If you can’t tell, I can be quite a numbers geek and might be enjoying my new calculator a little too much. In fact I’m considering pulling out my PHP web development skillz and programming a dedicated page to the rent vs buy calculator. I think it’s a great tool for anyone considering buying or selling a home. If you’re dedicated to trying to retire as fast as possible and assumed buying was the way to go, you may just be surprised. On the other hand, even if you prefer home ownership and are willing to pay the extra anyway, this information just may change the size or type of loan you go for.

If you would like me to run a calculation for you or just want to let me know you’d be interested in a dedicated calculator page, let me know.

True Cost of Owning a Home – Part 3

I’ve fine tuned this calculator pretty well. Yesterday I mentioned I would run a more apples to apples real world calculation. This calculation includes:

  • A $200,000 home($160,000 mortgage) vs $1300 per month rent
  • 20% down on the home VS investing that cash in index funds while renting
  • 4% APR 30 year loan
  • $3600 per year in property tax
  • $600 per year in home insurance
  • $4000 per year in home maintenance and upgrades
  • 2% inflation affects everything except your mortgage payment
  • 7% average expected return on the market

Cost of housing graph:

true cost of owning a homeYou can see Shortly after 10 years, the home has a lower cost per year than the apartment. After 30 years the loan is paid off and the home becomes much cheaper.

Housing vs Investing

true cost of owning a homeThis graph is showing how your net worth would grow.

Rules of the graph:

  • Blue line shows if we rented at $1300 per month and invested the $40,000 that didn’t get spent as a home down payment
  • While renting is cheaper, the blue line invests the difference you save
  • While owning is cheaper, the red line invests the difference you save
  • While either is more expensive it subtracts the extra cost you’re spending
  • It includes your equity in the home growing as well as your $200,000 home going up in value each year at 2%

This graph shows you’re better off renting the first 20 years, but if you did buy a home, it pays off pretty well in the end. You’re investments don’t run away as they did in yesterdays simulation even with your investments instantly starting off at instantly with renting. I noted that if you push the rent cost down just $100 per month, the wealth you gain while renting already takes off just as it did in yesterdays simulation.

Simulation Conclusion

Here is a situation where someone can call the home an investment, although it takes 30 years to see the rewards.

As I noted though, if you push the rent even just a $100 lower, renting becomes the better option to your short and long term net worth.

Afterthoughts:

I’ve been contemplating some of the rules I have set for calculating the wealth graph. The numbers I’m considering changing do not seem to change the results much though.

7/18/2015 Update: I just ran across Go Curry Cracker and he also did an almost identical calculation on rent vs buying recently. His results are approximately the same, uses the same methods and shows the results are repeatable. He also points out many benefits of renting that are worth noting even if you’re willing to doll out the extra cash to own a home.

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16 comments on “True Cost of Owning A Home-Part 3

  • Your example numbers are actually pretty close to our actual situation. We bought our place for $176,000, put 20% down, but got a 15 year loan (3.25%) instead of a 30. So the mortgage with taxes and insurance run about $1150/month (we have cheap property taxes). When we bought our home, it was 2 beds, 1 bath (1400 square feet). Coincidentally, we have a duplex (each side is we have a 2 bed, 1 bath. 800 square feet) on our street. The people pay $1,250/month to live on each side, so I’m happy with our decision.

    Some random thoughts:
    -> We always buy the ugliest house we can find on a great street. We then improve it ourselves (forced equity).
    -> We also like to live in an area that isn’t perfect, but on the upswing for a better chance of appreciation..
    -> Our situation is probably a bit of an anomaly. We managed to get our place off foreclosure and we got a good deal. Since we bought our place 2 years ago, no home on our street has sold for under 300K.

    Anyway, the debate between renting and buying is always controversial. I think buying a home is OK under the right conditions and with the right choices. As we both know, the maintenance can be a pain in the ass!
    Mr, 1500 recently posted…Thursday Rant: Of Marshmallows and MenMy Profile

    • I found these graphs down right interesting. I’ve already started working on a program that will get a dedicated page so anyone can plop some numbers in and see at least the financial side of the decision. I know for many the decision to buy a home isn’t entirely financial but at least they’ll know the numbers. Sounds like you snagged a killer deal just in time.

