Monday, May 4, 2009

Renting vs. Buying

I was discussing M and I’s decision to rent a duplex as opposed to buy a home with some of my coworkers the other day. My coworkers are proud home owners who thought I had made a mistake not buying a place. Their reasons were the $8K first time home buyers credit thanks to the government, the extremely low interest rates available, and the fact that the housing market has supposedly bottomed out. All of those are very good reasons and things I considered when looking at the option of buying.

However, I still thought that renting a place was the best option because of the following 6 reasons.

  1. Flexibility – Two years ago I decided to look for a new job. I talked to and in some cases visited companies based in North Carolina, Wisconsin, Ohio as well as my current state of Minnesota. It was a great experience that at one point led me to believe I was certainly moving to North Carolina to accept a job offer. Instead, in the final hour I received an offer from a company here in Minneapolis that was better than the offer in North Carolina. I decided to spend at least the next few years in the frozen tundra. Why does this matter? If I had bought a place in Minneapolis then I would have been stuck looking at local companies. That would have reduced my options and almost definitely would have reduced my starting salary. As a renter I am free to go wherever I want and my living arrangement didn’t hold me back. The flexibility is a huge key in renting because I have found that in many cases the owner doesn’t own their home nearly as much as the home owns their owner. Which leads me to my next point.
  2. The myth of home ownership – What do it mean to "own a home?" In my mind it means that you either paid in full for a house or have come to the conclusion of your mortgage. If you put 20% down on a house, then on day one you own 20% of the home with the other 80% belonging to the bank. Now it doesn’t take a genius to realize how long it will take for you to own a home if you take out a 30 year mortgage. (The answer of course is 30 years). However, how many people (besides my parents) actually make it to the end of their 30 year mortgage? Let’s say that after a few years you want to move and sell your home. How much of a home do you own at different intervals? I did the math using an amortization table and came up with a question to ask some of my friends and family to see what they thought. Below is the question I asked

    Zeke decides to buy a $300,000 home. He put 20% down ($60,000) meaning that he has a loan from the Bank of Kevin for $240,000. His monthly payment is $1274 for the 30 year fixed mortgage. Zeke plans on moving after 3 years. How much of the home will he own after 3 years?

    Zeke changes after his first 3 years and decides to stay an additional 2 years. Now how much of the home will he own after 5 years?

    Zeke finds out he really enjoys the winter and decides to an additional 5 years. Now how much of the home will he own after 10 years? (Answers below in italics)

    The answers I received for the most part very, very optimistic. One answer I got was 35% after 3 years, 46% after 5 years, and 71% after 10 years. Another was “he owns the whole thing the whole time.” A few of my friends gave realistic answers like 28%/33.3%/46.7%. Now, the tricky thing with this question is that without the Internet or at least a computer program it is nearly impossible to calculate the answer. I was hoping to get the best guesses from my friends to see what people thought about home buying. Most of the people quizzed understood the basic concept that you pay more interest at the beginning of a 30 year mortgage, but they didn’t know how that broke down by year. Just in case you were curious though the answer are that after 3 years Zeke would own 24% of the home, after 5 years, 27%, and after 10 years he would own 35%. This is all of course after he put down 20%, which means that in 10 years he would have gained an additional 15% stake in his home. This long, rambling point I am trying to make is that you don’t really build equity until after you have owned a home for a long, long time. And owning a home for a long, long time reduces flexibility that can be in high demand with changes in your family (marriage? kids?), job (layoffs?) or many other things.

  3. Reduces your “rainy day fund.” When I looked at buying a home back in 2006 I bought a “Home Buying for Dummies” book to help guide me along in the process. One of the key points I got from the book was that you had to pay a monthly penalty if you didn’t put at least 20% down when buying your home. Therefore having at least 20% of the home’s price was one of my basic rules because I didn’t want to get caught paying that penalty. Apparently while I was reading this book there were other more creative people who had found ways around this penalty. I heard you used to be able to buy a house with 0% down! Apparently the real estate market has tightened their rules a little bit since I found out from my prospective realtor that “you used to be able to put less than 5% down on a mortgage - now, the only option is an FHA with 3.5%, which does have extra monthly "fees" attached to the payment.” With all of that being written if I were to buy a home now I would still use the 20% down payment rule, which means if I wanted to buy an average (median) home in Minneapolis (for $221K) then I would have to put down over $44K. $44K is a lot of money that one might wish wasn’t tied up in a home when something really bad happens. If you get laid off (a possibility in today's economy) or injured (medical costs are extremely high) then you might wish you had the $44K to help you out during your time of need. One of the basic rules from magazines like Money is that one needs to hold 6 months of normal expenses in an easily accessible, safe account. If you have $44K sunk into a home it is not easily accessible and also as evidenced in some housing markets like Miami or Las Vegas it isn’t exactly safe. $44K would be more than enough for 6 months of normal expenses (unless you live like Flo-Rida) and that security in this economical climate would help someone like me sleep a little easier at night.

