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Welcome to the 33rd edition of the Tech Financial Planning (TFP) newsletter.
A common reason I hear people say they want to buy a house is because they want to “stop throwing money away at rent.”
I certainly empathize with that sentiment, but does that make it a good financial decision?
In this newsletter we will break down why this is partially true, because you “throw money away” when you own a home too.
TL;DR
A common complaint about renting is that you’re throwing money away at rent
When you buy a home, you throw money away at things like property taxes and interest
Especially with higher interest rates, the total cost between renting and buying is closer than you think
I’m Throwing Money Away At Rent
This is a very real feeling, especially if you live in a high cost of living area.
If your rent is $4,000 / month, that’s close to $50,000 a year in rent.
And you don’t get any financial return for it.
Which is why I hear people say some variation on “I need to buy a house so I can stop throwing money away at rent.”
But Are You?
So let’s run through a scenario - here’s the facts:
Buying a million dollar house with 20% down ($200,000)
You have an $800,000 mortgage - 30 year loan at 6.682% as of writing
Property tax is 1%
For ease of argument and comparison, we will not include any insurance, HOA, remodel, etc.
After 10 years you’ve built up $118,723 in equity
But you’ve paid nearly $500,000 in interest ($499,595), $100,000 in property taxes ($10k / year) and $100,000 in maintenance ($10k / year).
You paid nearly $700,000 to build up $118,723 in the name of not throwing money away at rent, on top of your $200,000 down payment (and closing costs).
That’s pretty expensive.
Especially because for the first 20 years, you pay more in interest each year than you do principal!
Huge note - interest rates play a huge factor!
Buying right now is much more expensive than in years past. If interest rates were to drop again, then these scenarios would change.
But What About Renting?
Obviously, we have to take rent into the equation (as the people of Twitter were so eager and willing to tell me last time).
So let’s say you are currently renting a place for $4,000 a month, and rent will increase by 5% a year.
Over 10 years, your cost of renting is $603,739.
Comparing The Two
You spent $100,000 more on home ownership than you did in rent.
And again, we didn’t include other factors like HOA, insurance, etc.
Nor did we factor in potential tax savings if you are able to deduct the interest expense (spoiler alert, you probably are)
With buying, you did gain $118,723 by paying down the principal.
But over 10 years, it’s basically a wash - home ownership comes out ahead by ~$18,000.
That’s $1,800 / year, or $150 / month.
It’s not nothing, but it’s not this massive difference that people can claim.
The two big unknowns
If you invested the $200,000 down payment, what was your rate of return?
At 7.5% yearly return, your $200,000 turns into $412,206.31
How much did your house appreciate?
At 3% a year, your $1,000,000 house is now worth $1,343,916.38
Remember, we haven’t included buying costs and selling costs into these calculations
Note: we don’t know what the return or appreciation will be.
The long term stock market return is around 10%, and houses typically appreciate ~3% a year.
But that’s not always the case.
Putting It All Together
Point number 1 - it might be closer than you think, at least from a numbers perspective.
I looked at this over a 10 year period.
In general, the longer you stay, the greater chance that buying comes out ahead.
And the shorter you stay, it might make more sense to rent.
Don’t buy just to buy, especially if you plan on moving frequently or if you are unsure of your long term plans.
There’s a lot of upfront costs with buying a house:
Paying much more towards interest than principal
Closing costs
Obviously we can’t predict with confidence how long you will stay in a house, but it’s worth considering.
Point number 2 - buying a house should be for personal reasons as much as financial reasons.
The finances matter, sure.
But there’s a lot of guesses and assumptions that we can’t be sure about.
If you bought in 2019 and refinanced in 2021, the numbers are probably way in your favor.
But if you bought in the last year and your house is worth less than when you bought it with interest rates as high as they’ve been in years, then it might not be as sound from a numbers perspective.
Ultimately, my goal is that you think through why you want to buy a house.
Is it for personal reasons or financial reasons?
Hopefully it’s both.