      I went through 2 attempts to get a foreclosure. I backed out both times. First one I found pretty bad structural issues and the second time it looked like a good deal but once I went and meticulously ran the numbers on fixing the place, it didn’t look like such a good deal after all The house needed to be gutted and it seemed to be over market value for the work needed. I wasn’t going to bust my ass for next to nothing though.
      I can see why flipping houses destroys so many people though, people underestimate basic costs way too much.

  • Interesting series. I thought your numbers were pretty on point, however I thought repairs looked quite a bit higher than I expected. For example my lawnmower cost $40 and my roof was $2,000 cheaper than that for an above average size American home.

    I would bet (though I’m not sure) we’re about breakeven versus a 2 bedroom apartment in the part of town we would want it in, but we’ve greatly moved the needle in our favor, by utilizing my favorite homeowner “BIG WIN”. We got a roommate. At the moment renting 1 of our 3 bedrooms covers 75% of the mortgage, taxes and insurance. If you didn’t want a long-term person, Airbnb can be used for a similar outcome.

    Also, from a psychological standpoint, owning a home is a forced savings account that very few average individuals would be able to maintain if they were depositing it in Tradeking each month for 30 years.

    Last possibility is that (like me) you are pouring a large portion of your savings in to the market through your 401k, IRA, and brokerage. Real estate adds a layer of diversification.

    Just a few random thoughts. Solid post. Cheers.
    Adam @ AdamChudy.com recently posted…5 Things I Wish I’d Known Before Buying a HomeMy Profile

    • The calculations do need some tweaks or more customizable to each persons situation. I may be estimating the average home to be bigger than it actually is on the roof, but I think even smaller homes can easily have complex roofs that can push the labor into that $8k range. Mine was a little over $5000 2 years ago but its a 1400 sq ft home with a simple A frame type roof. I also probably overestimated the average lawn. I have an acre of land and a riding lawn mower but I guess when I think about it the average yard size does seem to be a quarter to half acre these days.
      I did have a roommate two years ago when I bought the house but unfortunate circumstances happened and they left almost immediately. I may check into that Airbnb some day, right now my house is a mess from renovations.
      That is a good point about you’re home is another layer of diversification.

      Thanks for reviewing it, I needed more input. I plan to slowly work on a calculator everyone can use and give it a page, Started it yesterday. I think I have some new ideas now.

      I did hear about something called the 1% rule for home maintenance. %1 value of your home should be your maintenance, which would be $2k. There’s also a $1 per square foot rule. I think some of these rules don’t work so well in areas where you can get a tiny $70k home. At a certain point a water heater is still a water heater regardless of the size of your home.

  • One sort of “intangible” advantage of home ownership is that once you own the home outright, the majority of expenses could be deferred indefinitely which is excellent for cash flow. I’m not exactly recommending this, but it explains why houses that were occupied for the same couple for 50 years tend to be in poor condition. In a lot of cases, when their cash flow dried up, they just lived without the maintenance.

    This is sort of my family’s strategy. Right now, we are renovating a junky house (including doing maintenance that should have been done 15 years ago). It’s fine, because right now we have money. Once we’re done, I will feel a lot more comfortable moving to part time work, even though my husband will still be in grad school. Our housing expenses will be negligible for a few years at least.

    • Hi Hannah, The graph is actually calculating that “intangible” value. As you say, eventually you own the home outright and drop a major expense. When you pay off the home, that is where I’m showing the top graph’s red line drop sharply at 30 years(in this case a 30 year loan). That’s true about you can let maintenance go if you’re financially strapped and pretty obvious in a lot of homes. Mine also is in the process of a lot of maintenance and renovation that should have been done 15+ years ago.

      Even though owning a home is almost always cheaper in the end, when you finally finish paying off the loan. The thought is if you’re someone just starting out and they are happy living in a cheaper apartment but hear people say “oh you’re wasting money, renting is throwing away money that could go towards building equity in a home.” The cheapest home they may be able to get is actually more expensive, even in the long run when you would have paid your house off.

      This is because the difference in rent vs mortgage, insurance, property tax and maintenance can be so high that staying a renter and investing the difference can actually build you more wealth in the long term than the home even if after you pay off your home and start throwing that huge extra cash into investments you wont catch up to what you may have built renting.

      It’s a complex thought process I made up and totally dependent on home value and rent costs. This example I showed above is like you say, better in the long run to buy the house in terms of building wealth. You can see your wealth take off after paying off the home vs the wealth you would have built up renting.

