Should you BUY or RENT?

I’m writing this for a few reasons. Firstly, to get ideas out of my head into a viewable form where we can argue and compare the numbers and cost/benefits. I have never really written anything outside of uninteresting, formulaic college papers. 

The main reason I suppose I am writing this, is that my wife and I have really considered buying a house. Like we actually did a walk through with a realtor and talked numbers; all that Jazz. Through this process, as most decisions I make, I have tried to read a good amount on the subject. Almost every article I have found on the buy/rent issue seems to be more motivated by an emotional leaning on the topic and very few I have seen have real world situations and an objective, mathematical backing to one’s take on the argument. 

There seems to be two distinct sides pushing this argument of whether or not you should buy a house.

The two sides seemed to be represented as:

SIDE A: You should buy a House; it’s a great investment!

This side tends to be more aged; lLike a fine wine (old people). Often seeing viewing purchasing a home as a foundational part of the American middle class.  They see their home as an investment and view rent as throwing away your money. They emphasize the fact that a house grows in value and you actually keep some of your monthly payment.

SIDE B: Buying a home is usually a horrible investment! Rent! And then use the extra money to invest!

This is side has a younger vibe.  They like to travel. The ‘Rent over Buy’ crowd really highlights the hidden cost of home ownership.  They highly value the peace of mind that comes with not being fiscally responsible for major repairs, HOA fees, and the insurance and taxes that come with owning a home. They have cleverly pointed out several ways in which renting is not throwing your money away and how prosperous it can be in the long term.

Now, who is right?! As the old adage goes, ‘He/She who holds the gold makes the rules.’ And the way I interpret that.  Whoever thinks logically and clearly about their own current situation, with a long-term approach, and uses a variety of information sources to make the best possible decision for their respective selves and loved ones WINS.  And probably has more money when they die.

I think it is pretty apparent that there is absolutely not one clear right answer, and anyone claiming vague seeping generalistic maxims should be avoided.

Every situation is going to be unique (duh) but if you are armed with some foundational knowledge on buying a home and what that entails you can work out the numbers and make the best decision for yourself.

I do understand that situations are going to vary extremely based on a number of factors, but actually getting into the math would allow people to compare their situation to someone else’s and get a better understanding.  

I also absolutely love reading stuff like this so I think it would be fun to actually contribute for once!

So, for this article I am going to lay out a scenario that was basically our living predicament a few months ago.  We are currently renting a house in a neighborhood we liked but a house in a neighborhood we liked even more came up for sale.

Now my current situation might be a little different because I live in a high cost of living area.

Currently we pay $1250 for rent, for a 2 bed 1.5 bath in an awesome neighborhood.  This is actually a pretty good price for our city/neighborhood. So, we are looking at an even $15,000 a year in rent plus utilities.

Not to be overly redundant but that means we spend 15k a year and keep zero.  I have seen people argue you are paying for a service, to argue that you are not throwing your money away, but you are not able to keep any of these 15 thousand dollars just to be clear when we are comparing final numbers.

Now we went to go look at a 3-bedroom 2.5 bath house that we both loved.  A different neighborhood that was equal or better. It also had a small garage attached. 

We did the walkthrough and the house was really everything we wanted.  The bedrooms have tall ceilings, the backyard space was bigger than our current place, and my wife has wanted a garage for years, so she was giddy. So now we are talking to this car salesman of a realtor and he eventually hits us with the razzle dazzle that this place has a $208 A MONTH HOA (unusually high).  He explains this covers a new roof every 10 or so years and new paint every 5 or so. My heart dropped out of my chest.  That’s $2500 a year; steep.  So, we love it we love now time to do math. 

Now this place costs $320,000.  If you’re like me (from somewhere like Oklahoma) you hear this price for a 3-bedroom townhouse and you’re like, ‘Uhm are the walls made out of solid gold?’ Unfortunately, it’s fairly cost effective where we currently live.

