The true cost of owning a home – or reasons why renting isn’t all that bad.

The true cost of owning a home – or reasons why renting isn’t all that bad.

My wife and I were discussing whether her soon-to-be-married brother and his future wife should really be looking to purchase a home right away. Knowing what I know about the couple and my personal opinion about buy vs. rent I took the side of the argument that the couple definitely should not be looking to buy a house right now. The two of them are fresh out of college and from what I know don’t have a whole lot of money saved up. In fact I think they have some debt and are going even further in debt to pay for the wedding and honeymoon. Now at their age there is certainly nothing wrong with being in debt, especially if the reason for the debt is college education and well as much as I promote being frugal in all aspects of your life, you probably should enjoy your wedding/honeymoon as hopefully it’s an only once in a lifetime experience.

Seeing as how they already have a number of debts to worry about and little to no money saved up for a down payment there is no reason to go ahead and pile another huge chunk of debt onto their plate. Not only would having to pay for a mortgage decrease the resources they would have to pay down their existing debt, it likely would give them a host of reasons to spend even more money and run up even more debt for things they really do not need because of the house they just purchased.

When people often compare renting versus buying a house they often seem to leave so many things out of the puzzle.

When you rent you are just throwing money away
You often hear this as the number one argument to buy a home. When you rent all of your money is going to your landlord and you will never see a penny of that money back. Thus you would be much better off owning your own home and yes you have to make big monthly mortgage payments, but you eventually own your house so you really get that money back.

Problems with this reasoning

  • The bank doesn’t give you the money for free. They charge something called interest, which tends to add up, especially on big expensive things like houses. I paid more in just interest last year than I did in rent and utilities combined in an entire year at our last apartment.
  • Property taxes – Property taxes a lone are usually about a half years rent at an apartment.
  • Maintenace – Guess what? When something breaks you have to fix it now. Not only that you have to mow the lawn, shovel the snow, pay for garbage pickup, and kill varmints. This means you now need things like lawnmowers, ladders, power tools, hoses, varmint traps, etc.
  • Insurance – while it’s not going to break the bank, homeowners insurance is often 3-5 times (in my experience) more expensive than renter’s insurance. This is just more money coming out of your pocket when you decide to purchase a house.
  • Utilities – Often when you live in an apartment you get certain utilities for free or in many cases they cost a lot less in an apartment than they do when you own a house.
  • Landscaping, interior decorating, painting, remodeling, finishing off the basement, cementing/blacktopping the driveway, building a deck, staining the deck, repairing the roof, fixing/replacing the furnace or water heater or garbage disposal, etc., etc. You likely won’t have too many of these expenses while renting, but I’ll put money on it you will have most of them if you own a home for any extended period of time. Again more money out of your pocket and into someone else’s.

Just in interest, property taxes, and added insurance costs alone in one year of owning my home I could have lived in my previous apartment for nearly two years. I could have invested all this extra money, used it to pay down debt, or saved it for a major purchase (such as a down payment on a house)

Ok you bought a house, you’ve been “paying yourself”, and now you need to move
If you need to move you can’t just pickup and leave like you can with an apartment. Us young folks don’t tend to have our lives/career paths entirely figured out at this point in our lives, so it’s probably pretty likely that if you buy a house right away you will probably be selling it in the next couple years as you decide to move to take a new job or need a bigger house because your new wife is expecting triplets or whatever the reason. Just from my experience people in their twenties in general don’t tend to stay in the same residence for extended periods of time. So now you have to sell your house which in certain markets may take several months to a year depending upon how the local real estate market is doing. Yep it’s a market just like any other market and in the short run your house price can go down. So now not only do you need to move, the only way you can sell your house is to sell it for less than you paid for it. Guess what the bank doesn’t care what you sell it for and you are still on the hook for the full amount of your mortgage. What’s that you didn’t have enough money for a down payment and the bank let you finance 100% of your house? So now on your $200k home you’ve got a $198k mortgage (you’ve been paying yourself for a good year and a half now 😉 ) and you were just forced to sell it for $185k? Ouch. Oops I forgot to mention that selling your house isn’t free either. In fact it’s pretty damn expensive. The real estate agent gets their chunk (4-6%), legal fees, title transfer fees, other miscellaneous taxes, any repairs that need to be done before the sale is final, etc. Costs of selling your house are often close to 10% of its value. Got a $200,000 house that is another $20,000 that you will never see. Then even after all of those fees you do manage to make a profit, if you happen to sell it after living in it for less than 2 years you have to pay taxes on any gains (official rule is you have to live in it 2 of 5 years before you sell it) also.

