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| Home Sweet Home ... if only it was this easy? |
Buy the house with the white picket fence ...? Lock in that 30 year mortgage? Put in those 40 (+!?) years of employment? Then enjoy 10 - 15 “quality” years of retirement?? Does that sound about right?
What about THIS American Dream?
Forget the house (and that white picket fence...)... and definitely forget borrowing from banks!
This isn’t going to be a post where I try to convince you one way or the other in the debate about whether it is better to rent versus own. The fact of the matter is there are just too many different scenarios and too many different real estate / rental markets (just too many variables!). I get a headache just thinking about it. There is no right or wrong here. What best fits your lifestyle? Rather than enter into an endless rent versus own debate, we are going to illustrate how one can establish what I like to call “renter’s equity.”
What Are We?
We are currently “homeowners” (actually like many Americans our age, the bank owns our home, and we pay them a good chunk of money every month to slowly chip away at the power they hold over us ... side note: we are in a great financial situation where we COULD pay off our home, but it doesn't make sense for our current situation). We love our home for many reasons. Most importantly it has been a wonderful place to raise our family. We also had the unique opportunity of buying land (reasonably priced at the time in a suburb of Houston), hiring a very talented architect (Brett Zamore Design) and awesome family-owned home builder (Mealer Homes) (in fact our architect and home has been featured in a local publication - Houstonia).
BUT ... despite all that, our FI journey is taking us elsewhere (and actually our plan was to never stay in the Houston area long-term ... it is just too hot!) ... and now back to renter's equity ...
In our FI journey we are going to squash the “American Dream” of being homeowners and become renters (possibly for life? ... but never say never). Renting will fit best with our lifestyle as early retirees. It will allow us to live very cheaply in Spain (and / or travel the world). Renting will also allow us the flexibility when we come back state side (if we come back?) to try out different parts of the country to see where we are most happy (East Coast? West Coast? Mountains? Country? City?).
BUT ... despite all that, our FI journey is taking us elsewhere (and actually our plan was to never stay in the Houston area long-term ... it is just too hot!) ... and now back to renter's equity ...
In our FI journey we are going to squash the “American Dream” of being homeowners and become renters (possibly for life? ... but never say never). Renting will fit best with our lifestyle as early retirees. It will allow us to live very cheaply in Spain (and / or travel the world). Renting will also allow us the flexibility when we come back state side (if we come back?) to try out different parts of the country to see where we are most happy (East Coast? West Coast? Mountains? Country? City?).
We are choosing to rent for the flexibility but also for the peace of mind. As renters, we won’t have to put a HUGE down payment when we move in or be charged any closing costs. We won’t have to ever pay property taxes, and we won’t have to worry about any maintenance costs catching us by surprise.
But ... What About Your Equity?
But as renters you just “throw your money away", no?!! And as homeowners you earn equity! Using the examples below we are going to show you why we feel that in our case renting is going to be more beneficial versus owning, and we have figured out a way to earn “renter’s equity.”
Example: Homeowners
Let’s say Family A buys a house for $300,000 at a 4.5% interest rate on a 30 year fixed mortgage. They put 20% at closing so the mortgage is actually for $240,000. (We used this calculator to see the mortgage numbers).
For the purposes of this post we are going to assume that the house increases in value by an average of 4% per year over the next 30 years. This will help us estimate the property taxes year after year (we are using a tax rate of 1.86% based on the area that we currently live).
Family A: Homeowners
Family A: Homeowners
So over the 30 years Family A has paid $300,000 ($240,000 + $60,000) in principal, $312,950 in property taxes (these will vary depending on where you live), around $10,000 in closing costs (an estimate), $198,000 in interest to the bank (you basically bought the bank another house, thanks!), and (conservatively speaking) about $100,000 in upgrades / maintenance over the years (new roof, new AC, new fence, new counter tops, new appliances, new flooring, yard care, etc….) All in all, the $300,000 house has cost over $920,700 over the last 30 years (do you feel like you’re living in an almost $1,000,000 home, Family A?).
