Home, sweet home

This article on whether you should rent or buy that has been going around the web is . . . well, it's not very good. It's heart is in the right place--home ownership is not a path to easy riches. There are plenty of good reasons to rent.

But the details are all wrong.

Myth #1: Renting is Like Throwing Your Money Away

Buyers throw their money away for the first five years they own a home, because they simply give money to the bank for the privilege of borrowing money. Renters, on the other hand, pay for one thing every month: shelter. They don't pay interest to the bank, property taxes or maintenance fees. They pay rent.

Renters pay all of these things: the landlord usually has a mortgage, certainly has property taxes, and we hope he's doing maintenance. You just call it "rent", which means it's not deductible from your federal taxes.

Myth #2: There are Tax Benefits to Owning

Contrary to popular belief, buyers do not get back the mortgage interest they paid throughout the year at tax time. Mortgage interest can only be deducted from taxable income. This essentially means that buyers pay a dollar just to save 30 cents.

Furthermore, deducting interest has no tax advantage unless a buyer pays so much in interest that the amount exceeds the standard deduction that everyone--including renters--is allowed to take.

When it comes to owning, the only guarantee is that buyers will be required to pay property taxes. Since renters are not required to pay any taxes on the property they rent, it seems downright foolish to factor the 'tax benefits' of owning into a buying decision.

See above. Whatever these taxes are, you're paying them as part of your rent. It is true that housing becomes a better investment the farther you move up the income ladder, which is one of the many reasons that we should eliminate the mortgage interest tax deduction. But if you have one kid, you're not taking the standard deduction anyway.

A mortgage is an inflation play: you bet that rent will grow faster than your house payment. Probably not a good bet in many markets right now--but on the other hand, inflation's creeping up, so it also might not be totally crazy.

Myth #3: It Doesn't Cost Any More to Buy Than It Does to Rent

People can usually rent a home by paying first month's rent, last month's rent and possibly a security deposit. All the money that is paid initially actually goes towards monthly payment obligations, with the exception of the security deposit, which is nearly always returned to the renter in the end.

When a person buys a home, the money that is paid upfront is more significant and may or may not be seen again. For example, a buyer must pay closing costs (typically five percent of the loan amount) and real estate agent commission (typically six percent of the loan amount) before being called a homeowner. This 11 percent 'investment' ensures that the home must appreciate by at least 11 percent before the buyer can hope to break even.

This is just wrong--wildly wrong. A lot of closing costs are flat fees, which means that as the value of the mortgage rises, the closing costs fall. Looking at this estimate from Bankrate.com I get an average closing cost of 3.6%, not 5%, on a $125,000 loan.

As for the broker's commission, that's paid by the seller, not the buyer. One could argue that it is actually paid by the buyer in the end, but all that means is that it's factored into the house price. You don't pay another 6% on top.

Myth #4: Buyers Have Assets, Renters Do Not

At best, buyers have depreciating assets. Home prices are falling in nearly every area of the country. An estimated 50 percent of the buyers whose loans were originated after 2002 now owe more than their homes are worth.

Homeowners who have been paying on their homes for ten years or more are seeing their equity disappear. This means that the 'investment' they made through mortgage payments is gone--dried up virtually overnight through no fault of their own.

Renters may not co-own a home with a lender, but this doesn't mean that they don't have assets. Many renters have a large and prosperous portfolio, Star Wars collectibles (just an example) and other assets that can be sold IMMEDIATELY for cash. The reason they own these things is because they haven't been paying a lender to 'rent' money so that they could pretend like they own an asset.

This is maniacally unbalanced. It amounts to saying "asset prices change", which is true of everything, even, I'm afraid, Star Wars collectibles. Agreed, you can take the money you save not buying and plunge it into investments. Most people don't, however; a house is a form of forced saving.

I do agree with the last "myth": you shouldn't buy housing as an investment. You buy a house because you can't get what you want any other way; because you want to put down roots and have a house that you can do what you like with. If you're planning on moving every five years, and are in a lower tax bracket, you're probably better off renting. But you're much better off with something like the New York Times rent v. buy calculator than you will be with that article.