If you really break it down the crux of the problem is people need a place to live. In my opinion the cheapest solution to this problem is often to rent, especially if you are disciplined enough to take advantage of the cost savings of renting and put extra money away. It gives you a chance to sit back and decide what you really want in life, where you want to live, and in what kind of house you want to live in. Rushing into home ownership just because other people tell you it’s a smart thing to do probably isn’t the smartest move and could end up costing you a boatload of money and headache in the process. So for me, from a purely financial aspect, renting is a no-brainer.

Ok you got me, this article is entirely one sided and takes a look at many of the negatives of home ownership and all the worst case scenarios. It’s no better than any of those articles or people that say the smartest thing you can do is purchase a home, real estate never goes down. I’ll admit this article isn’t very balanced, but when you are having an argument with your wife you don’t want to be balanced you just want to win 🙂

Actually she thought many of the same thoughts, I just think that in many cases so many important things are left out of the buy vs. rent decision that it’s often just as one sided on the buy side. It’s not a clear cut decision financially/emotionally/or however else you look at it. There are pros and cons and every person’s situation will be different and yield a different answer. Just make sure you got all your facts in front of you before you make your decision, because it certainly not as easy as most people make it sound.

  • TFB

    Well done! Buying (and living in) a house is as much about consumption as about investment. When you live in a house, you are consuming more housing resources. When you consume more, you will have to pay more. It’s as simple as that!

  • edenz

    While I agree with you that the couple in question shouldn’t buy a house I think that many of your points are dependant on where you live:

    Interest: “I paid more in just interest last year than I did in rent and utilities combined in an entire year at our last apartment” – That is completely dependant on how much you paid for your rent. Our rent was $300 bucks a month less than our housing cost (mortgage, heloc, insurance, taxes) – for a much, much smaller space.
    Taxes: ‘half a year’s rent’ – Our property taxes for the year (including school) are about 1.5 months’rent.
    Maintenace: Yes this will probably be more expensive – but it depends on your house, and doing it yourself means that it is done promptly and well. We only pay a few hundred dollars for this a year (~300). You can also buy home warranties that cover these kinds of repairs.
    Insurance: Yes it is more expensive than renters’ – but like I said above all of our costs (mortgage, heloc, taxes, insurance) are only $300 more than our rent (house = 3 bedrooms, apt = 1 bedroom)
    Utilities: I don’t know where you live that you get utilities for free! Around here none of them are included. And it’s not that much less b/c your landlord has no interest in efficiency – our water bills are the same, electricty is about $20 a month more, and gas is about $40 a month more (keep in mind the space is about triple).
    Landscaping, etc: This completely depends on your personal preferences, and can easily be kept to a minimum.

    – Basically 70% of your argument is only valid if renting is much cheaper than buying – in many places this is NOT the case.

  • I’m with your argument in spirit, but there are some details that are a little fuzzy. Some of the items don’t apply to buying a condo. Sure you pay the condo fee, but you don’t need ladders, lawn mowers, show shovels, varmint traps, etc.

    You also are rarely “forced” to sell the home. People choose to move of their own free will most of the time. I think married couples can afford to stay around and plant roots. Single twenty-somethings are the ones that move a lot as they can look for the best job and best commute. When you are married, you can’t just move to the other side of the country, because you’ve got the spouse’s career (in a lot of cases at least) to think about.

    Lastly, if you home has depreciated and selling looks like a losing proposition, you can always rent and be the landlord. It’s not an ideal situation, but it can buy you a lot of time for the market to improve. So maybe you lose a couple of hundred bucks a month for a year or two. You factor that into what you gain from moving.

