Talk is needed. We need to discuss one of the most prevalent myths in personal finance. This myth is:
Renting is a wasteful use of money.
People call me multiple times weekly to tell me they want to purchase a home. They are worried about renting and losing money. This could have been something they heard from their parents or strangers online.
They make major financial decisions based on the opinions of others rather than what is best for them.
Renting is a waste of money?
The reason people think renting is a waste
Before I discuss why renting is not a waste of money, let me first cover why this belief is held. It is because homeownership’s many benefits have made it so appealing.
YOUR MORTGAGE PAYMENT BUILDS EQUITY IN YOUR HOME
When you pay your mortgage, a portion goes towards your principal each month. This is the amount that you borrowed initially.
Your equity is the difference between your home’s worth and the principal you owe on the mortgage. As you pay down the principal, your equity in your home grows.
HOMEOWNERS RECEIVE RISING HOME VALUES
While the real estate market can fluctuate, home values tend to increase over time. Many homeowners can sell their homes for less than they paid for them. This results in capital gains.
These statements are not falsifiable. While it is true that your mortgage will build equity, and your home’s worth will increase over time, it is also true that you can pay your mortgage off. In the next section, we’ll discuss why these things aren’t as important as you think.
The return on your investment in homeownership
Home values have increased steadily over the years, it is true. Home values have increased by an average of 5.5% since 1940.
Depending on how experienced you are with investing, 5.5% might seem reasonable. What if you look at it in comparison to other investments?
The Securities and Exchange Commission estimates that the stock market has an average annual return of 10%. This is near twice the amount of an increase in the value of a house.
HOW DIFFERENT ARE THESE PERCENTAGES?
Suppose you invest $100 each month for 30 years to a 5.5% annual return investment. You’d be able to invest more than $87,000 after 30 years.
What if you invested the same $100 each month in an investment that yielded a 10% return? You’d get shy of $200,000 with compound interest — twice the return for a 5.5% investment.
Remember that your house purchase is not the only investment made into it. After you consider all other expenses, your gains from an increase in value will likely be completely negated.
Let’s do some math: Renting or Buying?
You might think renting is a waste of money. The money you pay each month does not build equity in your home. Let’s take a look at a scenario that may change your mind.
CLOSING COSTS
Although closing costs are not an ongoing expense of homeownership, they can be significant in the first year. Closing costs can range from 1% to 3% of the purchase price. Your closing costs for a property valued at $335,000 would be $3350
INTEREST
Let’s suppose you rent an apartment at $1,500 per month. So you get fed up with renting and buy a $335,000 home. The monthly mortgage payment is $1,500.
However, the $1,500 does not build equity in your home. Most of your monthly payment will go toward interest in the first years of homeownership. A 3.5% interest rate means approximately $11,622 of your monthly payment will go toward interest for the first year.
These numbers were calculated using Bankrate’s mortgage amortization calculator, which applies to a mortgage amount of $335,000 with an interest rate of 3.5%.
PROPERTY TAXES
Let’s now talk about property taxes. Rates will vary depending on where you live. According to the U.S. Census Bureau, the average household spends $2471 yearly on property taxes. This will be used for this example.
HOMEOWNERS’ INSURANCE
Homeowners insurance is another ongoing expense. The cost of homeowners insurance will depend on the location you live, your home size, what coverage you need, and many other factors. ValuePenguin estimates that homeowners insurance costs $1,445 annually.
MAINTENANCE
Let’s finally talk about home maintenance. You are responsible for all repairs to your home as a homeowner. There is no landlord left to call.
It’s difficult to predict how much maintenance you will spend each year. Experts recommend budgeting for 1% of the home’s cost. For a $335,000 home, you can expect to spend $3335.
RENTING VS BUYING – WHAT’S THE VERDICT?
Many people argue that renting is a waste of money. As you can see, homeownership doesn’t create equity in your home. There are many costs associated with homeownership. Let’s see how much you spend renting versus what you save on your first year of homeownership.
