Renting Vs Buying A Home (What They Don’t Tell You)
The age-old question of whether it’s cheaper to buy versus rent a home is surprisingly controversial. On the one hand we have people that say that renting is basically just throwing away your money and you should buy a home so you can start building equity.
And in their eyes, that’s way better than paying rent and making your landlord rich. Then on the other hand, we have the people that usually consider themselves a bit more financially savvy but say that owning a house is a liability.
They say that instead of buying a house, you should continue renting and then use the money you would have spent on a home purchase to invest and continue to build wealth.
I mean that’s what Grant Cardone says to do right? I read quite a few articles online about buying versus renting and I must say I wasn’t quite satisfied with any of them.
Most of them made some kind of big mistake that resulted in really inaccurate comparisons. For example, someone made a comparison between buying a five hundred thousand dollar house which cost three thousand two hundred and twenty dollars a month to own, and assumed it would also rent out for two thousand one hundred dollars a month.
It is completely insane because a landlord would never rent out a five hundred thousand dollar house for so cheap. Two thousand one hundred dollars would be well below the market rent for a five hundred thousand dollar house.
So in this in-depth buy versus rent analysis, I really did my best to make sure I was as accurate as possible so we can get to the bottom of this age-old debate.
The first step to comparing buying versus renting a home is to actually be comparing apples to apples. By this I mean that we really can’t be comparing owning a one million dollar mansion to renting out a studio apartment.
So to do this, I found a house for sale on Zillow. It’s located in Grand Prairie Texas and is priced at nearly three hundred thousand dollars. I then searched for a comparable home for rent in the same area and found this almost identical house that is listed for rent at around two thousand two hundred dollars.
Both houses are eighteen hundred square feet, have three bedrooms, two bathrooms, and a double garage. So I think it’s fair to say that the market rent for this $300,000 home is about $2,200 a month.
I know these houses haven’t technically sold or rented at the listed prices yet, but it will likely be close enough to the list price. So let’s break down the costs of renting versus buying these homes first.
I want to make clear a few assumptions that I’m going to be using since homeowners stay in their homes for an average of 13 years. I’m going to calculate whether it’s cheaper to buy versus rent over a 13-year time period.
I’m also going to be assuming an annual inflation rate of 2 percent which is how much more expensive things will get year over year over the 13 years.
Okay, so let’s take a look at the costs of renting this $300,000 house and side note. The market rent for this home is around $2,200 a month. Another cost you’ll have when renting is renters insurance which i found a quote for $20 a month.
You’ll also have one more cost when you’re renting and that’s all the many fees that landlords will tack onto it for stuff like smart home features, parking, and utility management.
I’m going to assume $80 a month for these fees which brings our total monthly payment to $2,300 a month. But this is only our payment for the first year throughout the 13 years that we live there.
Our rent and other expenses will continue to rise because of inflation. So i’m going to assume that our rent and other expenses will increase with inflation which is 2 percent annually.
This means that even though we start out renting at two thousand three hundred dollars a month, as rent rises over time we’re going to end up paying over two thousand nine hundred dollars in year thirteen.
I’m going to take the average cost of rent over the thirteen years which is two thousand six hundred dollars a month so this is our total average inflation adjusted rent.
Now we have to calculate the money we can make by investing the money that we saved by choosing to rent instead of buying the three hundred
thousand dollar home.
The average down payment for a home in the USA is 12 percent of the purchase price. So I’m going to assume that we are the average so 12% of a $300,000 home is $36,000.
If we had bought the home then we would have also had to pay around 2% of the homes price and closing costs. So we’ve also saved an additional six thousand dollars when renting.
We do however usually have to pay one month’s rent to the landlord as a deposit. So if we total these numbers up, then the amount we saved by choosing to rent versus buy a home is $841. We can invest this money to make additional income.
So let’s say we invest it into an S&P500 stock market index fund which has historically returned eight percent annually. After thirteen years, we would have turned our initial investment of forty one thousand eight hundred dollars into one hundred and thirteen thousand six hundred and eighty dollars.
This is equivalent to around four hundred and sixty one dollars a month in investment income. We can subtract this number from our total monthly cost which gives us $2139 which is our true average monthly cost of renting this home over 13 years.
So now let’s take a look at the numbers if we were to buy this $300,000 home instead of renting it. In this case, we’re buying the house with a $36,000 down payment and paying six thousand dollars on closing costs.
This totals forty two thousand dollars. The rest of the money to purchase this house will come from a mortgage loan, and right now the average thirty year fixed rate mortgage is around two point eight eight percent.
