There’ve been plenty of blogs written about whether it is better to rent your residence or buy it. In the course of all of these blogs, there’ve also been plenty of misconceptions that have arisen. Now I’m renting my third apartment right now, and I’ve never owned. So right away I guess that disqualifies me from commenting, right? Think again.
Now as I’ve said there’ve been plenty of misconceptions. I’m not going to weigh in on the total "is it better to rent or buy" question, as the actual answer will depend on your circumstances. So instead I’m going to tackle individual arguments, Glenn Beck style, starting with this one:
Renters are just throwing away their money
And so are buyers if there is a mortgage involved. How so? Interest on the loan, taxes on the purchase, other expenses related to the purchase, fees on the loan, private mortgage insurance, closing costs, and so on.
Plus until you pay off that mortgage, you risk foreclosure. And even after owning it, you risk another foreclosable lien against the house if you fail to pay property taxes. So until you pay off the mortgage, you don’t truly own the house — you just own debt. And even after paying off the house, you still have property taxes to worry about — they just become a little easier to pay because you have money freed up from the paid-off loan.
And the minimum down payment that lenders typically require to avoid paying for mortgage insurance is 20%. If you don’t put down that kind of money on a home for the mortgage, you’re throwing away even more money. With mortgage insurance, you never see a dime of that money, and that money is paid to the lender in case of a foreclosure where the house is sold short.
Home owners are at least building equity
First let’s define equity in a home. Equity is the value of the home minus the liabilities against it. Until about 2005, home values and home prices stayed fairly well locked with inflation, not deviating much from it. This means a home that cost $100,000 in 1990 you could expect to cost about $115,000 in 1995, absent any improvements that might elevate its value.
Now even if you make improvements to the home, the value of those improvements won’t count as equity until any liabilities acquired to make those improvements are paid off. This means if you borrowed against the home or took out unsecured debt (such as with a credit card) to improve your home, you haven’t improved your equity situation at all, and possibly only made it worse. If you borrowed against your home to pay off other debts, you haven’t done yourself any favors.
So if you want to increase the equity in your home by making improvements, save up the cash first. Otherwise you’re only adding to your liabilities without actually adding to your equity. And avoid borrowing against your home unless you feel there is little other option.
But going on the mortgage, here are some surprising numbers for you, going on a 30-year mortgage with a 5% interest rate:
- After 1 year, you will have not even paid off 1.5% of the balance
- It will take 10 years to pay off only 20% of the balance.
- It will take 20 years to pay off 50% of the balance.
My, what big equity you’re building there — 20 years until you have 50% equity in the home. And this isn’t counting any other liabilities you might have against the home or any improvements you’ve made to it, only the initial mortgage. You might be building equity, albeit very slowly, but what you’re left with at the end, adjusted for inflation, is likely not much more valuable compared to where you started.
And when you factor in the taxes you’ve paid on the home purchase itself, along with any fees on the mortgage, plus the interest, it’s difficult to see where you come out ahead. And if you fall behind on the mortgage to the point where the mortgage is foreclosed, you lose any and all equity you had in the home in one instant. If you fail to pay the property taxes, you risk having the house seized by the government, meaning you’d again lose any and all equity in an instant.
Renters have free utilities and avoid property taxes
Not quite. First the property taxes on the home or apartment you are renting are already factored into your rent. There may be other taxes as well factored into your rent depending on where you live. Some apartment complexes also incorporate water, sewage, and trash into your rent as well at a flat rate. In these instances you may find your rent goes up because of an increase in price of water and sewage or increased usage across the complex.
I should point out that the complexes including water into the cost of rent are few and far between. Why is this so? It’s unfair to penalize water-conserving tenants for the usages of tenants who are quite liberal on their usage of the water. However most apartment tenants pay their landlord for the water bill, but the bill is still assessed on a per-residence instead of full-complex basis.
Rarely will you also find a complex that will also factor in electricity and heating as those are quite dependent not only and largely on the tenants, but the apartment as well, as where the apartment is located in the complex and in each building may determine its power usage for heating and cooling. Some complexes may provide an option for cable service at a discounted rate to also be a part of your rent, but most complexes will not include entertainment services, preferring to leave the choice of the level of service, the option of cable or satellite, or whether to have television service at all up to tenants. The same with Internet connectivity service.
Back to property taxes, though. As I said, the taxes are averaged out among all tenants and factored into the monthly rent. The benefit of renting, however, in these instances is the fact that you are paying a known quantity each month. You don’t have to worry about a bill from the county or State saying you have a certain amount due by a certain date — i.e. you avoid sticker shock at least with regard to where you live. Your car, on the other hand, is always a different story.
Renters aren’t stuck with a mortgage
Which is easier to get out from under: a mortgage or lease? If you answered "lease" you’d be correct. Now, both are contracts. With a mortgage you have a contract to pay back a loan. With a lease you have a contract of occupation.
Now you could just walk away from a mortgage and hope the lender doesn’t find you, and you can do the same with a lease as well, but it’s easier to legally get out of a lease without owing anything. Most leases will already have an early-termination agreement as part of its language: if you need to cancel the lease early, you can, but typically with a fee involved along with an advance notice (typically 30 or 60 days).
With a mortgage, you have only one option for getting out of the obligation: sell the house. If the home falls into foreclosure, you only evade the obligation if the home sells at auction for more than you owe.
Mortgagers have tax benefits
Ah the mortgage interest deduction, touted by many a homebuyer as a reason homeowners are better off than renters. This will depend on your loan, but first we need to establish a few things.
First, you can only deduct the interest paid on your mortgage if you itemize. If you don’t itemize, you can’t declare the deduction. This is in contrast with student loan interest deductions which don’t require you to itemize. This means that the benefit of the deduction must be taken in contrast with the standard deduction for your filing status. If your mortgage interest deduction along with other itemized deductions is less than the standard deduction, you’d be stupid to itemize.
This means for married couples filing joint, if the mortgage interest deduction is less than about $11,000, and you don’t have other itemized deductions you can take to bring the itemized to more than the standard deduction, why itemize? This means that for a married couple filing joint, you’d need a mortgage of at least about $200 thousand. For married filing separately or single, you’ll need a mortgage of at least about $100 thousand to make the tax benefits worthwhile.
Plus, if your mortgage is "under water" (you owe more than the fair market value), then your deduction is limited according to IRS publication 936. Further the interest deduction is only worthwhile for the first about five years of the mortgage unless you have other itemized deductions you can take or a very expensive house. If it’s the latter, you are likely in the highest tax brackets, meaning your ability to take itemized deductions is further limited plus you may become subject to the alternative minimum tax.
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I think that’s good for now as I feel I’ve addressed the more common arguments made. Now is it better to rent or buy? Well this depends on multiple things, first and foremost is your financial situation. If you don’t have the greatest credit, then renting is pretty much your only option anyway. But otherwise which will be better for you really depends on whether you hope or plan to stay in one area for at least the duration of the mortgage. If you cannot see that far into the future, rent.