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Renting vs. Buying

Introduction:
Every day of our lives we are told things. Often times these things are true, and often times these things are not true. So I was fresh out of college and living in an apartment, when I started to feel guilty about 'throwing my money away'. Like most people I had heard the old adage that... "If your renting, your just throwing your money away. Get a house and build up your equity." So being all fresh with those college math skills I set out to calculate just how much money I was loosing. The purpose of this article is to share with you my results.

The Therum:
After several days of research I found that owning a home isn't always better than renting. Now before you go getting upset, please note that I said "owning isn't always better", not "renting is always better" or "your as smart as a frog". I have facts and helpful graphs to back up my findings so don't go storming off just yet. The first few people I told about my discovery just about lynched me, to this day there are some people I won't talk about this with for fear of my own life. The thing that most people forget about is that in general renting is cheaper than buying. If you take the difference and invest it you can get some very interesting results.

The Controversy:
If I've got facts to back up my claim, why the agery response? I've got a theory about that.

Its what everyone says, including family friends and many financial institutions
If they are a home owner, they have a vested interested in beleiving home ownership is better
any people lack the will to invest the difference. This makes it easier to say "own a home" because they are guarenteed to get some savings

The Facts:
So lets start into the meat of the problem. Why is renting supposedly bad? Because you get no return on your investment. So, lets say you live in an apartment paying $600 a month. After one year you'll have paid $6,000 in rent, and at the end of the year you'll have bumkis to show for is. If you lived in a house paying $600 in morgtage payments, at that same year you'll have accumulated some equity (probabely around $50 or so). So, house wins... right? No. It all comes down to the difference between your mortgage payment and your rent payment. If your morgtage payment is close to your rent payment then home ownership is better. But the higher your morgtage payment is compared to your rent payment, the better off you are in an apartment, assuming you invest the difference. And there it is, the zinger... invest the difference. If you pay your rent payment and invest nothing, a home is always better. But if you pay your mortgage and invest the difference in stock, an apartment is often better. Lets play with some actual numbers. Lets say you have $1,200 for housing, and you can get a rent payment of $750, or a mortgage payment for $1,200.

$750/month rent
Rent Paid $Invested
Year 1: ($750*12m)=$9,000 ($1,200-$750 * 12m) = $5,400
Ah, don't forget interest (8% return)... $5,602.47
Year 2: ($750*24m)=$18,000 ($1,200-$750 * 24m + Interest) = $11,669.94
Year 10:($750*120m)=$90,000 ($1,200-$750 * 120m + Interest) = $82,325.72

$1,200/month Mortgage
Mortgage paid $Equity (Using standard CUMPRINC formula)
Year 1: ($1,200*12m)=$14,400 ($1,200 * 12m) = $14,400
Ah, don't forget the interest payments, so you only get $1964.82
Year 2: ($1,200*24m)=$28,800 ($1,200 * 24m - Interest) = $4,050.82
Year 10:($1,200*120m)=$144,400 ($1,200 * 120m - Interest) = $26,102.84

So now compare the end results of the two ten year periods.

Renting Total Value: $82,325.72 of investment
Mortgage Total Value: $26,102.84 of equity

Clearly in this scenario renting is the better route. Now I know whats happening, your thinking about things like tax refunds on mortgage payments, renters insurance, house maintance costs, rent increases, house appreciation... and your absolutly right. There are a ton of factors which factor into this. The spreadsheet that I made (link at the bottom of this page) takes all of those things into account with easy to modify variables. As an exmaple, the national interest rate when I made it was %5.25 (more like 6.25 now), the average stock return rate was %14.75 (more like %12.25 now) and the average house appreciation rate was 3% then. So you'll want to look over the numbers and make sure they are appropreate.

The Point:
The point here is that there are scenarios where renting is better, and some where home ownership is better. It varies on a ton of factors and situations, the largest two factors being the cost of the apartment and the house. The spreadsheet takes all of them into account (or at least all of them people have pointed out to me, yes that includes tax refunds for interest payments). So whats it all mean? Should we sell our homes and move back into apartments? Of course not. After two weeks of working on this spreadsheet, I presented my results to my wife. I was grinning ear to ear and was very pleased with the fact that we didn't have to buy a house. She patiently looked it all over and then said "Thats nice dear, but I want a house". WHAM. But shes right, these facts don't mean a hill of beans, as long as your getting a house because you want a house, not so that "I don't throw away my money". If your looking at buying a home I encourage you to create a spreadsheet of your own. Not because your it helps you make a decision, like I said thats a personal choice. No, do it because it will give you a superb understanding of the finances of buying a house. It will also help you know how much house you can afford (since one of the side-products of the spreadsheet is a mortgage payment calculator).

Recent Events:
oddly enough, several financial institutions have started to post similar statements on the web. I beleive the financial market is beginning to acknoladge that renting isn't evil.

This article talks about what to do with surplus cash, pay off your mortgage faster or invest in stocks. It should be no suprise at this point that puting your funds into your mortgage (which appreciates around 3%) is nowhere near as good a deasl as 401k investment (Averaging %10+).
http://finance.yahoo.com/expert/article/moneyhappy/30425

This interesting online calculator compares renting and buying with some interesting results. I actually don't agree with the results of this graph, I beleive it fails to take into account investing the difference. But it gives an interesting counter-point and generally says that in the short term its almost always better to rent.
http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?_r=1&oref=slogin

This article talks about the fluctuating housing market. It basically sums it up by saying there are benifits to home ownership beyond financial. Yea, pretty much what my wife was trying to drive home.
http://www.nytimes.com/2007/04/11/realestate/11leonhardt.html?em&ex=1176523200&en=c27e7d0948aecb80&ei=5087%0A

This is the spreadsheet I created for these calculations. Though as I said, I encourage you do create your own.
http://www.darkstride.com/files/HouseBuy_20071003.xls

This spreadsheet investigates how much money you'll say by paying ahead on your morgtage payments.
http://www.darkstride.com/files/MortgagePlanning_20071004.xls

Warstrider (10/11/2007)

Published on: 2007-10-10 (7272 reads)

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