Here’s the thing about being a twenty-something – just about everything you do turns into a pissing contest (thanks a lot, social media). Our twenties is the period in which “mandatory” structure is removed from our life and we’re able to choose where we spend our time. It’s the time when we’re grouped in with the rest of the twenty-somethings of the world, or the time when we separate ourselves from this group – for better or for worse.
Loads of life-altering shit tends to happen during these years: marriages, career starts and changes, babies, travel, education. Our priorities manifest themselves during our twenties either inadvertently or deliberately.
While I could talk all day about reproduction and grad school, I’d like to focus on a different life-altering event: buying a house. Specifically, I’d like to explore the differences between buying and renting.
“Mark wants to talk about real estate again, big surprise.”
Sarcasm. I know about that.
Buying versus renting – there is an inevitable stigma associated with each option. Buying conveys success and commitment – surely anyone who can buy a house must have his or her life on track. Renting, on the other hand, suggests uncertainty; maybe even a hint of immaturity. Hell, renting is something we all did in college, and I was god damn moron in college. Ex post factor, if you rent in the real world you’re a god damn moron.
In addition to being better socially, there is also the widely-held belief that buying is the superior financial decision.
If you’ll allow me, I’d like to offer my take on the whole buying/renting debate. Recall, this is a lifestyle design blog not a personal finance blog – I’m not going to get into the nitty gritty down-and-dirty financial details of the two. If you’re interested in this specific subject, Paula Pant over at Afford Anything wrote a terrific piece that dives into it.
Common beliefs as to why buying is superior to renting
- Renting is throwing money away. I need to buy my own place so I can build equity.
Equity. This is the primary reason twenty-somethings buy a home. They know enough about personal finance to know that equity is a money word, but not enough to know that they their understanding of equity is misapplied at best and wrong at worst.
“Hold up, Mark. I don’t know what equity is. And you’ve established a culture here where I feel like I can ask questions like this without being ridiculed.”
You’re absolutely right about the culture thing, idiot. Equity, in the world of real estate, is the difference between how much a property is worth, and how much you owe on the property (how much of a loan you have left to pay off). For example, if your home is valued at $200,000 and you owe $160,000 to the bank that gave you a mortgage; your home represents $40,000 in equity.
You’re probably thinking, “But didn’t I make a $40,000 down payment to buy the house – with $40,000 in equity, my net gain is actually $0.”
Right on, brother (or sister) – you’re smart as hell!
The reason consumers get so hot and bothered by equity is because real estate has a long history of increasing in value over time. That $200,000 house might be worth $240,000 in five years, and at that point you may have paid down your loan to $140,000. Now you have $100,000 in equity, and on the surface, your home looks like a nice investment. But that $100,000 in equity doesn’t tell the whole story; it doesn’t include expenses. And expenses are plentiful in the world of home ownership.
It’s helpful to take a step back to look at the broader financial picture of owning a home. Let’s break this picture into two categories: equity and expenses. It’s quite common for young people to justify buying a house by claiming that they are building equity as opposed to wasting money on rent payments. However, when you own property, only a portion of your total monthly payments goes toward building equity. The rest, just as rent is, are expenses.
- Principle portion of your loan* (the amount you borrowed not accounting for interest)
- Interest portion of your loan
- Property taxes
- Property insurance
- Capital expenses
- Home-owners association (HOA) fees or membership dues
- Closing costs
Returning to our example, your home currently represents $100,000 in equity. But equity isn’t equivalent to profit because in order to achieve that $100,000 you had to pay down your loan by $20,000. Plus you made a $40,000 down payment initially. Let’s say the taxes on your home run $4,000 a year – over five years that’s another $20,000 in expenses. $1,000 per year for insurance is another $5,000. And closing costs set you back $3,000. You may have needed to replace your roof or HVAC or furnace at some point in the last half decade. Let’s estimate another $8,000 in big ticket expenses. In addition, the grass doesn’t cut itself, nor does the driveway shovel itself, nor do the walls paint themselves. I know what you’re thinking and no I won’t go fuck myself. So maintenance expenses have run you another $5,000.
