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How Homeowners Beat Renters in a Down Housing Market

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Trendy Modern Northwest HomeI’ve been talking to a lot of people lately about home values. Many homeowners have seen their homes fall in value and they talk about how much money they’ve lost, how they can’t leave the house to seize other opportunities, how they won’t be able to sell for decades. In all the discussions, it seems there’s one thing that people focus on – purchase price. It happens when markets are good, it happens when markets are bad, and in both cases I think focusing on the purchase price is incorrect.

When markets are good, people say they bought a house for $100,000 and sold it for $400,000, implying they earned $300,000 of profit. The reality is that they didn’t – they paid interest and taxes and insurance, they paid agent commissions, they paid for repairs, etc. We forget that because it’s not the headline number. I think the same is true when markets are bad.

When the housing market is down, people focus on the purchase price without adjusting for tangible factors that improve their situation. As I thought about it some more, the more I realized that there’s a range of values, below the purchase price, where you may still come out “ahead” of renters if you were forced to sell.

Here’s the basic idea – if your mortgage payment is close to the cost of a rental in your area, then owning a home puts you slightly ahead each month. A portion of your mortgage payment is returning to your pocket as equity. The portion disappearing forever, like interest and insurance, can be compared to your rent payment. The savings, the difference between the interest/insurance/taxes (disappearing) portion of your mortgage payment and your rental payment, is how much your home can fall in value and have you break even.

Let’s take a real life example with our living situation:

  • Our mortgage is $1,400 a month with $1,000 in interest. Adjust our payment for the mortgage interest deduction and the cost of our housing is only $1,150 a month (assuming 25% tax bracket). The extra $400 doesn’t go towards principal, some goes to taxes and homeowners insurance. Last I checked, we’re accumulating about $250 in equity each month.
  • If we were renting, a two bedroom apartment averages, according to Rentometer, about $1,250 per month. There is no tax deduction for rent but we would claim the standard deduction, $11,400 for married filing jointly. Spread it across 12 months and rent falls to $1012.50.

With our mortgage payment, we are spending $900 that we can never recover. By renting, we would spend $1012.50 that we can never recover, a difference of $112.50. Each year, by owning, we come out ahead by $1350. As the years pass and rent increases, this difference will also increase since the mortgage payment will not change.

If our home’s value fell by less than $1350 each year of ownership, we as owners would be ahead of ourselves as renters. (plus we control our own destiny, a landlord can’t kick us out or raise our rents)

Warning… we’ve simplified the problem significantly because we haven’t discussed a lot of issues that complicate matters. We ignored capital losses (you can deduct $3,000 of capital losses each year, which is additional savings) and real estate agent commissions, which becomes tricky if you’ve lost a lot of equity in the home. My point was to introduce the idea that you can still come out ahead, or at least not as far behind as you think, if you are forced to sell your home for less than the purchase price.

This was just an idea that I had floating around in my head and I knew that if I wanted help in working it out, I could turn to the Bargaineering community to set me straight. I think the logic is sound, the math is only valuable as an example, so I’m curious what your thoughts are on the idea.

What do you think?

(Photo: pnwra)

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33 Responses to “How Homeowners Beat Renters in a Down Housing Market”

  1. Glenn Lasher says:

    What about property tax and insurance, though? I pay more to my escrow than to my mortgage payment, whereas a renter doesn’t pay this cost directly (though a smart one does pay renter’s insurance for his posessions); it is figured into the rent by the landlord, which, in turn, is part of the reason why rent goes up.

  2. Mr. GoTo says:

    Way oversimplified. You are also ignoring your return on equity. If you have $100,000 tied up in home equity (down payment + periodic principal payments) for a home that is at best not appreciating, you are getting zero return on that money. You must compare that to a renter who can invest that money in something that can appreciate.

    You also did not account for maintenance expenses. The cost of a new roof or exterior paint job quickly flips your equation.

  3. Courtney says:

    IRS website says “You may deduct capital losses only on investment property, not on property held for personal use” so I’m guessing that this excludes one’s primary residence – one less factor to consider, though there’s plenty others that have been overlooked in the equation. Unfortunate too, since we’re looking at having enough capital losses to carry forward for 16 years.

    So unless rents are *significantly* higher than mortgages in an area, this sounds like it only works when markets are a little bit down. Some places have lost 25% or more of their value (“won’t be able to sell for decades”); it’s unlikely that this still works out for those people.

  4. otipoby says:

    Something also to note. To keep this an “apples to apples” compare, you need to find what the rent would be in a house similar to the one you own (size, features, location, etc). If you own a 4 bdrm, 3 bath, don’t compare to a 2 bdrm, 1 bath rental.

  5. saladdin says:

    Can we please put this to bed? Just another homeowner trying to tell me how much better he has it then me as a renter.