Now we have about $25,000 liquid in an account we could use for a down payment. The rest of our money is mainly tied up in retirement accounts. 

Now for this example we are going to pretend we put a 5% down payment. At the time of writing this the US average is 5.3% for a down payment.  In my experience of talking to my friends that have purchased homes they have generally put 3-5% down, possibly due to being in a more expensive area.

Even is scraped together 5-10k more we still wouldn’t hit the 64k plus on our down payment to avoid PMI.

[ PMI– Stands for Private Mortgage Insurance.  It almost always required on a home loan when you don’t have 20% equity in the house.  Which is why a 20% down payment is often recommended.  It gets harder to hit after you start your mortgage because the interest eats up most of your monthly payment.  PMI ensures that whoever is giving you your home loan is going to make a decent amount of money on you. Since you put less than 20% down, you are riskier.  This helps them make a nice chunk of change in case you default on your mortgage.  Once you have the 20% in equity, you can call up your lender and have them take it off.  PMI can run from .5-2% of the OG loan amount but the ones I have seen have been closer to the lower end.]

A somewhat broad, but pretty accurate statement, a Rule of Thumb if you will; if you do not put at least 20% of the house cost as a down payment you are going to pay Private Mortgage Insurance of at least 0.5% of the total house value monthly.

Now my PMI estimated would have run me about $120-$140, so we will split hairs and call it $130 a month.  Now if you are like me you are slightly freaking out that you owe $208 dollars a month to get your house finger painted every decade and $130 a month because the bank said you haven’t given them enough of your money fast enough.  That’s a little over $4000 a year. This type of money is the hardest to spend and has little to no benefit to the payer. 

-Forgot to cover HOA- this stands for Home Owners Association. Now about 25% of US houses have an HOA.  Much more prevalent in cities over rural area, HOAs are small governing bodies that make and enforce rules over housing communities.  If you have an HOA, generally, they require you to pay a certain amount either monthly, quarterly, or annually and they use this money to act as a hall monitor for your area.  In some areas they will do snow removal, sometimes they clean your gutters, they once told me at an apartment I was living in that I had the wrong type of chair on my outdoor balcony (not kidding).  They can also determine things like what kind of fence you can build and where you can park. Since only a quarter of people actually have HOAs I will lower the HOA in this scenario to $100 which is more on par with a normal housing situation. Google searches will say HOA average is close to $200 monthly.

Now we will assume we got a 30-year mortgage since that is more common. Mortgages generally come in 15- or 30-year options.  15-year mortgages will have a higher monthly payment, but you will save a lot on the interest due to the fact that you will often get a lower rate for a 15 over a 30, and there is less time for the interest to hang around.  30-year mortgages are usually chosen to get the lowest monthly payment

Our credit is pretty baller, both of our scores are mid 700s.  Now looking checking some quick sites I am guesstimating our interest rate would be somewhere around 4%. I know I know some people will instantly think that is way too high or too low, but it is not as crucial as you would think for the points I am trying to make.

Now if we took this scenario, buying a $320,000, with the US avg of a 5% down payment, a $100 a month HOA, a modest 1.1% property tax rate, PMI, and home insurance accounted for we would be paying about $2078 a month.

Which would give us a yearly total of about $25,000. Remember the renting total was $15,000.

Now something I see the iT is So DuMb to BUy a hOUse crowd do here is say, “SEE!!!! It is $10,000 more expensive a year to buy a house over renting!!!!”

Which in this particular case, it is.  (In lower cost of living areas, it is not uncommon for the mortgage to actually be less than a rent payment.)

Yet we have not discussed one of the most important factors! You’re paying that big ole fat $2078 bucks a month to live in this place.  That’s your money! Right! You’re getting to keep that and each passing month you become Two thousand and seventy-eight American dollar bucks richer?! Right??

Not really.

This brings us to one of the saddest parts of buying a house; amortization.