Even in this situation where your home increases in value roughly 5% year after year, not only have you not profited, you’re actually down $1,000 over five years of home ownership.
Equity = $110,000
Expenses = $20,000 + $40,000 + $20,000 + $5,000 + $3,000 + $8,000 +$5,000 = $101,000
I know this is an arbitrary example with hypothetical numbers, but the point of it all was to clarify the misconception that buying a home is always a good idea because equity. Although the associated figures I chose weren’t factual, the expenses themselves are legitimate. At least I’m pretty sure property taxes are legitimate. If not, Uncle Sam has an ass kicking strongly worded letter coming his way.
If you’re in the searching phase now, don’t start thinking you’re making a brilliant investment because you’ve stumbled across a diamond in the rough that’s going to increase 20% in value every year for the next ten years. For one, banking on appreciation (property going up in value) is not investing; it’s speculating. If you think this is investing you probably think playing slots is investing too. In addition, there are people who do this shit for a living (scour the market looking for deals). Why do you, a naïve first-time home buyer, think you’re more adept at finding a deal than the guy or gal whose livelihood depends on finding such deals? That’s insulting. Don’t be insulting.
With all this said, there are absolutely situations where it makes better financial sense to buy then it does to rent. But this is not a universal fact nor is it even the norm. If you learn one thing from this article I hope it’s this: when comparing buying to renting, you need to dig deeper than simply looking at monthly rent and monthly mortgage payment.
One of the reasons people don’t make a comprehensive comparison between the two is because we just don’t know any better – we’ve grown accustomed to the simplicity of renting. By the time Joe Shmo purchases his first home, he’s been renting for almost 10 years. He signs a lease saying what his monthly rent is, he pays that rent, and he’s done. It’s constant. And it’s repeatable. No surprises. Combine that simplicity with a few misleading mortgage broker advertisements, and it’s no wonder that people don’t understand what they’re getting into when they buy their first place. They’re told the monthly mortgage payment by their loan officer, compare it to similar properties available for rent, drool, and write a check.
After digesting all that, you might still be thinking, “But wait, renting is 100% expenses. Even if owning comes with some heavy expenses, you still have something to show for it in the end – you still have a property that’s probably going to increase in value. That has to be better than renting.”
Good point. Take back everything I’ve written so far. Article over.
The comment here is not false. At least not always. But the numbers need to be crunched for every situation. More often than not, the home you live in is not an asset. It’s a liability. I’m going to throw that in some block quotes for good measure.
“The home you live in is not an asset. It’s a liability.”
That means that your primary residence, unless it was bought very strategically/luckily, or was an income producing property at one point, is going to cost you more money than its going to make you.
Knowing that, I would suggest that you’re better off tying up a little bit of money with a security deposit and rent, and using what’s leftover to buy index funds (or a rental property!) than you are tying up a ton of money with a down payment and plethora of expenses, and not having much leftover to actually invest.
That escalated quickly! It’s not my intention to discourage anyone from buying a home. I only mean to offer a different perspective – one that doesn’t seem to be shared or considered by many of my fellow twenty-somethings – on the financial aspects of owning the place where you live. There are plenty of great reasons (I think) to want to own a home. Just don’t trick yourself into believing that one of them is because “renting is throwing money away”.
- Owning a home is part of the “American dream”.
Living in the United States sure is neat. One of neatest things about living here is having the ability to own property. We’re all able to exchange our money for material possessions. One such possession is a structure with walls and a roof that sits on a plot of land. Another possession is a thumb tack. Another is a stick of deodorant. Okay, maybe I’m being an asshole but I think this mantra of “buying a home is part of my American dream” is somewhat antiquated. I mean, where do you draw the line? There is no limit to the number of things you can own. What is so glorious about owning the place where you live?
And I’m using the word “own” loosely here. Because, shit, you don’t own the home until you pay off your mortgage, and Americans take their sweet time achieving that if they ever do it at all. 30-year mortgages are the norm and most people either “trade-up” to a more expensive house before they pay theirs off, refinance their mortgage for a number of reasons, or get foreclosed on.
