Renting vs. Owning Your Home

As the housing market continues to evolve in today’s economic climate, we are noticing three important pieces of information:

• Home values are coming down
• Interest rates are dropping
• Rental costs are increasing.

As I would have argued even during the “peak” of the housing market that owning is better than renting, that argument is even more definitive these days.

As a renter, you have the rental cost itself. You may also have additional utility costs such as PG&E, water, and telephones. But if you owned a home, you would have similar utility costs associated with the home, so I will leave those off the table for our comparisons.

So here is the question, is it better to rent a place for $1,500 per month, or buy a place for $325,000? Your rental amount will have annual increases based on cost-of-living adjustments, so let’s call that 3% per year. Your purchase option will have many variables, so I will need to state some assumptions. As much as the lender would like to see a 20% down payment, not everyone has that much available. So to be really conservative, I will assume just a 5% down payment.

Using today’s market rates of 5.965% APR and an even higher second loan rate, I estimate a total housing cost (including mortgage principal, interest, taxes, and insurance) of approximately $2,250 per month. That is an increase in monthly expenditures of $750. However, some of that increase will be re-captured in taxable benefits (mortgage interest is tax deductible, rental cost is not). Also, part of that increase payment is going towards the principle of the loan, which is building the equity in your home.

Lastly, if I assume some annual appreciation of your home, I won’t even use the 10%+ that we have seen historically. Instead, I will use just 5% average annual appreciation.

So how does it compare? Just over a 10-year period, your rental cost will amount to about $206,350. You will have built NO equity (except that of your landlord). In the same period, the equity in the home that you owned would have grown to over $270,000. Obviously, the home purchase wins in that case.

But then you say “but I had to pay an extra $750 per month on the home ownership option”. Fine, let me add the value of a $750 per month contribution to an investment account to the renting option. Therefore, both sides are now paying out exactly the same dollar amount each month. Additionally, I will take the amount of the down payment and add that to the renters opening investment account. By using an average return on his/her investment of 5% per year (an aggressive number), that investment account could grow to over $143,000 in ten years.

But even then, a renter putting aside the extra amount he would have paid towards the increase cost to own a home is still better off owning a home. In this particular analysis, the renter may have wasted $206,350 on rent, but may have built up an investment portfolio of $143,000. The homeowner, however, has seen the equity in his home grow to over $270,000. Once again, a clear winner. There are a few reasons while the two scenarios differ greatly, which will take too long on this article to discuss. But they are caused by leverage, appreciation rates, tax benefits, to name a few.

Perhaps it’s time to start building your equity, not your landlords.

We are offering a complimentary copy of Your First Home to first-time buyers that book an appointment with us.