So that means that the monthly mortgage payment will be one thousand ninety six dollars a month. Unlike renting, this number is fixed so we don’t have to worry about adjusting for inflation.
This is one of the benefits of buying a home versus renting but there are so many more costs to owning a home. These costs will increase with inflation. You have to pay things like property taxes and for this home, I worked out that the average taxes paid over 13 years will be $610 a month.
You also have to pay homeowners insurance which will average $110 a month. One expense that many people forget to factor in when buying a home is the cost of repairs and maintenance on the home.
For example, let’s say that every 15 years you have to replace your roof and that this will cost you $15,000. Then you have to set aside one thousand dollars each year to budget for this repair.
So for repairs I’m going to assume that it’s going to cost on average $200 a month. We also have to pay mortgage insurance which is $130 a month. This is an extra payment that you have to make in order to secure the mortgage lender when you have a down payment.
That’s less than $20 and since ours is $12, we have to pay it. This brings our total monthly out-of-pocket housing expense to $2145. But here’s where it gets interesting.
When you make monthly payments towards paying off your mortgage, a portion of that goes towards paying off the interest of the mortgage, and the rest of that goes towards paying the mortgage principal.
During the 13 years we own the house, we will be paying off around $560 a month in principle. This is equity we’re building in the home. So it’s not really a cost but more like a forced savings account that’s trapped in your home until you sell or refinance it.
Another form of savings that we receive by owning a home versus renting is tax savings. As a homeowner, we’re allowed to deduct our taxable income by the amount we spend on mortgage interest payments and property taxes.
So in this case, we’ll spend $1146 a month on interest payments and taxes. We’ll be able to reduce our taxable income by this amount and if we assume that our marginal tax rate is 22%, that means we’re going to be able to reduce the amount of taxes we pay by $252 a month.
Another form of income that we’ll gain by owning a house is appreciation over a long time horizon. Housing has historically always increased in value. I know that the real estate market increased by around 18% in 2021 but this isn’t sustainable.
Data has shown that real estate has historically kept pace with inflation. So we’ll assume that our house will go up in price around two percent a year. In 13 years, our house will actually be worth $388,000.
On a monthly basis, we’ll be gaining around $565 in appreciation which is a gain we can subtract from our housing expense. But we’re not done yet. We also have to factor in how much it cost us to close on the home which we said was six thousand dollars, as well as the cost of selling the home.
After thirteen years, I’ll assume that this will cost seven percent of the sales price since the typical realtors fee is six percent, and you also have to pay for a few other different things when selling a home.
Even though we pay these expenses when we actually go to buy or sell the home, I’m going to stick to calculating everything on an average monthly basis.
So this will cost us $213 a month and this brings our net monthly cost of owning a house to $981 a month. But there is one final step that i feel is only fair to include. In the rent example we calculated
how much we could make through investing our housing down payments.
It’s only fair in this buying example to also include the extra money we can invest monthly since our housing payment is lower than our rent payment.
Since our out-of-pocket rental cost is $2,600 a month and our out-of-pocket housing cost is $2145 dollars a month, our out-of-pocket housing cost is 455 dollars less than renting.
This is money we can invest into the stock market at an eight percent annual return. This will actually make us a massive $117,364 over 13 years. This is equivalent to $752 dollars a month in extra income.
I know this sounds ridiculous but if we take this into account, then the true cost to own this $300,000 home is actually $229 a month. I know it’s crazy to go from an out of pocket housing cost of two thousand one hundred and forty five dollars and somehow end up at a true cost of two hundred and twenty nine dollars.
But that really is the power of tax advantages, house appreciation equity build up, and investing the difference. So in this scenario, buying a house is actually cheaper than renting that same house for 13 years.
With that being said though, there are just so many factors that can change the results of a buy versus rent analysis. To name just a few, your tax rate, how long you stay in the home, whether you invest or not, how much the housing market appreciates, and the rate of return on your investments.
These are all things that can change the result of what’s cheaper. Just because in this scenario it’s cheaper to buy a house than renting doesn’t necessarily mean that it doesn’t make sense for you to rent.
If you don’t want to worry about housing repairs, buying and selling a home, and want to have the flexibility to be able to move whenever, then renting is probably a better option for you than buying.
Another thing that’s important to note is that as our analysis showed us buying and selling a home is expensive. So if you only plan to live in the home for a short time, then you won’t have as much time to recoup these costs. So it would make more sense to rent.
Overall, it will usually make more financial sense to buy if you’re planning on living in the same place for three to five years or more.
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