Renting vs. Buying
Buying a property or renting a property, which one makes sense for you?
When you Google this question, almost all the answers focus on comparing what you are paying now in rent versus an equivalent mortgage payment. They conclude that if the mortgage payment is nearly the same as the rent, then you should buy.
Even though this advice makes sense, there is something else missing which I have never seen covered, and this is what this article is about.
What I am about to describe applies equally to purchasing a residential property or a commercial property.
The best way to describe the missing element is with an example. Let's take an $850,000 purchase with a 10% down payment (loan amount would be $765,000) at a 6.5% interest rate.
If you punch these numbers into a real estate calculator it would spit out a payment of $4,835 per month.
Most people would view this number as a bill, a necessary evil, a payment "until death do us part" or a Mort-gage, from Latin "Mortus - dead" and "gage - a pledge," from a Germanic word.
Let's look a little deeper into this pledge.
Out of the $4,835, the first year:
About $760 per month are being returned to you in the form of increased equity
About $1,138 per month goes as a credit on your tax return
This means that:
Mortgage Payment: $4,835
minus $ 760
minus $1,138
Money Lost $2,937
In other words, you are paying $2,937 to remain in your place for the next 30 days!
Wait a minute, isn't that what rent is?
Rent buys you 30 days, it has to be paid by day 3 or shortly after that, in California, you are getting a notice to "Pay or Quit" (“Quit” here means “Leave”) within 3 days. If by day 15 you have not paid your rent, depending on your city or state, your landlord would be making your life difficult. I guess if you rent in Texas, your Landlord would be showing up at your door and....well, I’ll leave it up to your imagination!
In contrast, when you have a mortgage, most lenders give you a 15 days grace period! what? Yes, a grace period,—this means you could be late up to 15 days! For most lenders, if they receive their payment by day 16, this is when you get assessed a late fee.
What if you don't have the money to pay until NEXT month? well, you get a ding on your credit report and a “mortgage late” mark, but other than that...your life is not altered.
I am not trying to say you should be late, I am trying to say that as a homeowner a mortgage gives you MORE flexibility than rent! Especially if you are a business owner and your cash flow is variable!
Coming back to the numeric example, a mortgage of $4,835 per month would be equivalent to a rental amount of $2,937. The reason is because you are reducing what you owe by $760, which means you now own $760 more house - money that is now yours! AND you are getting a credit towards your taxable income of $1,138.
This means that (and bear with me for a second with the math) $4,835 / 2,937 = 1.65. In this example, the mortgage can be 1.65 times MORE than the rent and still be equivalent in terms of occupancy rights.
In other words, if you pay $2,937 in rent, it makes sense to have a mortgage payment of $4,835, because at $4,835 per month, you are still getting 30 days of occupancy for $2,937.
You could say that your "break-even" point for a rent of $2,937 would be a mortgage of $4,835.
So even if the mortgage payment is HIGHER by 65% or 1.65 times, relative to your rent, you are STILL getting a benefit from the Mortgage Payment versus the rent.
And you are still getting a benefit, because
$760 x 12 = $9,120
Just by paying your mortgage, you are accumulating in equity/savings about $9,000 per year!
Even if you have to spend ALL your income in the necessities of life, you are still saving!
I have seen a lot of debate about this on the Internet. Some people would tell you that this is an inefficient way to save, because if you took $760/month and stuck it into a securities account you would make a lot more!
While this is theoretically true, that analysis does not take into account human nature.
How hard do you think it is for most people to save $760/month? Very... for most people that won't be possible on a consistent basis.
So even though in theory you could do better, for most people a mortgage is the best and only way to effectively save anything!
But it gets better:
Historically—and when I say historically I don't mean a few decades, I mean hundreds of years—a home keeps up with inflation.
This means than when you buy a $850,000 home, generally speaking, when you sell it, you would get an equivalent amount in purchasing power.
This is called Appreciation of Real Estate Values, or Appreciation in short.
In today's volatile times, if you buy in an up-and-coming neighborhood, chances are you will get MORE than just preserving your purchasing power.
The Appreciation is powerful because you acquired an $850,000 asset with only $85,000 in cash (10% down) but your Appreciation is over the ENTIRE $850,000.
So if the home in this example, appreciates by 2%:
2% of $850,000 = 0.02 x $850,000 = $17,000
But you only used $85,000 of your own cash! This means you made a return on investment of:
17,000 / 85,000 = 0.2 x 100 = 20%
In other words, if your home went up in value by 2% a year, that year, you made an extra 20% since you only put down $85,000 to begin with, the rest of the money came from the bank!
There is a lot more to this, but I want to keep this article somewhat concise.
Needless to say that Appreciation can be a HUGE factor, in addition to everything else!
Other aspects that most analyses of buy versus rent don't take into consideration:
Having helped many people buy a home for many years, I noticed that a mortgage increases your credit score versus non homeowners
It makes it easier to buy investment properties, if you ever decide to do so
It gives you access to bigger lines of credit
It increases your net worth, which then qualifies you for a bank loan - this is especially important if you are a business person
In Summary:
The reason, generally speaking, a mortgage gives you more value than rent, is not necessarily mathematical but has to do with Human Nature:
A person or organization will almost always spend what they think they have! No matter the amount of money. Therefore in order to save, you have to trick yourself and disguise the saving as an expense. So while all the money is gone, some of it went into an asset.
As inefficient as this sounds, this is the way that most families have been able to create a financial future for themselves throughout history!
Is it always a ratio of 1.65 times the rent? No, it depends on the downpayment, the interest rate, the loan amount and what you are paying in rent.
A rule of thumb would be twice or 2X. Meaning, if you pay $3,000 in rent you could contemplate a mortgage of $6,000 and still derive economic benefits when comparing it to the rent you are paying today.
This analysis works for states where rents and properties are expensive such as California, however there are many states where a mortgage is just UNDER the rent payment. If you live in any of those States you are blessed with a HUGE ADVANTAGE! Take it!
If you have thought about buying a property and need assistance in getting qualified, don't hesitate to reach out.
If you would like to see how this would work for your situation, what kind of mortgage would make sense for you, feel free to self-schedule an appointment here.
I hope this article gave you some food for thought!
Thank you for reading this!
