Yorkie - your answer, Part II. (Thank goodness for your double post... I get to answer twice.)
You asked what I would have in ten years after throwing my rent money away. I’ve been struggling with that question myself, which I will answer and then show you with gory math numbers...
First the answer: If I rent, my costs will be much lower than owning. I can invest this difference. So the real question is, financially, will I have more net worth with the appreciation on a home I own, or will I have more net worth by renting and taking the cost savings by not owning, and investing these savings in the stock market.
I performed exactly this analysis for a 15-year period and found that I would break even on a $220,000 house. So I should buy if I can get a home for $200,000 or less. $250,000 and over means, I lose money buying a home.
I can rent an apartment for $800 per month. I assumed rent would increase 5% per year.
I compared this with buying a $200,000 home.
I took into account the following costs...
$40,000 downpayment.
$4,800 closing costs ($3,100 after tax deduction)
$9,000 annual mortgage cost, after tax deduction
$2,500 per year property tax, increasing 2% per year
$1,000 per year homeowners insurance
$1,500 per year flood insurance (Sacramento is mostly flood plain)
Add to this...
$24,000 real estate commission when I sell the $400,000 home in 15 years.
$10,000 minimum in improvements over the 15 years of ownership
Note: I will still owe a $120,500 loan when I sell in 15 years...
As a homeowner, utilities like heat and cooling will cost double for a 1,500 square foot home compared to an 750 square foot apartment.
As a homeowner, I will have to pay for garbage, water and local tax assessments not required of a renter.
So you ask, what will I have at the end of 10 years. I’m looking at 15 years.
My cost to rent for 15 years is $220,000.
My net cost to own a home I buy for $200,000 is $80,000 if it doubles in value from $200,000 to $400,000.
By renting and investing the $40,000 down payment and the saving month over month by renting, if I got only an 8% return from the stock market, I would make a profit on my investment of $100,000, after paying about 40% in federal and state taxes. (I used 40% instead of 15% capital gains tax, because this is going to a tax-deferred 401(k) and when I take the money out in retirement, I believe it is taxed as normal income.
So...
$200,000 cost to rent.
- $100,000 investment return.
$100,000 is net cost to rent, vs. $80,000 net cost to own.
That is not a HUGE difference in cost. And with all the assumptions I made, who knows the true difference?
Will homes double in 15 years, just because they have historically? I don’t know?
Will rents rise 5% per year? I don’t know?
Will I only get 8% return on my stock market investments? I don’t know, but most people expect 10-11%, so I low-balled my expected return.
The point is, I need to buy a $200,000 home to make it financially worth buying vs. renting.
If you can find me a $200,000 home in a decent neighborhood in Sacramento, I’ll give you a 10% finders fee and a kiss besides.
You see... THAT IS THE ENTIRE PROBLEM.
It is not that I don’t want to buy a home or that it can’t be financially beneficial. When homes are still going for well over $250,000 and most near $300,000 in Sacramento, they are still far overpriced.
I make close to 6 figures, so it is not as though I can’t afford a $300,000 home. But the asking prices are WAY out of line with both incomes and rents. You can’t sell a home that people can’t afford to buy. 100,000 sellers can’t get 100,000 buyers to buy at these prices and the only solution is to lower prices. To that end, it makes more sense for me to rent, unless or until I can buy a home in Sacramento for around $225,000, tops.
Otherwise, it makes more financial sense for me to rent and invest the difference in the stock market.
So your suggestion that renting is always a waste of money is patently false. You have to compare your net expenditure renting vs. purchasing. At a certain price, rent is a waste of money. But when homes are too high compared with rent, then renting makes sense and buying is a waste of money.
If I can rent an apartment for $800 per month, that typical home in Sacramento the owner is asking $300,000 for is over 375 times monthly rent. It makes no sense to buy.
Even a home for $250,000 is 312 times rent, and still makes no economic sense to buy.
Renting is not always a waste of money. Not by a long shot. If I can’t buy a home in a decent neighborhood in Sacramento for $200,000 when home prices hit bottom, it is not going to make sense to buy when I can sock the difference away in my tax-deferred 401(k) plan for retirement.
If I am missing something here, please let me know. I don’t see where my assumptions are wrong, and I end up agreeing with the article I posted.
I disagree with one part of your assumptions. You took the full value of the tax deduction off of your mortgage. Everyone gets the standard deduction regardless of whether they actually have anything to deduct.
You should only be figuring the difference between your tax deductions once you are carrying the mortgage and the standard deduction.
This would reduce your tax savings on the interest on the loan, and make owning a little less attractive than you made it seem. If you are married, the standard deduction is up around 13,000 per year. I can't speak for you, of course; but my wife and I don't itemize because we can't get above the standard deduction. The deductability of mortgage interest is irrelevant to us.
You posted: If I am missing something here, please let me know. I don’t see where my assumptions are wrong, and I end up agreeing with the article I posted.
***
Do you account for the value of living in a home vs. renting something presumably of lesser value in your analysis?