Renting vs Buying

5 reasons homeownership trumps renting

NEW YORK – Aug. 31, 2010 – The seemingly endless run of bad housing news is discouraging some potential homebuyers from considering a purchase. But the truth is that the advantages of homeownership have very little to do with investment gains, and a lot to do with personal comfort and satisfaction.

Here are five of them:

• Be your own landlord. The bank can only kick you out if you don’t pay; a landlord can be much less dependable – deciding to sell the property or choosing to live there themselves.

• Paying the principal is forced savings. Yes, it’s possible that home prices will fall further. It is also possible that your 401(k) will lose value. But over the long haul, both are likely to enjoy modest gains in value.

• Fixed-rate mortgages never rise – and eventually you pay them off. With mortgage rates at record lows, people who buy now are locking in real bargains.

• Good schools. Family-sized rentals are harder to come by in areas with excellent public schools.

• Spacious properties in pleasant neighborhoods. Sizable homes in attractive communities are almost always owned – not rented.

Source: The New York Times, Ron Lieber (08/27/2010)

Does buying a home always beat renting?

The tax breaks aren’t what they used to be, and price appreciation is never assured. But if you’re in it for the long haul, homeownership is usually lucrative. Here’s how to find the right answer for you.

By Liz Pulliam Weston

President Bush’s 2003 tax cuts did more than put some money back in people’s wallets. For lots of folks, it also reduced -- and in some cases, eliminated -- the tax benefit they got from owning a home.

That certainly wasn’t the intent of the legislation. But by lowering tax brackets and, more importantly, boosting the standard deduction for married couples filing jointly, it certainly was the result.

That shouldn’t cause you to shelve your plans to buy a house. The tax benefits to home ownership have long been exaggerated.

The big benefits of home ownership

Fortunately, there are a lot of other good reasons to own a home. One of the best, financially speaking: the chance to benefit from appreciation as the value of your home (one would hope) rises through the years. In fact, if you’re like most people, buying a home can be the smartest financial decision you’ll ever make.

Average Net Worth of Homeowners vs. Renters

Source: VIP Forum, Federal Reserve Board

Homes create wealth in two ways.

First, most mortgages require you to pay down your balance over time, creating a form of “forced savings.” Even if your home never appreciates at all, you gradually build up more equity over time with your payments.

Of course, houses typically do appreciate, averaging 6% a year over the past 30 years, according to the National Association of Realtors. And thanks to your mortgage, you get to take advantage of that appreciation using leverage. That means using a little of your own money, plus a lot of someone else’s money (in this case, the mortgage lender’s) to make even more money.

How your mortgage helps you build wealth

Here’s how it works. Say your $170,000 home appreciates at that 6% annual rate. In 10 years, your house would be worth more than $304,000. That means your down payment -- $17,000 -- would have grown to equity that equals $151,000. (We’ll leave out the growth in equity that came from paying down your mortgage, since that money actually came out of your pocket.) The growth in your home’s value represents a return of 24% a year on your original investment.

Even if you subtract maintenance costs of 1% or 2% of the home’s value each year and throw in another 1% for higher insurance and utility bills, you’re still looking at a return of more than 16% a year.

But this calculation also comes with caveats:

    • House hoppers won’t get all of the benefit. Every time you change homes, you lose about 10% of the value to selling and moving costs.

    • Out-of-control spenders can still lose. If you drain off every dollar in appreciation through home equity loans and lines of credit, you aren’t building wealth -- you’re destroying it.

    • Home prices don’t always appreciate. Sometimes they plateau or even decline. There have been periods in several real estate markets where you would have been better off renting and investing your down payment in the stock market.

That was the case with my first home. The house, purchased with two friends during the Southern California real estate slump, lost about 10% of its value in my initial years of ownership, then recovered to post a 20% price gain.

Not bad, huh? Except after considering all my outlays for maintenance, repairs and insurance, and factoring in the tax benefits, I determined that I had barely broken even when compared with the rent I would have paid during those six years.

Had I invested my down payment in an index fund that matched the Standard & Poor’s 500 instead, I could have tripled my money in the same period.

The flaws of rent vs. buy calculators

The case has been almost exactly reversed in the five years we’ve owned our current house: The stock market hasn’t done that well; the S&P 500 is down 7.2% since Dec. 31, 1998. But our home in the insanely hot Southern California market has appreciated about 65%.

There’s no way I could have predicted the performance of either market -- stock or real estate -- in advance. Yet most of the “rent vs. buy” calculators you find on the Internet pretend that you can, and these base their results on those crystal-ball assumptions.

That’s not their only flaw. Just like many first-time buyers (and even some long-time homeowners), the calculators tend to ignore or underestimate the total costs of owning a house. Outlays for maintenance, repairs, insurance and utilities almost invariably will be greater for a homeowner than a renter, yet many calculators fail to consider the full impact of these expenses.

Why your home may not get you a tax break.

Then there’s that presumption that you’ll get tax savings from your mortgage -- regardless of your actual tax situation -- which these calculators inevitably make.

Here’s a dose of reality:

At least half of the nation’s homeowners get no tax break. Some own their homes outright, but many don’t pay enough mortgage interest and/or property tax to be able to itemize.

If you do get a tax break, it’s probably less than you think. What matters isn't the total amount you pay in interest but whether all your deductions added together exceed the standard deduction amount. In other words, the standard deduction gives married couples who file a joint tax return $9,500 in "free" deductions this year, even for those who don't pay a penny in mortgage interest. Suppose you're a homeowner with mortgage interest and other deductions totaling $10,000 last year. The only advantage you would have over a renter who paid zero interest is an extra $500 in deductions. If you're in the 25% tax bracket, that $500 extra in deductible interest is worth just $125.

Any tax break that you're getting now may drop to zero in the next few years. Recent tax law changes boosted the standard deduction from $7,850 in 2002 to $9,500 in 2003 for married couples who file jointly. In addition, the standard deduction amount will increase yearly to keep pace with inflation, while the amount you pay in mortgage interest declines each year, due to amortization. For many middle class couples, the tax benefit of home ownership drops to zero in less than 10 years. (For a $180,000 mortgage for 30 years at 6%, your annual mortgage interest payments drop under $9,500 in year 6.)

So don’t put too much stock in the figures a “Rent vs. Buy” calculator coughs up.

How you can win by owning

You’re most likely to win by owning, rather than renting, if the following are true:

You plan to stay put at least three years and preferably more. In most markets, it can take three to six years for a home to appreciate enough to offset the costs of selling and moving.

You’re psychologically prepared. Home ownership means dealing with whatever comes up -- from noisy neighbors to clogged plumbing. You can’t just pack up and move as easily as when you were renting or call the landlord for help.

You have some extra savings. Home buyers who spend every dime they have buying a house inevitably get blind-sided by repairs, maintenance and all the other costs of owning a home. Then they go into debt trying to keep up their current lifestyle. Smart home buyers make sure they have an amount in savings at least equal to two mortgage payments after the deal closes, and preferably much more.

You manage your money pretty well. That “forced savings” aspect I discussed above works only if you can keep your hands out of the cookie jar. Otherwise, it’s too easy to drain away your wealth with home equity loans and lines of credit. If you’re the kind of person who lives on credit cards and doesn’t know where the money goes, you’d be smart to clean up your financial act long before you go hunting for a house.