Comments

Renters pay all of these things: the landlord usually has a mortgage, certainly has property taxes, and we hope he's doing maintenance. You just call it "rent", which means it's not deductible from your federal taxes.

I don't know about DC, but in Boston it usually costs you 2x as much to own as to rent. In a number of markets people are renting out homes to help stem their losses. You may be on the hook for 2500 a month but at least if you rent it out for 1250 you might be able to stay afloat.

Posted by Jmo | March 20, 2008 12:58 PM

"Buyers throw their money away for the first five years they own a home, because they simply give money to the bank for the privilege of borrowing money. Renters, on the other hand, pay for one thing every month: shelter. They don't pay interest to the bank, property taxes or maintenance fees. They pay rent."

Wow. Just...wow. At the end of five years of renting, all I ever ended up with was the past five years' worth of shelter. At the end of five years of mortgage payemnts, a home buyer not only had five years' worth of shelter, they are also five years closer to owning the property.

However, I think we can figure out what kind of nutball actually wrote this:

"Renters may not co-own a home with a lender, but this doesn't mean that they don't have assets. Many renters have a large and prosperous portfolio, Star Wars collectibles (just an example) and other assets that can be sold IMMEDIATELY for cash. The reason they own these things is because they haven't been paying a lender to 'rent' money so that they could pretend like they own an asset."

Voila: The writer of this piece is someone with poor fiscal discipline, who has been dumping income into knick-knacks and other non-essentials. Now s/he is trying to justify why s/he has no savings to put toward home ownership, and spin it in favor of renting.

Posted by anony_mouse_ | March 20, 2008 1:01 PM

Personally I plan on retiring on my collection of vintage TV Guides.

Perhaps the author felt the need to overstate the case because the case for home ownership is also wildly overstated. And since so many people bought homes they couldn't afford, perhaps overstatement is justified.

Posted by toxic | March 20, 2008 1:02 PM

In fact, I have a buddy who bought a condo in Miami as a investment. The mortgage, property taxes, condo fee, and insurance run about $500 more than he gets in rent. He was hoping to keep it for a few years and flip it, looks more and more unlikly given the South Florida real estate market.

Posted by Jmo | March 20, 2008 1:04 PM

Anony_mouse_: I dunno. I've got a never-out-of-the-box Darth Vader that's gonna fund my kids' college education. And a deed to a bridge in Brooklyn...

Posted by Klug | March 20, 2008 1:20 PM

"As for the broker's commission, that's paid by the seller, not the buyer. One could argue that it is actually paid by the buyer in the end, but all that means is that it's factored into the house price. You don't pay another 6% on top."

megan, you are definitely wrong here. because you will pay the 6% on the way out, you do have to achieve an additional 6% of Home Price Appreciation to break even.

for Myth#1, the author doesn't make the point the way i would have, but it is a commonly held opinion (that renting is throwing money away), and it is a myth. you wouldn't believe the number of people i've spoken to who plan on buying a home primarily for this reason.

for Myth#2, he is clearly wrong

for Myth#3, i don't know anyone who actually believes that myth now, though it may have been the case 2 years ago when you could wrap all your fees into the mortgage

for Myth#4, it's a really poorly written section, but i think it's trying to get to the very real point that buying a house and paying a mortgage simply redirects savings towards a house and away from other assets (like stocks)

Posted by Sean MacLeod | March 20, 2008 1:25 PM

Buyers throw their money away for the first five years they own a home

I've moved twice in the past 7 years and tripled my nest egg. And that's before factoring in the fact that my 3-bedroom/3-bath/2-car garage on 1/3 of an acre that I just sold cost as much monthly as a 1-bedroom apartment with 1-car garage in the same town.

I'm in both the buying and renting markets right at this very moment in Portland, and the one thing I notice most strongly about houses for rent (little apartment not an option for 4 people) is that they're dumps. It's probably worth paying extra just to not have to live in one of them, and I can't find any decent places to rent.

Furthermore, deducting interest has no tax advantage unless a buyer pays so much in interest that the amount exceeds the standard deduction that everyone--including renters--is allowed to take.

Who the hell has so small of a mortgage that this isn't true? And who wouldn't like to pay 70 cents for a dollar's worth of impact?