  • Maf1adon

    I agree.

    There’s one other reason why renting may be better then buying, the cost of entrance.

    To least an apartment or even a home in my area, one would have to pay first + security which averages around $5,000. Add the month average lease payment of $1,400/month. In contrast, to buy a house a 20% down payment is recommended (average home price #800,000; DP = $160,000 [ouch!]). On top of that add a monthly mortgage payment of around $3,900 P+I (@ 6%), insurance and property taxes and that amount climbs to about $4,500.

    Point is why not invest the $160,000 dp in index funds, online savings or both and pay the $1,400 a month? Yes, the lease payment will increase but $1,400 looks a heck of a lot better than $4,500. Plus the dp invested in a broad index fund should yield around 12% average. That’s about $20,000 per year in pretax investment income.

    Enough said…

  • MossySF

    While this article is one-sided, it does point out a lot of the costs of homeownership that people just never consider when doing the math. The only thing most people seem to know is “interest is deductible!” but of course don’t know the limitations. It’s the usual story of people coming to the table with a conclusion and finding reasons to support that conclusion.

    The real answer is to get the full picture and do the math before making an emotion-based decision. What the cost of owning/renting in other parts of the country is, I have no clue. Where I am (San Francisco), it’s $1500 to rent my unit in San Francisco and $4500 ($4000 after mortgage deduction in my case) to buy. It’s an absolutely no brainer to rent — as long as you don’t blow the entire difference on drugs and hookers.

  • modmod21

    I like this article because it addresses the things most young (and of course old..ahh seasoned) people don’t consider.

    However, I do have a question: If in a certain area it is a lot cheaper to rent than to buy, how does your landlord make any money? If you as a renter don’t pay certain expenses, someone has to. And being a landlord is not charity.

    Please comment…I’m really curious

  • MFJ

    If in a certain area it is a lot cheaper to rent than to buy, how does your landlord make any money?

    Very interesting observation and off the top of my head I’m not sure I have a good answer for you. Only thing I can think of is that rents fluctuate so while it may be cheaper to buy now in a certain area it may not always be the case.

    Also there are some economies of scale, especially with apartment complexes so assuming the landlord is able to fill all his units even at the lower rates he probably still can at least cover his debt costs (if he doesn’t already own the whole place)

  • Anne

    I do like that this post brings up a lot of talking points. Everyone considering buying should do the math for her particular area. Now, if I were writing this post, I could make a strong argument in favor of buying, simply using the assumptions relevant to my area (Chicago).

    In my favorite neighborhood, rent for a 1 bedroom apartment is around $1200/month. I just bought a 1 bedroom condo, put 10% down, and the monthly payment (including mortgage principal and interest, real estate tax escrow, and assessments) will be $1650. Considering that some of that is principal, which theoretically I’ll be getting back when I sell (which I don’t plan to do any time soon) and some is interest and taxes which are deductible, buying makes more sense than renting. Not to mention the intangible benefits, like pride of ownership, and being able to paint a wall or build in a bookcase.

    And the place I just bought has a new kitchen and bath that were renovated by the owner, who did a great job with it, presumably because he was remodeling for his own benefit and not to flip. The rental units I looked at were depressing, run-down and had no character.

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  • [if you happen to sell it after living in it for less than 2 years you have to pay taxes on any gains (official rule is you have to live in it 2 of 5 years before you sell it) also.]

    Err.. not in the case you’re specifying; If you’re moving to start a new job somewhere else you can take a pro-rata amount of the $250.000 exclusion. (So if you live somewhere for a year, then move cause of work, you can make $125.000 and still pay no capital gains).

    In addition, if you’re married (and that’s the reason you bought in the first place, no?), you can add your deductions – so you can make $250.000 profit in a year and still not capital gains.

    The real fecker is the real estate agent fees.

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  • Ri

    I must agree with the article. Buying a house can cost a ton when only ten percent of the monthly mortgage payment goes to principle in the beginning. Unless you have extremely good credit, which most of us do not, renting is the only practical alternative.

