To own or to rent, that is the question. And for many years the answer has been the same – of course to own is better! In the past, conventional wisdom insisted that renting is throwing money in the toilet while paying a mortgage is “paying yourself”. Never mind that most of your payment actually goes to the bank, making “owning” look a lot like renting from the bank. Except, this landlord won’t fix your roof should it spring a leak.
Still, it was considered to be a better deal with mortgage interest deduction offering a rare tax saving opportunity for the middle class folk. And of course, for the longest time buying a home has been looked at as “an investment” – you may be spending more than you otherwise would now, but you’ll get it all back and more later. It is at the times like now, when this theory gets blown out the window, that people begin to take a closer look at the real cost of owning a home or an apartment vs renting one.
Calculating the cost of renting is fairly simple. It is what you’ve agreed to pay your landlord every month plus some of the utilities. The only relative unknown is the annual rent increase, but something like 2 to 5% can be anticipated.
With owning your home things are a lot more complicated. Assuming you did not pay cash for the property, you have a mortgage.Then there is property tax, insurance, and all utilities. If you own a single family home, you might need a gardener, a security system, and things like that. If you own a condominium or a home in a community that has a Home Owners Association, you have to pay those dues. Your mortgage, assuming you got a fixed rate, will stay the same through the years, but other costs will creep up.
In addition, things will inevitably need repair, appliances will need to be replaced. Even if you buy new construction, there is no guarantee you will be spared those expenses, as building quality often leaves much to be desired. These costs depend on your luck (you may stumble across a house where nothing ever breaks), your taste (yes, you can get yourself that fancy stove you’ve always wanted, you’ll just have to pay for it), your level of tolerance for things not perfect (there is a smudge on your wall and it won’t come off – ignore or repaint?), and your ability to do things yourself.
Another cost associated with owning a home as opposed to renting is the loss of earnings on the money you’ve put as a down payment. Banks these days won’t accept anything less than 20% of the purchase price. So, if you buy a home for $250,000, you will have to shell out $50,000. Even with today’s abysmal rates the most clueless investor who only knows how to buy CDs can get 2% interest or even more if he or she is willing to have the money locked up for 10 years. And over that time that is more than $10,000 lost right there. A savvy investor who can play the stock market (and win) would lose a lot more. And what if you need that money, for example, to start a business or pay for your kids’ (or your own) college education? You may have to borrow – with all the costs associated with that.
Mortgage interest deduction should not be left out of this calculation as it does offset the cost of owning a home somewhat, though not in all cases. To figure out how much, if anything, you are actually saving you need consider the following. Mortgage interest and property taxes are part of your itemized deductions. The only portion of the total itemized deductions that actually reduces your tax bill is that in excess of the standard deduction – something you get if you don’t itemize.
According to the IRS website standard deduction for a married couple filing joint return is $11,600 in 2011. If you have a $200,000 mortgage at 4.5% interest rate, the interest you would pay during one of the first years will be roughly $9,000. (That number will go down, very slowly, every year.) Property taxes can be, for example, another $2,000. That is $11,000 and it doesn’t get you anywhere. Fortunately, itemized deductions also include State Income Tax, charitable contributions, medical expenses in excess of 7.5% of income, job related expenses in excess of 2% of your income, and a few other things.
So, if you live in a state with high taxes, donate a lot to charities, or spend a ton of money on doctors and hospitals, your mortgage interest and property taxes could actually save you a nice chunk of money on your income tax. To calculate how much, you can take the difference between your standard and itemized deductions, or the sum of your mortgage interest and property taxes, whichever is greater, and apply the highest tax rate for your income which can be found in IRS Form 1040-ES. If your income is close to a border, use the next highest rate.
Lastly, there are costs associated with moving out. If you are renting and either can wait until the end of your lease or don’t have one, your only cost might be a part of your deposit the landlord would not return because you’ve messed up the place more than he can accept. If you need to move out quickly, whether for a job or because you can no longer deal with the schizophrenic across the hallway going off his medication, and you are in a middle of your lease, you may have to pay your rent for the remaining months.
If you own your home and need to move, you have two options: rent it out or sell it. If you choose the former and the rent you are able to charge does not cover your mortgage and other costs, you will be paying the difference out of pocket. If you decide to sell, at the very least you will have to pay the commission to your selling agent and to the agent representing the buyers. The standard commission is 3% each. You may or may not be able to negotiate it down. Most likely you will also have to spend some money to improve the curb appeal of your property. In addition, the buyers might request that you fix some things. If you have to move quickly, you might also end up paying for both your old home and your new one until the former sells.
Of course, if your house has appreciated in value, much or all of these costs can be offset by the profit you are making. Unfortunately, for many people nowadays the opposite is the case. Not only do they have to pay for all of the above, but they can’t even recover their down payment, or worse, have to pay the difference between what they owe and what the place can sell for if they want to preserve their credit. Or they just can’t move. It is hard to estimate the cost of that.
Unfortunately, it is also impossible to put a value on never having to look at white walls – landlords’ favorite color.