Family B: Renters
Family B: Renters
You Are Just Throwing Your Money Away In Rent!
Sure you aren’t going to get any equity when you move from your rental property, but you have been able to save from some of the expenses that you haven’t had to pay as a homeowner. Let’s set up another example.
Family B is in the same financial standing as Family A; however, they decide to rent rather than own. Naturally they are more open (and able) to move around their city, state, country and even world over this 30 year time frame in order to find a place that has reasonable rental prices while providing a high quality of life. Now, I don’t have some Magic 8 ball to tell me how much rent is going to cost Family B thirty years from now, but seeing as how they are open to moving if needed, I am comfortable coming up with a range of $1,200 - $2,500 per month. Let’s pick the middle ground and say that over the course of 30 years their rent averages $1,850 per month.
As renters Family B has experienced different parts of the country (and possibly even the world) and has cost them about $666,000. This is $254,730 less than the homeowners.
Now, Family B doesn't have equity, but they do have this extra $254,730 which is going to represent their renter’s equity. Let’s divide that up evenly over 30 years (keeping it simple), and invest it into VTSAX at a 7% inflation adjusted rate of return.
Now, Family B doesn't have equity, but they do have this extra $254,730 which is going to represent their renter’s equity. Let’s divide that up evenly over 30 years (keeping it simple), and invest it into VTSAX at a 7% inflation adjusted rate of return.
Wow, so Family B divided up the $254,730 that they saved as renters evenly over 30 years at $8,491 per year and invested that amount every year directly into VTSAX. Now they have $858,200 sitting in their Vanguard account. Family B can treat this as their “equity” as renters. This essentially lowers the $666,000 that they paid to rent over the last 30 years to, well, a surplus of $192,200 ($858,200 - $666,000) which is the equivalent of paying themselves $6,407 per year to rent ($192,200 / 30 years)!
Something To Think About
Again, I’m not here to convince you one way or the other because there are just too many variables when making this decision. What I hope you gain from this post is to not just assume that owning a home is profitable and that renting is “throwing away” your money ... but rather run the numbers for your particular situation, and see what they say (they won’t lie!)!
So what do you think? What is your situation? Are you a homeowner? A renter? What do you think about "renter's equity"?
-Erik
So what do you think? What is your situation? Are you a homeowner? A renter? What do you think about "renter's equity"?
-Erik
Good way of thinking. Two suggestions based on my experience:
ReplyDelete1) In my experience, the rent for a $300k house is not going to be $1850. The high end of your range is more likely ($2500), which will increase over time. Of course, in your situation, you may not need or want to stay in a $300k house for the next 30 years, but I think it's apples and oranges to compare $1850 in rent over the next 30 years with a $300k house today.
2) Unless you know a real estate agent or want to sell a house without a real estate agent (which is becoming easier to do), the closing costs will be way more than $10,000 on a $300k house. When you sell the house, you're probably going to pay 6% in real estate commissions plus another % or two in other closing costs.
My general rule is if you're not sure that you're going to be in the same place for at least 5 years, rent. In 5 years, you will have paid off about 7% of the price of the house (assuming 20% down payment), which means you just about break even on the real estate commissions and closing costs.
Hey, thanks for the great comment. You're correct in that we have no desire to stay in a $300k house for the next 30 years. We are simply saying that we think we can consistently find nice places to live over the next 30 years for an average of $1,850 per month (actually I believe it will be much less than this). For example, our first year renting in Spain is going to cost us about $800 per month. That doesnt mean the apartment we rent is worth $300k (this is irrelevant to us as renters). We are more concerned with living in a place that provides us with a happy/high quality of life. I agree that it's apples to oranges to compared $1,850 in rent with a $300k house, but I also believe comparing renting versus owning is apples to oranges, which is why I say that there is no right or wrong here. Work the numbers for yourself and see where they lead you.
ReplyDeleteAgreed on closing costs. My numbers were purposely conservative here. We could certainly increase this value, which would further the case to rent in our situation.
I like your 5 year rule.