Financial

Is Renting Really Throwing Money Away?

One of the most common goals our clients have is to buy a home. Some are looking to expand their space because they have a growing family. Others are relocating from cities to places where they can enjoy a little more space. Some want to house hack and create a source of relatively passive income. But one of the reasons we hear most often is that they are tired of throwing money away on rent.

We want to dispel some myths about this. Is renting really throwing away money? Here are three.

Your mortgage payment is an investment. 

When people say renting is throwing away money, they often have a specific calculation in mind, and it is based on certain assumptions. One is that the full balance of what they pay each month is going to waste and that if they were putting that towards a mortgage instead, that would be like money in the bank. 

This is an oversimplification. 

Housing always costs money, some of which you never get back. You have to pay to live somewhere, whether you are paying a mortgage lender or a landlord. It’s a basic necessity, and it’s always going to come at a cost. If you pay a landlord, you are paying not only for the space you live in, but for your share of the taxes, insurance, maintenance, and repairs. You just don’t see the bill. Once you start paying a mortgage, you are also paying for all of these things, and on top of it all, you’re also paying for interest on your mortgage. 

The interest portion of your mortgage is considerable. For example, if you took out a $200,000 loan, by the end of a 30-year mortgage you would have paid the $200,000 principle and also about $103,000 in interest. So, while you will have that asset at the end of the day, you will have paid more than half the original value of the home in interest.

One might argue that the house is also going to appreciate, which it may, but the average rate of appreciation nationwide is about 4.3%. So one way of thinking about this is that you have a savings account with a 1.3% interest rate, once you adjust for the costs of the loan itself. This is a lower rate of return than some savings accounts and a much lower rate of return than what you could expect to gain if you invested in a total stock market index fund.

On top of this, you’ll have to pay property taxes, which vary according to location, but average out at 1.1% of the value of the home, and homeowners insurance, which also varies but averages about $1,300 per year.

Your primary residence is always a good investment.

While you will build equity over time as you pay off a mortgage, it is important to remember that your primary residence is probably a lousy investment, as Paula Pant says.

While this may seem counterintuitive, there are a few reasons why the home you live in shouldn’t always be considered a great investment. One is that you will spend a LOT of money on maintenance and repairs. The general rule is that you can expect to pay about 2% of the value of your home, per year, on these costs. Sometimes these expenditures increase the value of your home, but sometimes they are just a matter of upkeep.

For instance, let’s consider your roof. You can expect to replace your roof every 10 or so years. If the roof replacement costs $10,000, that’s about $1,000 per year for the privilege of having a roof. Add on to that other large ticket items like boilers, water heaters, and AC units, and you can see that there are a number of other costs that have to be accounted for when you are calculating your housing costs.

On top of this, your house is not a liquid investment, meaning that, as long as you plan to live in it, you cannot count it as cash. Sure, depending on the market and how large a downpayment you put down on the house, you may have equity that you can borrow against to get loans, but overall, your equity is not an asset you have access to until you sell your home, unlike stocks, which you can sell when you need cash.

Real estate is always the best way to build wealth.

As we mentioned before, how much the investment in your home pays you back depends on a lot of factors. One is that you need to account for interest, which will make up a large portion of each mortgage payment for the first 7 years, at a minimum. Then, you’ll need to deduct the amount that you spend on maintenance and repairs. Yet another consideration is inflation. These are huge variables that impact your return on your investment over time.

Again, we’ll turn to Paula Pant to provide more fodder for determining whether renting is throwing away money, because there’s no need to reinvent the wheel when it comes to providing some formulas for doing the numbers, and she’s got some great considerations in this article

But the takeaway is this: most of the time your home is not a great investment, and typically will not get you the estimated 7% gains, adjusted for inflation, that you’d get by investing the same amount of money in a total stock market index fund.

That doesn’t mean you can’t make money from real estate. As our trainer Bevin Morgan discusses on this Clever Girl Finance podcast episode, real estate investing can be a lucrative endeavor. There are also a lot of other reasons that purchasing a home might be right for you. Maybe you like doing DIY home repairs or love interior design and just want a place to make your own. Or maybe you want to live in an area where the rental stock is low, but homes for sale are plentiful. These are all great reasons! We’re not here to squash your dreams, but we do want to make sure you do the numbers and make sure the equation works in your favor.



Source
Is Renting Really Throwing Money Away? is written by The Financial Gym Team for financialgym.com

Related Articles

Leave a Reply

Your email address will not be published.

Back to top button