re: home ownership
Updated: Read the comments; Bert's broken down the math even more to make it a better net-plus to own vs. rent
Alright, I've always been REALLY unsettled by the prevailing mindset that "owning is better than renting." I'm going to finally sit down and do the math. I know jack-shit about home owning, so any hidden financial benefits of owning a house like tax write-offs are lost on me. Feel free to comment with any errors in the math here.
Let's say Bob (a 25-year old single male) has $60,000 of cash saved up and is attempting to determine whether renting or buying is the better decision (mathematically).
Bob, who has certain standards of living, has decided that if he were to buy a house, wants to buy the priciest house he can afford (since those $200-$300K value houses have the great appreciation value). Given his initial $60K, he decides to buy a house in the $300K range (which gives us the round 20% down). For the sake of mathematical simplicity, let's assume he goes with a traditional fixed-rate 30 year mortgage (so we can discount HELOC and the 80/20 loans, which as far as I can tell, are even worse financial net-negatives).
Let's say that Bob wasn't stupid enough to constantly sign up for new credit cards offers that gave him $250 statement credits (unlike an idiot named Roy), so he has decent credit. Mr. Moneybags at the Bank gives Bob a nice 7% rate. This means:
Bob put down $60K for a $300K loan @ 7%
(For the math, I got lazy and used this calculator).
This equates to a monthly payment of $1597, of which roughly $16,000 your first year is an interest payments alone.
I asked my mom about some added costs of owning a home (roughly in that price range): annual property tax: $6000, annual insurance: $1000, maintenance: $500
This works out to about $2200 per month to own a house.
Let's look at the flipside. Bob decides to rent an apart instead for $1300 (number pulled out of my ass, but I can safely say that living in my $1300 loft affords roughly the same level of luxury as a $300K house)
The annual rental cost for Bob works out to be -$15,600.
The average annual cost of a house is -$21961 (6000 + 1000 + 500 + 14461).
This is a net difference of $6000 in owning a house versus renting an apartment. But wait, when you buy a house, you're buying a piece of investment!.
Very true; the principal you pay is a part of your investment into your home.
So let's say that the difference in costs between owning and renting ($6000) is the amount you need to clear on your house's investment in order to be profitable in the short-term (notice I've discounted the actual value of the house). That means that a measly 2.5% appreciation on the value of your house will make it the net-positive move.
But wait! What about that initial $60,000 you DIDN'T put away when you rented? Investing in the S&P 500 over a long period if time returns roughly 10% annualized... this means you need to make $6000 year on your house(~5% appreciation per year for your home)
So the 10-minute conclusion is this: if your home will appreciate more than 5% per year, buying a house in the short-term is the smart move. Otherwise, rent.
Bert or somebody smarter, please feel free to tear this math apart. I'm sure there's a bunch of logical errors here that I'm missing.
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bert
A couple of quick corrections for you.
1.) your P&I should take into account property tax. well.. crap.. mine does =)
2.) interest is deducted by a little bit each month, meaning your loan amount goes down by a little more each month. (nickel and diming the loan to death).
3.) you assume you live by yourself without a family for the rest of your life.
outside of that.. I'm looking at a comparable situation (living in Chapel Hill (not the college area) is like living in an up and coming young professional area. My buddy pays $875 a month for Alta Springs, but that's more decent college living. The stuff by Southpoint is more like $1000 a month.. so we'll use that.
or buy a townhouse/condo/etc.
so from a purely I'm wanting to save as money as i can perspective, a 3 br makes sense no? but why would you want to live alone? is it worth more to you to live alone? is it worth more to be able to change your walls? or to actually legally own a pet? ok enough of that hyperbole.
what hannah says is right too btw.
essentially you get back 37% of your annual interest payments so of your 16k you get back for sake of laziness $6k (surprise, my tax return was slightly over that last year).
so back to math. lets say my place was a $300k place, and I put 60k down. now i'm a SMART kid.. and i refuse to get locked into a loan for anything more than 5.5% (i actually got 4.875 and 5.125 on my two mortgages), but lets just say 5.5%
so each annual payment should come out to be $240k*5.5% = $13,200.
monthly INTEREST payment of $1100
P+M+I = your aforementioned 1597, rounded to 1600 to make things easier
ok.. so wtf is PMI.
well your place is say worth $250 to the state of Cali. and if you're lucky to live in irvine you pay 1% property tax a year. ($2500, or roughly $200 a month)
Principle = $300
Mortgage = $200
Interest = $1100
=$1600
which is $19,200 a year.
(renting by yourself is $12,000)
we cool? just remember the MI part is tax deductible. so.. yeah.. roughly 1300 a month is tax deductible.
15600 is tax deductible, at 37% tax rate, you're getting back $5800 or so.
meaning your end of year costs is 19200-5800= $13,400 a year., but roy said there is insurance (mine costs me $500 a year), maintenance (this is really a wash, since this is your choice). ok.. so lets say $14,000 a year for simplicity. =)
ok so for essentially $170 a month more, you are owning your own place.
But what if... WHAT IF...
you were to get it at 5.25%? then your payments go down... because you owe less every month. its' a good deal and we're almost even. =)
ok. so price point justification is just one part of it.
Second, owning a house is a long term deal. each month you're paying this pesky principle assuming you take this kind of loan (i took a interest only loan in Cali since i knew i was moving relatively soon.)
but what this means is if you owe $240000 at month 0, then after your 1st month payment you will owe, 239,700 and your PMI structure goes a few dollars more to principle and less to interest. the idea is that you pay off everything in 15 or 30 years.. depending on your loan agreement.
ok..
now.. your 2 or 3 br townhouse that you bought for $300k... you're paying $1600 a month for it. so you get 2 roommates to help pay for it. say for $600 and $700 a month.
so what would someone really be paying for the place? well you can do your own math there.
as for the more touchy/feely stuff. How about space? I guarantee you that my place is bigger than the place anyone else rents.
I have a garage built into my place.
I don't have to ask anyone for permission to do anything to my place.
so the last parts are just debating what is worth what to you.
prolly much more than you needed to know.
jinshil
hapy
jinshil
Second, tax benefits are really great, which is the main reason why people are constantly saying buying is better than renting. PMI (the monthly mortgage insurance you have to pay if your down payment is less than 20%) is now tax deductible. Plus, the mortgage interest is all tax deductible.
I think ignoring the tax benefits of owning in the math will unfairly skew the argument towards renting.