    In my case though I bought a three bedroom two bathroom house and rent out both extra rooms so I am able to get by. The rent I get from my boarders pays the mortgage but I still have to cover all the other costs .

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  • You must ask yourself this question:
    Where will a renter be in 20 years?
    Where will a home owner be in 20 years?

    One will still be poor and renting.
    One will have quadrupled his money and be ready to retire.

    Owning a home is a sacrifice. Nobody said it was easy. But the rewards outweigh the trouble 1000 to 1.

  • Home ownership “can” be a good thing; If your ambitions are to become wealthy via real-estate or just plain “live somewhere,” it’s a good thing; but look at what it can do in the Chicago Market..

    read more:

    http://chicagoviprealtors.typepad.com/chicago_metro_vip_realtor/2007/03/and_in_this_cor.html

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  • Ken

    When I was 23, I just got done with my first year of renting. My parents convinced me to buy a home. I had a ton of doubts because I was young, I didn’t know what I wanted to do within a year. I decided to listen to my parents and all their financial reasons (the ones you listed above). What they didn’t do was figure out the pros of renting. Or allow me to see the other side of things.

    Now after a year of owning the home, I’m sick of it. I plan to move to Seattle and rent until the day I decide I actually want to stay one place long term, and stay with a career long term.

    Being mobile is what young people need. Young people who don’t constantly think of money that is. I want to travel and live different places in the world. Dif strokes dif folks.

  • Katie

    Amen.

  • I’m 26 and I bought my first multi-family property at 21 — I now own three multi-family properties (consisting of 10 units all together) in Lowell, MA. The properties were not in great condition when I purchased them but thats why I got a good deal. I have the know-how to fix anything, so my intention was to keep them long-term and slowly fix them up.

    Mistake #1: I opted for 2 year fixed, 28 year adjustable-rate mortgages to save money on interest in the short term with the intention of refinancing before my 2 years were up. That worked for my first property. A year after purchasing it I refinanced for $200,000 more than I bought it for and used that money to purchase two more properties.

    Taxes went up. Insurance went up. Market went down. Problems with tenants increased. Now I cant refinance to cash out because I owe $70-100k more than my house is worth. The houses have been on the market for sale for the past 6 months at prices $100k less than what I owe the banks and I haven’t received a single offer.

    All three of my properties are nearing foreclosure and I’m probably going to end up filing for bankruptcy this year instead of owing the banks $900k+.

    Mistake #1: I should have got 30 year fixed mortgages.

    Mistake #2: I should have paid a little more an bought properties in slightly better condition.

    Mistake #3: I should have gone a little slower and learned lessons from owning one rental property for a few years instead of buying a new property every year (2003, 2004, and 2005).

    Would I do it again if I had a chance to go back? Without a doubt. The amount of knowledge I have gained about property maintenance, tenant screening, and lending processes is invaluable and even if I don’t have a penny in my bank, I’ll still have a huge wealth of information.

    I’m back to renting and I strongly believe with what you said about young people rushing into purchasing a property. When they’re ready to have kids, then they should think about settling down. People don’t realize how much time and money owning a house requires and how much it anchors you to a particular area.

  • Joe P.

    Though this article is somewhat dated, it does point out that many of the “fuzzy” arguments about owning/renting can be accounted for using economic theory.

    It suggests that due to the transaction costs of purchasing and selling a home, it is cheaper to rent if you have a short term horizon. In the case of the housing market in 1968, this was 4 years or less. Plugin the values for your market, and you will be able to determine if it is cheaper for you to rent or buy.

    http://www.jstor.org/pss/3159610

  • stefan

    “To least an apartment or even a home in my area, one would have to pay first + security which averages around $5,000.” … average home price #800,000″

    Maf1adon, THe houses for rent in my city only require one montsh’s security deposit. The average price of a very nice house is about 280,000.00 (US).

    As far as this talk about landlords or building managers not making money, I totally disagree. While they have the same high costs as any home owner would have to bear they collect a huge “mark up” on each space rented out that is worth more than it’s intrinsic value.

