan would make the principle plus interest equal to roughly $1,080 a month with a 6.25% loan and no points.
"$1108a month! Wow, that's not much more than my rent, might even be less than rent! Where do I sign?"

Not so fast my entitled American peer! You have to pay property taxes too. I know you knew that. Buy how much can that be? Quite a bit! I looked around DuPage county and found most $200,000 homes have about $4,800 a year in property taxes. This varies widely from place to place, but in the near Chicago suburbs, this is going to be within 20% of what you're going to pay. This nicely rounds up our total mortgage payment at this point to about ($1108 + $400) $1,508 a month.

But of course, you knew about the property taxes, and this isn't a shocker for you.

Where do I sign? Give me the loan!

Step one is to sign your checkbook for a separate check to the bank for closing costs, not just the down payment. I'm not talking about buying points (prepaid interest) I'm talk about costs like:

• Lender Feeds
• Appraisals
• Title Insurance
• Tax Services Fee
• Courier Fees
• Flood Check Fee
• Closing/Escrow
• Recording

Countrywide.com estimates a $200,000 home with 10% down in 60187 zip code would have closing costs in the $2,400 range. That's ZERO points. Just the "cost of doing business."

After you cut that check, you'll find out that since you didn't put a down payment of 20%, you'll have to pay for mortgage insurance, about $90 a month. (On top of the $1508 for principle and interest and property taxes.)

So now we're at the point where you can own your own home for the low low price of just $1598 a month. You're paying yourself, not your landlord, you have a nice fat tax deduction and your house is appreciating. You're sitting pretty!

Many calculators assume that you spend roughly 1% of your houses value on maintenance costs each year. This includes things like maintaining appliances (refrigerator, air condition, furnace, hot water heater, garage door, etc) and general maintenance on items like the roof, windows, screen doors, door knobs, the driveway, flowers and landscaping and chores like mowing the lawn, clearing snow in the winter, salting your walkways, etc. On a $200,000 home that's $2,000 a year. It might seem a little high, but I'd imagine it's close.

So let's take a look at this sort of thing and assume average house price increases, property tax increases and other elements of inflation, all 3%. Contrary to popular belief, property taxes do rise, so your mortgage does too. Depending where you live, property taxes could raise quite rapidly if you're in a still-developing suburb in the far west Chicago burbs.

Year	Home Value	Mortgage Payment	Maintenance Costs	Principle	Interest	Mortgage Insurance	Taxes	Total Deductions	Standard Deduction	Difference	Tax Back
1	$200,000	$1,598	$(2,000)	$2,109	$11,190	$1,080	$4,800	$17,070	$10,900	$6,170	$1,543
2	$206,000	$1,610	$(2,060)	$2,245	$11,055	$1,080	$4,944	$17,079	$11,100	$5,979	$1,495
3	$212,180	$1,623	$(2,122)	$2,389	$10,910	$1,080	$5,092	$17,083	$11,300	$5,783	$1,446
4	$218,545	$1,635	$(2,185)	$2,543	$10,757	$1,080	$5,245	$17,082	$11,500	$5,582	$1,395
5	$225,102	$1,648	$(2,251)	$2,707	$10,593	$1,080	$5,402	$17,075	$11,700	$5,375	$1,344
Total			$(10,618)	$11,993	$54,504	$5,400	$25,484	$85,388			$7,222

The other funny thing is that the "great taxes breaks" people talk about aren't as neat as they first sound. Sure you can deduct property taxes, mortgage interest and even mortgage insurance from your taxes, but then the standard $10,900 tax deduction goes away that you've been getting all along, so you're only deducting the difference. In our first year example, the deduction difference is $6,170 dollars! However, it's a tax deduction, not a tax credit, so you're only getting back an amount equal to your tax bracket. If you earn between about $35,000 and $70,000 a year, that's just 25%. If you earn over $70,000 a year, the next tax bracket is only 28%

So what is this telling us?

If we were to sell this house after 5 years for $225,102, subtract 6% that goes to the buyers and seller agents ($13,506) add in the tax benefits ($7,222) and principle that I paid ($11,993) and subtract out my remaining loan amount ($168,007), I have...

$33,109
Whoo hoo!

In 5 years I am sitting on $33,109 dollars! Unfortunately, if you were paying attention, you should be very, very alarmed. You actually started with $20,000 for that down payment, and $2,400 for the closing costs, and you put in $10,618 of maintenance.

Total Costs of Ownership:
$20,000 + $10,618 + $2,400 = $33,018

So the last step: $33,109 - $33,018 = $91.

So your "investment" after 5 years yielded you $91. I won't bother with the math, the rate of return is basically 0%.

Sitting in a passive savings account at 3% interest would have turned that $20,000 into $23,185.
If you had been able to rent and save just $300 a month over those 5 years ($1,300 gets you a pretty nice place!) You'd be sitting on an extra $4,173 if you just put that savings in a passive 3% yield savings account. Total extra cash after 5 years: $23,185 + 4,173 = $27,348.

Renting implies I earned $7,348, while owning means I made $91. While I was renting I had more cash flow and more liquid assets, cash just in my savings account, ready for an emergency. At best, the homeowner has a home equity loan where they can borrow and pay interest on their money.

Now you can argue that you won't spend $10,618 on maintenance over 5 years - this is quite possible, but we must agree you are spending more than $0. Think about it - you move into a house and you decide you want to upgrade a few things, maybe replace an appliance or two, fix a leaky roof, waterproof the basement, the furnace goes out, neighbor kid breaks a window, etc. These are things that have real costs associated with them. Mowing your lawn isn't expensive per say, but do you own a lawnmower? You'll need to buy one if you don't.

That's all I have for this post for now.... comments welcome!