Should I Buy a House if the Mortgage is the Same as my Rent? Is Owning a Home For 5 Years Worth It?
Ever heard this: "I might as well buy a house because the mortgage is about the same as the rent"? It’s not that this statement is wrong, but there’s a crucial next question you have to ask: “How long are you planning to stay in that house?”
Many people think they’re making loads of money on their “investment” when they sell their primary home. I’d challenge this mindset of primary home ownership being an “investment” and rather I see it as a forced-savings plan. In today’s post, I'm going to assess buying a house, living in it for 5 years, then selling it and seeing how much the "investment" actually made after all is said and done.
First, some assumptions:
Home Price: $331,400 -- which is the median sales price for new houses sold in the US according to the St Louis Federal Reserve in December 2019. Using the same Federal Reserve data since 1989, the average appreciation for the past 30 years has been 3.30% on the median sales price.
Closing Costs: I've read from multiple sources that as a general rule, closing costs (title fees, inspection fees, taxes, etc.) run from 2% to 4%, so we'll use 3% of the home value in our example. This equates to paying ~$10,000 when you buy the house and ~$12,000 when you sell the house.
Maintenance Costs: Let's assume 1% per year, on average. Some years will be much less, and some will be much more. This is a general rule of thumb -- or you could apply the $1 per square foot rule and arrive at a similar figure.
Property Taxes: 1% of home value per year. Some states and counties have as low as 0.30% while others are as high as almost 2.50%.
Home Insurance: Average annual homeowner's insurance premium is $1,192 according to the National Association of Insurance Commissioners -- which equates to about $100/month.
Last assumption for the house -- you actually have 20% down to avoid the mortgage insurance premiums -- so in our case, you have ~$76,000 saved up ($66,000 for house and $10,000 for closing costs) and take out a loan of ~$265,000 to buy the $331,400 house -- you get an interest rate of 4% for 30 years.
Are you excited? I know I am. Keep reading!
After 5 years when you walk away from the house, pay the bank back and all closing costs, you're walking away with about $138,000! Remember, you started with $76,000, so you made $62,000 right?!
Well, not quite. Remember, you paid about $117,000 into the house through your mortgage, property taxes, maintenance, etc. So really, you poured in $193,000 (the initial $76,000 saved up plus $117,000 over the 5 years you lived in it), and you only walked away with $138,000, which equates to an internal rate of return of negative 0.84%, or losing $55,000 over 5 years.
Doesn't really sound much like an investment does it? Rather, to me it sounds like a forced savings plan (because you HAVE to pay your mortgage and property taxes -- or else you're living in your parent's basement).
So in essence, you paid $55,000 over 5 years to live there -- meaning you had a house to live in for a cost of $11,000 per year ($55,000 divided by 5 years). Whereas if you rented that same place for $1,500/month you would have paid $18,000 a year in rent.
So the house still wins on paper right? Yes. That is right. From a purely technical perspective, yes.
HOWEVER, there are 2 key considerations that most people fail to consider. And these are huge. One of the biggest mistakes when assessing personal finances is ONLY looking at what makes sense on paper. This is where having a financial coach or a financial planner (depending on where you are in your financial journey) comes in. How does this major life purchase align with your mission (or your collective mission if you’re married) and your collective financial goals? How does it tie into your personal money habits and money scripts (unconscious beliefs about money developed through nurture) and help you better achieve the goals you personally are seeking after? Not because it’s “the right thing to do” or “because my peers are doing it”, but because it makes sense for my personal, unique financial situation.
Here are the 2 factors:
1) Monthly Cash Flow
The above example completely ignores how much money is paid every month to cover total housing costs in the ownership vs renting scenario. On average, when considering in mortgage, insurance, property taxes, and maintenance, your monthly housing costs are $1,950 when you own the house, whereas when you rent it's only about $1,600/month average over the 5 years. Meaning if you rented, you would have an extra $350/month to do WHATEVER you wanted with -- travel, save, give more, go out to eat more, pay down your student loans faster, whatever that is for you. In other words, that's flexibility (because you lowered your monthly fixed expenses).
In the world of personal finance, there are a couple rules of thumb about debt to income ratios. The first is that housing costs should not be more than 28% of your gross (pre-tax) income. The 2nd is that your total monthly debt payments from all sources should not exceed 36% of your gross income.
So if your household gross income per year is $70,000, your total housing costs should not exceed $1,630 per month (which owning the house would exceed that threshold sitting at $1,950/month, whereas renting would not at $1,600/month). And if you have other forms of debt like student loans, a car loan, or credit card debt IN ADDITION TO owning a home, you can say goodbye to most of your paycheck as soon as it hits your bank account.
2) The Value of Your Time and Consideration of Stress
To think that the time commitment in owning a home vs renting a home are the same is far from true. I will admit looking for rentals is time consuming, but nothing compared to getting pre-approved for a mortgage, finding a real-estate agent/broker, inspections, getting a loan, and doing all the forms of paperwork.
Additionally, when something breaks down in your rental, you call your landlord. In your owned home, it's your problem from both a time perspective and money perspective! And stressful too.
Again, while cleaning your entire rental is kind of a pain when you move out, it doesn't even compare to the amount of time to list your property, send your dog to your parent's house and keeping the house spotless for when potential buyers come, and having to work with your agent to sell the house and repay the bank their money.
All of these intangible factors (the value of your time and the amount of stress) HAVE to be considered when comparing the rent vs own analysis.
1) Owning a home for 5 years (or amount of time shorter than this) is not so much an investment but a more expensive forced savings plan.
2) Finances should not only consider what's best on paper. You've got to consider the other factors such as limiting monthly cash flow, and the value of your time and stress. This is where a thinking partner who is competent in personal finances comes in -- whether in the form of a financial coach or financial planner (one who can give as unbiased advice as possible - especially when it comes to how they are compensated). I personally am much more apt to trust someone who isn’t making a commission from selling me a product such as a home. Finding an independent source of quality financial information is key – THEN you go in knowing what you desire for your financial situation.
3) Owning a home is NOT a bad thing; but I think many people (including myself for a long time) are ill-informed about what costs go into owning a house aside from a mortgage.
4) Owning a home can be a powerful wealth-building tool in the long-run. The overall burden (both financially and intangibly) of short-term home ownership often exceeds that of renting. Buying a house can be a great thing – but similar to marriage, it needs to be at the right time and with the right person – a house is no different (except with the right house!).
If you are thinking of buying a home or debating the whole rent vs buy analysis in your own life, we at Financially Forgotten would love to help with your individual situation. We can assess your holistic financial goals and perform a “financial health snapshot” based on your monthly cash flow and be a thinking partner for you in the pros AND cons of buying a home and how it fits into your overall financial life. We have a no-obligation 20 minute discovery call available at https://www.financiallyforgotten.com/contact and our affordable, transparent pricing is available at https://www.financiallyforgotten.com/pricing.