Since renters are not required to pay any taxes on the property they rent, it seems downright foolish to factor the 'tax benefits' of owning into a buying decision.

I'll agree that it's foolish to calculate your monthly payment without taking taxes into account. But that's a hazard for idiots, not for homeowners.

Many renters have...assets that can be sold IMMEDIATELY for cash.

Which contrasts so very sharply to the homeowner who has a HELOC.

Posted by Rob Lyman | March 20, 2008 1:33 PM

So here's a question for all the financial whizzes not watching NCAA hoops today:

What should a youngish (30-35) couple save for, retirement or a 20% down payment? We fully fund our 401(k) and do our best with our IRAs. We'd like to own our own place, ultimately. Is there a case to be made for diverting savings from IRAs towards a down payment? (I tend to think no, but what do you all think?)

Posted by Klug | March 20, 2008 1:36 PM

You have to look at where the writer of TFA is coming from:

Potential buyers bought into all sorts of rent vs. buy myths to justify buying houses that they could not afford during the boom. Now that the U.S. housing market is in shambles, people are starting to realize that renting may not be a dirty word after all.

The article is not aimed at people like myself, who didn't buy more home than I could afford expecting to "flip" it and/or cash out in a few years; If your time horizon is 3-5 years, then uh no, buying during the housing bubble peak and pop is not a good idea compared to renting. This article was written by and for those who are looking for ways to get rich quick, not people who are looking to economize.

I bought my home because I was tired of apartment rent going up and up every year for the exact same apartment. I wasn't sure I was going to stay here as long as I have, but I was sure that rents were going to double in the next 5 years (which they did) while my mortgage payments would remain constant (which they have).

As far as TFA itself, every single one of this shyster's "myths" is complete bullcrap. #1, you may only think you're just paying "rent" but included in that rent are "interest to the bank, property taxes [and] maintenance fees." The owner passes those along to you. The property owner likely doesn't own the property either; there are too many tax benefits to NOT owning the property outright, so you are going to be paying his mortgage interest as part of your rent (interest that he gets to deduct on his taxes). Property taxes are an obvious pass-through to the renter. And if maintenance goes up one year, you can bet your rent is going to go up the next time your contract is up.

#2, I don't know what planet this goober lives on but where I live the fact that you get to deduct every dollar of your mortgage interest from your AGI is the primary lever I have for beating the Standard Deduction. I don't have tens of thousands of medical bills or much of any of the other deductions you can claim; if it wasn't for the mortgage interest deduction, which I would not have if I was renting, I would be paying far more in taxes (and paying as much or more for housing into the bargain). So to me, devaluing the mortgage interest deduction is idiotic. It's also why I will argue strongly to maintain that deduction.

#3, Megan dealt with part of it but here again TFA writer's agenda gets in the way of his analysis. An 11% appreciation over the life of a 30-year mortgage surely is not unreasonable; even if your time horizon is 5 years, are you saying you don't expect to average a 3% per year appreciation? Maybe today that might be true, with the bubble bursting; but when I bought in 1998, the closing costs were an afterthought compared to the appreciation I expected even in the short term.

#4, is clearly bullcrap on its face. Yes, home values are declining NOW- after a decades-long runup and fantastic gains in the past decade, gains which surely won't all be given back. Yes, equity is disappearing; but that also happens when the stock market drops, or to Star Wars collectibles when nobody wants them anymore. Even if your home value were to drop to zero, you would still possess a place to live; if you are renting, you own precisely nothing.

This article is just completely asinine. But the dude got paid for writing it.

Posted by liberalrob | March 20, 2008 1:42 PM

Who the hell has so small of a mortgage that this isn't true? And who wouldn't like to pay 70 cents for a dollar's worth of impact?

Not that I'm siding with the author, but the MFJ standard deduction is $10,700 in 2007. If you take out a mortgage of 180k on a 225k home, a 6% interest rate gets you almost exactly 10,700 in the first year.

Posted by Independent George | March 20, 2008 1:56 PM

If you take out a mortgage of 180k on a 225k home, a 6% interest rate gets you almost exactly 10,700 in the first year.

I remember when I could buy a house for 225 and not have to commute by Cessna.