So if you’re going to use the American dream rationale to justify buying a property, either buy it in cash or pay it off as quickly as possible. If you don’t, I’m going to ask that you admit you’re a hypocrite and acknowledge that the American dream isn’t about home ownership but rather about having mortgage documentation that describes how close you are to owning a home.
- Buying a house offers more room for activities.
There’s another demographic that chooses to buy a home because they’re starting a family and need a bigger space. These hill-folk don’t have access to the internet so they have no way of knowing that it’s possible to rent homes that aren’t apartment units. Any type of home that is available for purchase is also available for rent. From luxury beach front properties to urban lofts, if you can find one to buy, I guarantee you can find one to rent. So arguing that it’s necessary for you to purchase your home because you need a bigger space for your family or rock band doesn’t have much merit.
Freedom and flexibility
There ya go. Three of the common justifications for buying a house shot down with Mark’s blogpedo. In addition to being a perfectly good financial decision to make, not being a requirement to fulfilling the American dream, and providing sufficient space for your kids/motorcycle, renting offers something else that has a profound effect on the design of one’s lifestyle. It offers freedom.
- Renters tend to have fewer possessions.
If you’re renting, chances are you’ve accumulated less shit. This isn’t a fact, as there are plenty of people who rent detached single family homes that have just as much junk in the garage and basement as your typical home owner, but I would suggest that renters in general have less stuff. Having less stuff means it’s easier to be adaptable. Adaptability is a nice attribute to have (I’ll explained by the time you can say amortization)!
- Renting provides less obligation.
I understand that you signed a lease, but it’s like I always say, “I’m not lettin’ no stinkin’ piece of paper tell me how to live my life.” Really though – if something came up where it made a lot of sense to up and leave, breaking a lease isn’t the worst thing in the world. I can live with losing my security deposit and not getting a recommendation from my landlord (I really hope my tenants don’t read this).
This isn’t an option for home-owners. They either put the house back on the market and sell it (this takes time, effort, and money) or ditch the house and let the bank foreclose on it. I wouldn’t want these to be my only two options if I’m ever caught in a situation where it’s really appealing to move and to move quickly (job opportunity, family emergency, change-of-heart, etc.).
Or maybe you just dig the nomadic lifestyle and want to live in new cities/states/countries every few years. Chances are if this is your lifestyle you wouldn’t have bought a home in the first place, but that’s not to say people can’t change. I, for one, have no idea what to expect from 30 year old Markie. All I know is I like having options. Literally, that’s all I know.
- Buying is risky business.
You must think pretty highly of yourself if you take out a mortgage. Consider what you’re actually doing. You’re betting that your financial situation stays the same or improves for the next thirty years. You’re betting that you won’t ever lose your job, or have health problems, or fall out of favor with your bookie. Because if any one of these things happen, and you’re living paycheck-to-paycheck (like the vast majority of Americans), you’re going to be in trouble. T-R-O-U-B-L-E.
I’m playing a bit of devil’s advocate here. I mean, I have a mortgage and like to think I have a decent amount of humility. But I fully realize that being in any kind of debt is a risk, and shouldn’t be taken lightly. On the contrary, renters have the ability to adjust their housing costs each month. If something unfortunate happens where they can no longer afford their rent payment, they can always find a cheaper place to rent. Again, not the case with home-owners. Once you take out a mortgage, you’re committed to it. If you lose your job and can’t make mortgage payments, you either sell (time, effort, money) or get foreclosed on.
So which should you choose?
While my tone suggests that I’m strongly in favor of renting and that owning is always a foolish decision, that’s not the objective I had for this piece. Like most of my articles, the purpose of this is to encourage you all to make decisions deliberately – as simply following the herd is not the ideal way to maximize your quality of life.
If and when you start considering buying a house, first make sure that you’re not just getting caught up in another pissing contest – make sure you’re buying a home for you and not for all the attention you’ll get on myspace. Once you’re convinced of that you can start intelligently weighing your options.
Don’t buy a house because you like the idea of buying a house. Don’t buy a house because renting is throwing money away. Don’t buy a house because you need more space.
Buy a house because you feel it will bring enough value** into your life to justify sacrificing all the benefits associated with renting.
*Paying down principle can be said to build equity because principle always stays constant while home values generally increase.
**Not monetary value