Amortization is how loans spread out the interest payments.  So, for this hypothetical $320,000 house, you put the US average 5%, $16,000, down so your home loan is now only $304,000.  You got a 4% interest rate which means per year you owe that lender 4% of that 304k. Which is $12,160.  The first year of your mortgage, you (aren’t I talking to myself?) are going to pay about 12k in interest to a bank to thank them for letting you have loan. Interest is what you pay to rent out a loan.  It is the banks fee. Monthly this comes out to about $1013 a month in interest when starting your mortgage.

Now our monthly payment is about $2078. So $2078, subtract that $1013 interest payment and that means $1065 a month is going on your principal (principal is how much is actually left on your loan) aka in your pocket! Awesome!! At least I am becoming a thousand smackaroos more wealthy each moon cycle! Except that’s not what happens!

Two more things! Generally, your property taxes are rolled into your mortgage payment.  In my situation this was going to run me about $293 a month. Yay! You also are generally required to carry home insurance; gotta protect that asset. This was gonna run me about $100 a month.  These are both required and usually the mortgage works this out for you and just rolls it into your monthly payment.

So now from that $2078 a month payment we take away $1013 in interest, $393 for taxes and insurance, $133 in PMI, and that $100 HOA payment and that leave us with…………. $438 going towards principal.

That means of the $2078 we would pay monthly, $438 goes towards what is referred to as equity.  Equity is how much you have actually taken off of the initial price of the home.  Your down payment counts towards your equity and $438 of your first mortgage payment would also go to that amount. That’s right, in this scenario, only 21% of the first payment ends up on your side.  Now, one positive is that with every single payment going forward the amount that goes onto your principal will be higher.  Since you just put an additional $438, your total loan just shrunk be that amount! Instead of owing $304,000 on your home you now owe, $303,362! Since the total is lower, the interest taken is lower as well, that change in interest will now be applied to your principal, meaning that in month two the amount that goes to your principal will be $439.47! An increase of $1.47. These increases do grow progressively, and he last few years of the mortgage most of the payment is towards the principal. 

So, $438.

While that is low, it is more than the Zero dollars a month that go into your pocket from renting.  We now need to look at what is costs for you to get that $438 back.

In our renting scenario (my actual life?) we were spending $15,000 and keeping none.  We do get a place to live and a hot wife comes included.  Now, theoretically, we would have to hope that this situation is cheaper than buying and we can utilize/invest the difference since we get no equity or return on our rent. It is, we are; great.

In our home buying scenario, it is going to cost us over $25,000 yearly. BUT each year we are keeping that monthly $438 (growing progressively) principal payment which comes out to over $5000 the first few (5ish) years. Which would make our total yearly buying cost to $20,000. ($25k- $5k we keep in principal).  This figure does not take into account house maintenance.

Now in our renting scenario we have an extra $5000 a year to invest.  You can almost finish your IRA off with that! (Which is also tax deductible…. Just saying.)

Now since mortgages so heavily front-load the interest, it is going to take well over a decade (approx. 16 years) till we get to the point where our principal payments cover up this almost $10,000 yearly differential. Meaning it’ll be 16 years until we are reaping $10k in principal making both scenarios an overall $15k yearly net loss. It was going to take us 5-6 years to get up to 20% equity, the minimum amount to get rid of that $130 ish monthly PMI payment. 

After only 8 years our yearly principal is increasing by almost $8000. And our PMI would be gone. This is when the tide starts to really turn in your favor.

Now, before we really start to break down whether you should buy or rent, I want to add in some other scenarios inside of this one.  A scenario inside a scenario; inception; inscenariocion. Exactly.

Now first the hypothetical above, $320,000 at 4% on a 30-year yadda yadda yadda you would end up paying $712,483. Yep! Well over twice the actually value of the home.  About $220,000 of this is just interest alone. Most people do not realize that when they see a price tag on a house that more often than not, they will be paying double that.  With that being said there are several strategies and techniques that could literally save you hundreds of thousands of dollars! All you have to do is click the link below and sign up for my 8-week course! I’m kidding.

