Article
As a 27-year-old financial advisor, between my friends and clients, I am frequently questioned about whether or not to the rent or buy. Owning a home has many benefits. Who doesn’t want to customize a house and take pride in the home they have created? Being a homeowner is also a rite of passage into adulthood and a symbol of financial well being. However, a common misconception is that renting is throwing money away, and owning prohibits this waste of money. This may or may not be true, depending upon your circumstances.
A rent vs. buy analysis is not a one-size fits-all deal. Each individual’s or couple’s decision will be unique to their circumstances. The following analysis is an illustration of the cost (or benefit) of renting vs. buying in a general scenario for someone in our area. The following variables will be used in the analysis. (Note that rounding may cause some calculations to appear off by one or two dollars.)
House Price
$215,100 (9/30/2017 median sales price of existing homes in the South)
Mortgage Rate
3.83% (National average for 30-year mortgages for the week ended 9/28/2017)
Property Tax
0.57% (Per the tax foundation, South Carolina’s average property tax rate)
Repairs and Maintenance
1% of home price each year (Rule of thumb: will be less in some years and more in others)
Homeowner’s Insurance
$75/month (Per Zillow, approximately $35 a month per $100,000 of home value)
Rent
$80l/month (Per census bureau, the average rent in the South was $725 as of 12/31/2014. Rent increased 1.6%/year in the South from 12/31/2009 – 12/31/2014. I assumed rent grew and would continue to grow at 2% from 12/31/2014 – 12/31/2021, and I took the average rent from 12/31/2016 – 12/31/2021 of $801.)
Marginal Tax Bracket
25% (Under current legislation for 2017, this tax bracket ranges from $37,950 – $91,900 single and $75,900 – $153,100 married filing jointly.)
Utilities
Equal to renter’s insurance.
Life Insurance
Equal to renter’s insurance.
These variables pass the eyeball test as reasonable assumptions here in Columbia. If you make a 20% down payment on the house of $43,020, your total monthly bills for ownership would be $1,161 ($805 mortgage payment + $102 property taxes + $179 repairs and maintenance + $75 homeowner’s insurance). Those bills are actually reduced by $438 when you consider $156 of tax deductions for interest expense and property taxes and $281 equity being built by mortgage payments,* which gives you a true cost of ownership of $724 a month compared to $801 a month for renting (or $77 of monthly savings). That means ownership provides annual savings of $924!
While $924 a year is a material amount of savings, you made a down payment of $43,020. That $924 is only a 2.15% annual return on $43,020. That’s not a fantastic return—and over the financial long-term horizon of 30 years, you will likely do better in the stock market Also, I assumed a 20% down payment, which means you avoid mortgage insurance. Banks are willing to lend you money for a mortgage for less than a 20% down payment (20% down). However, to lend you money at less than 20% down, a bank will require you to purchase and maintain private mortgage insurance until you own 20% of the house. Private mortgage insurance costs about 0.5% of the home’s value each year.
On the other hand, if you were to only put 10% down, your cost of ownership would increase from $724 a month to $833 after the larger mortgage payment and the introduction of mortgage insurance, which is more than the $801 monthly cost of renting—and would cost you a $21,510 down payment! From a purely financial standpoint, this is certainly a situation to avoid.
The Tax Cuts and Jobs Act (TCJA) has roughly doubled the standard deduction. For individuals for whom the above scenario applies, that likely means you will no longer itemize deductions, causing you to lose out (or largely lose out) on the mortgage interest and property tax deduction, raising your monthly cost of ownership to $880 in the 20% down scenario (and to $1,026 in the 10% down scenario). The TCJA almost exactly reverses the cost of ownership in the 20% down scenario from a $924 annual benefit compared to renting, to a $948 annual cost compared to renting. Note this change does not necessarily mean you will owe more tax, it simply means the direct tax benefit of a home purchase is replaced by a higher standard deduction, which can be received by home purchasers and renters alike.
Look closely at your personal financial situation when making a rent vs. buy decision. Also, be sure to weigh the non-financial benefits of each alternative when making your decision. However, do not purchase a house under the assumption you are throwing money away by renting because that might not be the case. Home purchases are the largest financial decisions most people make. As with any large long-term financial decision, consult with a trusted professional when making a home purchase decision.
*Based an average monthly interest expense and principal payment in the first 5 years of the mortgage.