  4. Stocks – I am stealing this from an article “5 Reasons Renting Still Beats Buying” but stocks have returned 7% a year (he stole this stat from Wharton professor Jeremy Siegel) ending in 2004, while houses have returned a 0.4% a year over 114 years ending in 2004. Both of those percentages are adjusted according to inflation, so keep that in mind when reading more below. Now let me go through an exercise where I bought a $221K home with $44K as my down payment. Taking into account that stocks return 7% as a historical average and a home returns 0.4% here is my calculation on what would be a better financial option. Let’s say that I am one of those rare few that make it to the end of my 30 year mortgage and my home is now worth $249K. That $249K is less than the $336K I would now have in stocks after 30 years of 7% a year returns on the $44K down payment. Now of course just because homes have historically gone up 0.4% and stocks have gone up 7% on average does not mean the same will be true in the future. The DOW has dropped 21.9% in the past 10 years, so I can certainly understand the argument against the 7% number. However, home prices (especially in some areas) have been going down as well, so in this market it seems like one would have been better just putting their money underneath their pillow. Based on what you think about the stock market or the real estate market then maybe you will argue with my math above. I just wanted to provide the argument that based on the historical returns putting you money in stocks seems to make more sense than putting it in a home.

  5. But isn’t rent just throwing away your money. Yes. But so is buying a home. Even with today’s really low interest rates you still have to pay a lot more than a home is worth over the length of a 30 year mortgage. In fact for Zeke to buy the $300K house used in the example in point two he would have to pay $218K in interest on the $240K loan over the course of his 30 year mortgage. Even with the very low interest rates around 4.9%, this amounts to paying almost double your loan. Check out the calculation yourself with an amortization table such as the one on All of that is based on the full completion of a 30 year loan, which is probably unlikely. Let's say that after 5 years in the house Zeke wants to move out. He will have thrown away over $56K just paying interest, which averages out to $941 a month. At that time in his mortgage the $56K is nearly 3 times what he has paid off in principal and is basically the "rent" he pays on his loan. Also, none of this is taking into account the home maintenance (I was shocked to find out how much it costs to trim the trees around your house), which can easily make one wish that they had a landlord to take care of those expenses.

  6. Location, location, location. Some day this might be a reason to buy a home as opposed to rent, but right now I can’t think of a much worse place to live than at the end or large, sprawling suburb that is far away from downtown or my place of employment. Spending time in traffic is not something I want to do with my life. Also, many of the suburbs where houses are on sale are not within walking distance of any shops, restaurants, movie theaters, etc. However, a lot of the places where you can rent are in the heart of the city or in a cool area with many things to do. I have been on a kick trying to find out different address’s walk scores to see what fun activities are within walking distance. The freedom of being able to walk to a bar (or probably more important walk home) or go pick up some fresh fruit from a grocery store or go play basketball at a local park is an important aspect of any living space for me. There are examples of places that you can buy that have great walk scores, but I would say that odds are better that rental properties have a much better walk score than homes.

I haven’t bought a house yet because of these reasons and because renting has allowed me to save a lot more money that I would be able to do if I bought a home. Of course I might reconsider someday and decide to push my chips to the middle of the table and buy a home. There are advantages in buying a home, but this post is long enough and I know plenty of other people who can carry that flag much better than me.


BC said...

I'm sorry your colleagues felt like it was appropriate to second guess the decision that you and M made. They probably want to continue to be your colleagues for a while---like a back-handed compliment.

Anonymous said...

You may probably be very curious to know how one can make real money on investments.
There is no initial capital needed.
You may commense earning with a money that usually is spent
for daily food, that's 20-100 dollars.
I have been participating in one company's work for several years,
and I'll be glad to share my secrets at my blog.

Please visit my pages and send me private message to get the info.

P.S. I earn 1000-2000 per day now. [url=]Online Investment Blog[/url]