Now the smartest thing you could do is just pay for the house in cash! You don’t have to go through the long and arduous process of getting a mortgage and you don’t owe jack squat in interest! If you don’t have hundreds of thousands of dollars laying around, then uhm keep reading.

Quite possibly the most beneficial thing you could do to save a mountain of cash is scrap together a 20% down payment.  In some cases that is a TON of money, but it is SO. WORTH. IT.  In this scenario, 20% would be $64,000. If you had put the 20% you eliminate the PMI which would have run me, $12,400 on this house. Your monthly payment would now go down to $1715 and the total expense of the house payments after 30 years would only end up being $617,585. ALMOST $100,000 LESS! The total interest drops down to $183,000, because instead of taking a loan for $294,000, your larger down payment only requires  you to borrow 256k. Smaller loan= less interest. One thing I thought of late and wanted to add in here is the confusion on the success of a down payment.  I have talked to a good number of people who recently bought a house and almost every single time they pridefully told me how little they had to pay down. 

“You wouldn’t believe it we got the whole thing done for 10k!!!”

It will save you hundreds of thousands of dollars to sit down and think about why someone would sell you a half a million dollar asset for only 2% cash up front. I’ll give you a hint, it rhymes with, ‘Because they are going to make a crap load of money of you, you didn’t get a good deal, you did not win by putting so little down, go passed go, do not collect $200.’

Now the second really really smart money saving technique to mortgages is paying extra.  Almost all loan payments; student, car, and house loans, have a weird impact on people where they just pay the given amount and don’t question it.  But, if you are able to, paying on top of your given monthly payment will make you a LOT of money.  When you pay extra the entire extra portion can be directed at your principal. This shrinks your interest down MUCH quicker. In our first scenario, 5% down, if you put an extra $100 a month, making your payment $2178, (this will go down) you would end up only paying 661 thousand for the house saving you 50k over the course of the mortgage and it would be done 4 years early!

You ever heard that saying about how the rich get richer?  Well if you for some reason did have $64,000 in your sock drawer to plop down for that 20% down payment, and you wanted to make that same $2078 payment as that poor sucker (me) that only had enough for a 5% down payment, you would pay $483,000 for the same house that 5% homeboy is going to $712,000. Putting 20% down and adding the $363 dollars a month to make your payment $2078 would also have your mortgage down in under 20 years.

Sounds crazy, but it happens, every day.

Now, I have probably said now too many times, maybe even three many times, and I need to wrap this up.

How do you know if you should buy or rent a house?

Should I buy?

Good Question. Once you buy that house there are a lot of other costs that come with it.  Replacing and repairing appliances, plumbing, flooring etc. now falls to you. This is expensive. You can no longer just call your landlord and have them send someone to fix it. There is also a weird incessant desirable trend of vast amount of home improvements after home ownership. I blame you HGTV.  This costs lots and lots of time and money, and rarely if ever adds the kind of value to your home price that people imagine before they begin. Also, if you move you are going to have to pay closing costs and fees to a realtor.  If you haven’t lived in the house long you won’t have built up much principal and could lose some serious dough.

So before you buy a home you should really consider the following; How close am I to being able to afford a 20% down payment? What kind of repairs/upgrades does this place need and how will I budget for such? How long am I going to live here and how sure of that am I?

Another huge thing to consider is the social pressure of buying a home. When I told friends and family, we were looking to buy a home, everyone was SO EXCITED for us.  It is really seen as a mature adult milestone in the US.  It felt really cool that people were proud of me or thought, ‘Oh wow! Didn’t know they were doing that well!’  That admiration can be misguiding and have you paying 700k for a 300k house, dude.

