Rent or Buy?

Recently, I was asked by a friend why we had not bought a house yet.  I am working part time to help make ends meet while I finish up school.  We still put away money for retirement, we put away money to cover any sudden large expenses we might have, and we put away money to cover expenses and lost income when we finally have a child.  Even with all that, we still put money away towards a down payment on a house.  It’s not a large amount right now, but we have a few expenses, like a car payment, that will be going away soon, so our saving rate will increase when that is over.

So, we are making more money than we spend, and we save that money.  We’re in a decent position financially.  Yet, we’re not buying a house, why is that?

Note:  These numbers are obfuscated a bit to not reveal too much information about my life.

First, let me guesstimate that the condo we live in would sell for $400,000.  Searching for a loan, I found one at 5.75% APR if we put 20% down on the $400,000 loan (which we do not have right now.)  That works out to be a $2,334 a month house payment.  That is significantly more than we pay now, like around 150% more than we pay in rent, not including condo fees which we don’t have to pay now.

But we save money on taxes because of the interest, right?  Sure we would.  The first year of the loan, we would spend ~$18,000 in interest.  That’s $7,300 more than the standard deduction for a married couple.  Since we are in the 15% tax bracket, that would save us a total of $1,095 a year in taxes.  Even if we were in the 25% tax bracket, we would save $1,825 a year.  So, I could spend ~$7,000 more a year on the place I live to save $1,825 a year in taxes.  This is also the most I’ll ever save on taxes because of the interest, too, since you pay less and less interest every year.

But what about the equity you gain?  Well, with that same loan, you pay about $4,100 on principle.  So, we would have increased our equity in the condo by that amount.  So, we’ve saved $1,825 on taxes and built up $4,100 in equity for a grand total of $5,925.  We still haven’t reached that $7,000 of extra cost yet, though.  The only way to make it up is to hope that the condo increases in value.  Over the long haul, it will go up.  However, there is no guarantee that in the next 5 or 6 years it will go up in value significantly, no matter what real estate people try to tell you.

Let’s assume the condo does go up a few percentage points in value over the course of the year.  That would put the buying ahead of renting in money terms.  However, I’ve only talked about the good parts of home ownership.  There are more costs associated with owning a house than with renting.  Renters don’t have to pay to replace appliances.  They don’t have to pay for upkeep.  All I have to do is call my landlord, and she is obligated to fix it.  Renter’s insurance is also less than homeowner’s insurance.  Oh, and I don’t have to pay property tax.  That saves me $2,900 a year right there.

Frankly, unless we move somewhere lower in cost and more inconvenient for us, there isn’t a large monetary incentive for us to buy a house.  Think about it, do people that own houses really have a lot more money lying around?  I’ve never really seen any evidence of this.  In fact, I’ve seen a few people that were house poor, and we actually had more disposable income than they did.  For now, I’m happy renting, and until we make more money, renting is at least as good of an option as buying, if not better.

Down With The Payments

Most people think of mortgage companies requiring a down payment as a way to protect the lender. They even require you to buy insurance if you cannot make the 20% down payment requirement. Standing on the outside watching the mortgage meltdown, I see things that could have been prevented if only people had made significant down payments.

WARNING: MATH AHEAD!

Say I bought a house four years ago for $500,000, not too unreasonable for the Washington, DC area. If I borrowed the entire amount with an ARM and a low teaser rate hoping to refinance into a fixed-rate mortgage and my house lost 10% of its value bringing it down to $450,000, I would be stuck with an upward-adjusting interest rate on a $500,000 loan and an increasingly bad financial situation. However, if I had made a 20% down payment, I would have only owed $400,000 on a house now worth $450,000. That would have given me room to refinance and let me prevent a larger jump in payments.

So:

$500,000 – $0 down payment + rising interest rate – drop in house value = you are screwed

$500,000 – $100,000 down payment + rising interest rate – drop in house value = you may be able to pull it off

The other side to the 20% down payment coin is that accumulating enough money to make that down payment requires you to be fiscally responsible enough to gather that money. This is something that has been neglected recently with 80/20 loans, piggyback loans, and/or loans for 100% of the value. They allow people with enough income but not enough discipline to get loans they are unable to keep up with.

Equity is something you should start with in a house, not hope to accrue through a rise in property value and a long history of payments.