    If you have to invent formulas to justify your stance then maybe, just maybe, renters aren’t as stupid as you make us out to be.

    You probably bought high, are seeing depreciating home prices, neighbors are walking away killing property values but you still think homeownership still comes out a head.

    Keep thinking that as I pay rent half what a mortgage would cost me and I pile the difference in my IRA/401k.

    saladdin

    • Jim says:

      :)

      This was more of a “silver lining” post than a “nyah nyah buyers are better” post. You know me Saladdin, I see the value in renting and in buying and think that your own personal situation should dictate which one is best for you. That said, my mortgage is only a hundred dollars or so more than what rent would be (I bought about a year and a half before the high, but still near highs) and part of the mortgage is tax deductible.

    • adam carolla fan says:

      saladdin,
      i’m totally with you. i plan on buying a home someday, but am totally happy with renting for the near future. i love renting!

  6. bb says:

    Realtors must love your article. But in fact, owning doesn’t save as much money as people think. Sometimes owning does cost more…

  7. cubiclegeoff says:

    This works best with people that buy because they plan on staying for a while, rather than for a handful of years. If you plan on buying and selling in 5 years or less, unless conditions are right, you probably won’t be ahead. However, if you plan on staying for a significant amount of time, there are advantages, one being that rent in some places will increase faster than your taxes and homeowners insurance.

  8. Ryan says:

    I believe this “as long as you stay 5 years” limit is outdated. Every calculator I’ve seen comparing rent vs own shows you are still paying mostly interest well past 5 years. Maybe we should start considering staying 10-15 years in the same house…

  9. Matt K says:

    there’s no way to put a silver lining in my situation when i’ve lost as many $$ i have in the “big numbers”.

    no way…

    • Courtney says:

      I agree :-/ (I tried to just post “I agree :-/” but it yelled at me for having a comment that was too short. So hopefully now it is long enough)

  10. Jen says:

    In my area, housing is still overpriced and it is still cheaper to rent then to buy.

  11. Troy says:

    World is full of opinions.

    Owning wins. Virtually every time. Sure you can manipulate the variable, the comparisons, the timeframes, etc to get your wished outcome, but owning wins. Someone owns your rental. Why do you suppose that is? To lose money?

    And what calculator are you usins, and at what ammoritization term. on a 15 year fixed at 4% more than half (55%)of the payment is going to principle and only 45% is going to principle. Oops.

    Whcih ties into my next point. Why all the comparisons to monthly cash flow of rent vs a 30 year mortgage. why not compare it to a 20 or a 15. Because the shorter term of the loan, the better owning becomes.

  12. Norman says:

    In the LONG-RUN, it is better to buy a house than to rent if you are middle class. I am 52 and looking towards retirement someday. Sooner rather than later hopefully! Anyways, I won’t have a house payment in retirement. I have to worry about taxes and insurance going up but it is a fraction of the amount that I would pay in rent for the same house. So, I look at it as an inflation protector. My house is small so it will also be easier and cheaper to maintain in retirement than a huge house. There is one thing that has been on my mind. What is going to happen to all these oversized homes that people purchased when they all decide to downsize for retirement?

    • saladdin says:

      So did you run these numbers with paying lower then mortgage rent, not paying property taxes, repair bills and investing the difference?

      saladdin

  13. roommate says:

    It’s better to buy a Cheap house and pay it off in 10 years than to keep paying rent for the rest of your life increasing @ 2 percent annually.

  14. Maria says:

    I like the overall approach, but I think you’re oversimplifying when you simply exclude the equity portion of your payment. While each payment may be decreasing the principal of your loan by $250, if your home value has gone down since you bought it, so has the equity that $250 buys you. A $250,000 house at purchase time worth only $150,000 if you were to sell it tomorrow means that the $250 you’re paying in to equity will only net you $150.

    That’s another $100/month lost, bringing you even with a renter before we even consider expenses unique to homeowners: appliance replacement, roof repairs, and maintenance. As a landlord, I budget at least $100/month for such things.

  15. zapeta says:

    Right now, I pay rent on an apartment and that money is gone each month. I feel like having a house is the same, except there is a chance I may get some of the money back eventually. Either way, I need a place to live and as long as I can afford it and I am happy there I don’t care about owning it or renting it. I’m not depending on a house to be an asset, just as a place to live.

    • cubiclegeoff says:

      I agree, it’s a place to live no matter what. That’s why I don’t think of my house as an investment and I didn’t buy more than I could afford, even though people pushed me to.

  16. Jackie says:

    “Our mortgage is $1,400 a month with $1,000 in interest. Adjust our payment for the mortgage interest deduction and the cost of our housing is only $1,150 a month (assuming 25% tax bracket). The extra $400 doesn’t go towards principal, some goes to taxes and homeowners insurance. Last I checked, we’re accumulating about $250 in equity each month.”