If you buy and then end up wanting to sell, you then become captive to the housing market.  While many assume houses just keep shooting up in value, this is not always the case and can be difficult to predict.  Often housing prices don’t rise as quickly as inflation. What people sell their houses for in your area can greatly impact your house value.  If a few people want a quick transaction and don’t need they money, they might underprice their home, making your maket drop.  A major business might decide it should move across state lines for a tax break, taking thousands of jobs and potential home buyers with it (this happens a lot). Quite often, houses do appreciate in value, and many people have gotten somewhat wealthy by just purchasing a house 30 years ago and now it is magically worth a million dollars. Yet, it is always good to be mindful that this is difficult to predict and unwise to bank on.

Should I Rent?

Ah yes, renting; buying’s ugly cousin! Often the overall cost of renting is cheaper than buying.  This can change in low cost of living areas, but when you factor in taxes, maintenance, upgrades, repairs, appliances etc. etc. etc., renting is often cheaper.

Renting is often for people that do not like home improvement projects, have no aspirations of starting an Instagram to chronicle their home renovations, and people who take great joy that when something breaks, they just send a text or two and it is no longer their problem. Growing up in a rural area where everyone has massive yards and outdoors space, I never imagined I could live without such.  Yet, weirdly as an adult, the one place I lived that I had to mow my yard it got annoying after the second month.  It is just not something I care about anymore.  Of course, there are always projects you can do as a renter, but you certainly are limited and almost everything needs some permission before you start cutting into some drywall you don’t technically own.

For people who have started investing and have a good plan, the cheaper rent cost can be a way for them to put more of their money away for retirement, live a higher quality of life outside the home, or even save up for that 20% down payment. 

Wrapping up

One thing I really want to point out that gets lost on many people is that mortgages should and can end. If you don’t miss any payments and stop trying to refinance every other year your mortgage will eventually end.  You are still responsible for the taxes, insurance, HOA, but the interest and principal portion will someday be gone. Having a paid off home is probably one of the wildest wealth building tools. Unfortunately, a lot of the jack-wagons out there mess that up and ended up paying for their house many times over.

With all that being said I am actually a huge fan of home ownership.  It is the largest expense for a lot of people, and to think there is way to keep a portion of that expense is insane. What’s crazier is that after a while, and a lot of money, you won’t have that expense at all.    Not having a house payment would be huge but getting stuck in a mortgage you aren’t ready for would be just as harmful.  I hope you could use this scenario to run your own numbers and start your own discussions of what is right for you and take those one-sided vague articles on home ownership with a grain of salt.

I ran my numbers through most of the online mortgage number crunchers I could find on the google. https://www.calculator.net/mortgage-calculator.html was by and far the absolute best one I came across. There are so many different options to mess with.  You can run an insane number of different scenarios and make the best decision for yourself armed with numbers.  Bankrate didn’t have an option for PMI (seems not in good faith). The rest you will find on a normal google search are all bare bones and generally just pointing you in the direction of a lender or realtor and not actually trying to help you.  They leave out the options to put in PMI, HOA, and insurance and taxes sometimes so that you’re given a low quote to get you excited about an expensive house. 

Would really love to know what you think I messed up on or how your numbers are different! 110% of the numbers and figures are just rough guesstimations but I tried to be honest with myself and bipartisan.

$320,000 House, 4% interest rate, $100 monthly HOA
3% down, minimum monthly payment	5% down minimum payment	5% down, plus extra $100 monthly	20% down, minimum payment	20% down, extra $100 monthly	20% down, extra $363 monthly to match 5%/min
Total Cost: $724,000	Total Cost: $712,000	Total Cost: $661,000	Total Cost: $617,000	Total Cost: $565,000	Total Cost: $483,00
Interest: $223,000	Interest: $218,000	Interest: $189,000	Interest: $183,000	Interest: $155,000	Interest: $112,000
PMI: $13,600	PMI: $12,400	PMI: $10,400	PMI: $0	PMI: $0	PMI: $0