    If a private house owner rented out 3 of his/her 4 bedrooms for 400.00/month (US) that is enough to cover a mortage payment. If the house is paid for,as many apartment buildings/houses indded are,then, despite expenses, there is a profofit to be made. It’s called REAL ESTATE! Believe me they are not in it for charity.

  • David

    I would buy a cheap house for $100 grand and pay it off in 10 years rather than keep paying rent for the rest of my life.

  • MFJ

    @David – ok but you still have property taxes to pay every year (pretty much probably close to the amount you are currently paying in rent) – not to mention that your “cheap 100k” house is probably not going to be brand new so when the furnace goes or the roof leaks you have to pay to fix it and immediately or else your in an even bigger hole. No more luxury of just calling the landlord to fix and pay for these things. Paying rent for the rest of your life strictly financially speaking is not so bad.

  • David

    Good luck with the house you bought.

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  • Leaf

    Very good article. I think the pricing for homes will eventually go up. I believe real estate is still the best form of investing. I do believe though that right now in today’s environment, renting isn’t a bad option at all. Its like financing a car in some aspects. If the prices of homes continue to go down, not a bad idea to rent. Homes will still be at record breaking lows for the next few years, so if you can wait for the best deal, wait!

  • matthew

    When I left home for 1 year on a short term contract, I was delighted that my tennent was paying the bank interest and some of the principal.

    And, when my 1 year contract aborad was up, i asked the tennent to leave, and took back my home.

    I think you arguements dont stack up but they are somewhat valid if you have a holiday home.

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  • You make some great points! I am a landlord and sometimes get envious of all the things I know my tenants don’t need to worry about. Renting has many advantages people don’t think about like you mentioned. Once you find a great tenant screening service I think land lording is a pretty good life as well.

  • blah blah

    Like a few others, where I live renting makes more sense than buying. In a large metroplex you’re mostly paying lots of money for a house in order to enjoy the peace and security of the neighborhood it’s in. There are <$100k houses around here, but I would NOT want to live in that neighborhood lest I live next to a crack house or get mugged every night. My father bought a home for ~$200k when they moved here 15 years ago. It went up to $215k, but has now gone down to $190k. The neighborhood it's in has slowly gone down as the ghetto encroaches. With maintenance, taxes, insurance, etc all added in, he pays about $2k/mo to maintain the place. It's all paid off, but the taxes and ins rates keep going up. I spend $600/mo renting a room in a nice house w/ all utilities included. Landlord gets all my money, but also has to worry about all maintenance & issues. As a single guy, I really want a place of my own, but can't justify living in a house or condo when it would cost so much more and I don't even use the space I have. (I could literally live in a small RV, and still have space left over). So, I rent, and take my extra money to invest in the stock market & mutual funds. Eventually I may hit an age where I want to buy a small home if I like where I'm at, or just jump right into an RV or retirement home. But for now, I just rent. It's a prudent financial option. But, the intangible thing is you give up that joy of owning something. There is always that insecurity of not owning your own home, being able to call the shots, knowing you have it for as long as you want it. If my landlord wants me gone, she just has to give me a 30-day notice. Of course, I can do the same, so it's great if I want to hop to a place closer to work (whcih I've done in teh past). But, maybe it's just me, I have this sense that I'm just a drifter; I don't have any roots. However, I have no debt, I have investments making a profit, and i'm frugal. I see everyone around me taking car loans, home mortgages, etc, etc … I just don't know how they can look at themsevles in the mirror every day knowing they owe thousands to someone else. I owe my landlord $600/mo. Other than that, my job owes me money for the work I do, and my investments owe me money for the returns on the market. But, I don't have a place to call "home". It's a trade-off.

  • I’m with you….home ownership is ‘wonderful’, but renting can be pretty sweet. For the amount I pay for my mortgage, insurance, interest, maintenance and upkeep, I could be renting a pretty sweet place.

    How about that you also don’t have to worry when you have to more about selling? Also, no agent fee’s.

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