    If this is the case, then your market isn’t down! When the market is down, home values are dropping, often by more than $250 each month, so you’d not be building any equity.

  17. H Lee D says:

    If my home’s value fell by less than $1350 each year, I wouldn’t be complaining about my home’s value! Mine has fallen an average of $1350 every two weeks for the last four years!!!

  18. billsnider says:

    I like to think of my house as my “home” and not as an investment item. I amke repairs and improvements to improve my standard of living. I do not think of it as a return of capital or can i be better off financially by not doing it.

    If renting gives me a better living standard, so be it. If home ownership is better, so be it. All these calculations make my head spin a nd thus i avoid them.

    Bill snider

  19. Shirley says:

    I think the length of time that you intend to stay in a house is important in the decision to either rent or buy.

    If the house is situated in an area where you intend to put down roots and raise a family, then buying it seems logical since you will eventually be living there with only insurance, taxes, and maintenance costs.

    If your lifestyle is one of moving around, it wouldn’t be worth the hassle of buying and selling.

    I understand the concept of considering financial gain or loss but I feel that this decision should first be based on long-term goals and practicality.

  20. cm says:

    How can you possibly do this seriously and ignore property taxes? That alone can be $200-$300/month–goodbye difference.

    And as Saladdin above added, there are also repair costs, maintenance costs, possibly mortgage insurance, closing costs, realtor fees–none of which renters need to pay. And there is a big opportunity cost IF you could have been investing the difference in a good investment (like stocks, etc.).

    Lastly, there is risk. Millions of homes are now “under water”–which means you take a loss on a sale. That risk is shouldered by property-owners only, not renters.

    I can see buying working out fine for many people, but there is no *general* formula that always favors home-buying; it depends on a number of factors.

  21. Honey says:

    Most people do not deduct their mortgage interest, they take the standard deduction. So I think that if the cost of your mortgage, taxes, insurance, maintenance, and PMI all together is less than the cost to rent for someone who takes the standard deduction (and, of course, if your down payment, closing costs, and realtor’s fees are “appreciating” through the investment in your house faster than if you had invested it) then you have made a good deal. Otherwise, mathematically, you have not.

    • Bobby says:

      Agree on the cost difference should include standard deduction for renting in cost of ownership. Also there should be an accounting for the ability to move and change jobs easily for renting to follow ones career. With the length of time spent at each job on average decreasing over time, it is important to consider the career flexibility. After all your career is your most important asset.

  22. Honey says:

    That said, I appreciate the fact that most of the reasons to buy a home have nothing to do with getting a good financial deal. It just drives me crazy when people try to convince others that they are getting the best of both worlds. Usually, they aren’t.

  23. TTFK says:

    Besides all the other costs given, there is the TIME cost that needs to be factored in.

    - Time needed to mow the lawn.
    - Time needed to fix the leaky sink.
    - Time needed to shovel out the driveway.
    - Time needed away from work to wait for a repairman in some situations.

    Then of course, you have the long term costs of eventually needing paint/siding, the new roof, new furnace, repaving the driveway, resodding the lawn.

    Now tack on the new environmental regulations that require you to now pay thousands for a job that used to cost hundreds thanks to new licensing requirements, lead paint abatement, etc. etc. etc.

    Owning a home may be an EMOTIONAL victory, but it is far from always a financial one.

  24. People do forget all the money they pour into their homes when they figure in a profit. In fact, home ownership, especially now, is not a fabulous investment unless you plan to keep it for life. Don’t bother looking at sale value. Look at the value of having a place to live rent free once the mortgage is paid.

    Home ownership is just an effective vehicle for savings these days. If renting is cheaper than the cost of owning (interest on loan, taxes, repairs) then ownership doesn’t help much in the short term. If you plan on staying in your home indefinitely, it sure pays off well once the mortgage is paid for. Once you’re paying only taxes and upkeep, your cost of living goes way down. That’s when a home becomes a good investment.

    • cm says:

      I disagree that a home automatically becomes a good investment once the mortgage is paid off.

      If I buy a $40,000 home in this town free and clear of a mortgage (possible) and in 5 years housing prices have declined even further so that the house is now worth $30,000, this has NOT been a good investment AT ALL.

      That same $40,000 could have been earning at least a few percent in stocks/CDs/gold over 5 years and may now be worth $45,000, instead of the $30,000 it would be in if in the house.

  25. Gates VP says:

    Hey @Jim;

    I know you cut some corners, but you’re definitely not allowed to cut the “maintenance costs” corner.

    Costs to maintain are simply too big to be pulled from the equation. My experience has maintenance costs around $1500 / year which really eats into that differential.


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