      Yesterday’s example showed outright that with a cheap enough rent to higher cost home ratio, renting can knock purchasing a home out of the park in terms of building wealth.

      Its really for people,like one of my friends, who is mainly looking at home buying as an “investment” he just wants to build wealth. I want to point out to him and others that if you’re happy in a lower cost apartment that may actually be your best path for building wealth at this point. Later, if you want to upgrade your housing, it may make sense to buy a home in terms of building wealth.

      I hope that kind of explained the calculation and thought process – I may need to amend the post to clarify that more.

      • To clarify my comment, I mean the cost of home ownership could drop to just above zero (like you pay for zero maintenance). The value of your home will deteriorate, as will your living conditions, but if cash flow is more important than wealth, and you have a paid off home, then ownership has an “intangible benefit”

        • Ah I see, I agree you are often able to be a bit more flexible with money when owning a home. You can even push off taxes a little bit if you really needed. And my numbers make a lot of assumptions. If/when I build that calculator I’ll let people enter all their own variables including maintenance cost.

          I saw on your blog you’re also a big fan spreadsheets and number analyzing. Nice to know I’m not alone :).

  • Enjoyed the read and following along as you crunched the numbers. Preparing to board a flight, but looking forward to checking out the first two posts in the series once I get settled at my destination.

    • A nice detailed look the numbers and a great series overall. I found it interesting that you start the series by noting that you were predisposed to believe that owning a home is not an investment but more akin to buying a luxury item. Interesting to me because the post that has probably received the most views and generated the most discussion on my blog is where I contend that a house, a primary residence anyway, should be viewed as a liability and not an asset if a mortgage is owed. I approached the question of homeownership from the perspective of retirement planning and don’t believe there is a good way to include a home’s future worth in a good retirement plan.

      • I agree, plus as long as you have a mortgage, technically the bank owns your home. If your home somehow went into foreclosure you could lose all your built up equity. And if you buy too much home you can lose out in hundreds of thousands in possible wealth over the years.

        I looked at the problem in terms of building wealth but I tried to point out even if a home does help you build more wealth than renting in the long run, the home’s worth means nothing to your retirement plan if you’re not willing to sell. Whereas the renting scenario often comes up with more wealth in the end and you can definitely figure those investments into your retirement portfolio.
        Although my graph shows that when you’ve owned the home long enough and becomes cheaper per year than if you rented, I start to add in the amount you save over renting into investments. So in the example above in the second graph the red line after 30 years is a mix of equity in your home plus growing investments. As we’re agreeing on a home being unusable for portfolio without selling. If i took that second graph and removed the homes equity and just show the investments that could also make for interesting information if you happen to live in an area with super cheap homes. I’m sure there’s scenarios out there where you can get both home and more liquid wealth.

  • Interesting stuff. I’ve run similarish projections on rent vs. buy scenarios to see what would be the most optimal choice to make in a mathematical sense.

    One of the biggest issues we have about potentially buying a home is moving from liquid assets to non-liquid assets. My wife and I are both wired to really appreciate and value having capital at a moments notice (even if we would never in a probabilistic sense need this amount of liquidity).

    Whenever we do decide to own a home, I don’t think we’ll ever think of the home as an investment. It’ll just be a place to live and raise a family. Appreciation will just be a bonus.
    Kapitalust recently posted…A Beautiful 10 Mile Run in PortlandMy Profile

    • I think that’s the best way to look at it. I’m aware my home isn’t the smartest move financially but pretty much everyone would agree there are some pretty nice upsides, or luxuries, to owning a home. If buying a home, attempting to keep it low cost and not go too crazy can greatly minimize the pain, or eliminate it completely in some cases. I just might have the calculator ready for you to use by the time you’re ready to buy but it sounds like you’ve been doing calculations by hand already.

        • I’ll have to check that out. I do have a physics degree and math minor. Kind of automatically get the math minor. Sounds like a good one to compare with. Maybe I’ll clean up my spread sheet and post it on here for people to check out.

          One of the issues I know I have with rent vs own is I would be OK renting, but I know I’d like to have certain things that would push me into $1100/month renting in my area. But, I guess if I move around a lot, the fees of selling make a quick easy case for renting still. As long as I’m working full time I’ll probably want to move around a decent amount.

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