But point taken. A childless couple with a cheap house and a hefty downpayment doesn't get the deduction.

Posted by Rob Lyman | March 20, 2008 2:18 PM

If you take out a mortgage of 180k on a 225k home, a 6% interest rate gets you almost exactly 10,700 in the first year.

I remember when I could buy a house for 225 and not have to commute by Cessna.

But point taken. A childless couple with a cheap house and a hefty downpayment doesn't get the deduction.

Posted by Rob Lyman | March 20, 2008 2:20 PM

At the end of the day the two are almost identical from an economic perspective. My guess is that from a pure investment point of view buying is a little worse than renting but the owner gets other benefits of having complete control.

When I lived in DC (2000-2005) I ran the numbers for my wife and I. Renting was clearly better, to buy a condo in the same area my apt was in would have been a terrible investment given reasonable assumptions for asset appreciation and maintenance cost.

A big part of the equation is your tax bracket. Just like muni bonds the tax break increases the value of a home so it cost more to buy initially because of the tax break. If you are a high income earner you make that back because you save a lot in taxes, but if your tax rate is low you pay too much for the tax break. If you are below the median income you should probably rent and if you want to invest in real estate put the money that would have gone toward priciple in a REIT.

Once my wife and I got to a better market and made more money we went ahead and bought.

For those who believe in experimental econ. Buying a house might help by providing forced savings to an undisciplined saver. That may be a good reason to buy a house, but if you have self control and are below the median income or in an inflated market you should probably rent.

Posted by eccdogg | March 20, 2008 2:28 PM

"If you take out a mortgage of 180k on a 225k home, a 6% interest rate gets you almost exactly 10,700 in the first year."

But then you get to add property taxes, state and local taxes onto that. That's 15% of a few thousand dollars that you're saving, minimum.

However, when Megan states, " But if you have one kid, you're not taking the standard deduction anyway.", she is wrong. Children are not a deciding factor when considering itemizing. It is quite possible to do better with the standard deduction regardless of the number of children. You still get exemptions for each dependent, and can claim the child tax credit even if you don't itemize.

Posted by Njorl | March 20, 2008 2:34 PM

BTW. The long run appreciation rate of housing after maintenance cost is about the inflation rate.

Another thing that a house does give you is big time leverage, it might be hard to get that type of leverage elsewhere. The best you can do in the stock market is about two to one with a double S&P mutual fund.

That type of leverage might be good in the early years of your life.

Posted by eccdogg | March 20, 2008 2:34 PM

Leverage is a double-edged sword. It magnifies your profits if the value of the underlying asset goes up, but it also magnifies your losses. If you borrow 80% of the value of your home and housing prices decline by 20%, you just lost your downpayment. It's not quite as bad as that kind of leverage for stock investments would be, as houses don't have margin calls, but it's still a big increase in your risk.

Posted by Maniakes | March 20, 2008 2:55 PM

Absolutely I agree that leverage is a two way street.

However, one of the insights of the capital asset pricing model is that you should hold a market index of stocks bonds and if you want to amplify your returns take on more leverage. Early in your life you may be able to handle more varirance in your total returns and thus your should leverage up early and slowly deleverage over your life. That is exactly what a standard mortgage does for you.

I am not sure that I totally buy it, but I have seen that argument made.

Of course if you have only 0-10% down on a house you can't lose more than that so you are not really exposed to the really nasty side of leverage (the bank is as we have all seen).

Posted by eccdogg | March 20, 2008 3:06 PM

Who the hell has so small of a mortgage that this isn't true? And who wouldn't like to pay 70 cents for a dollar's worth of impact?

Not that I'm siding with the author, but the MFJ standard deduction is $10,700 in 2007. If you take out a mortgage of 180k on a 225k home, a 6% interest rate gets you almost exactly 10,700 in the first year.

Yes, but if you're a single person your standard deduction is only $4,850--and you'd have to have a pretty small mortgage not to exceed that.

Not to mention that getting the mortgage deduction can make it possible for you to take other deductions--such as deductions for charitable expenses and state/local taxes--that weren't big enough to justify itemizing before you bought the house, so the actual tax benefit from homeownership can be bigger than the mortgage interest deduction alone.

Posted by flippantangel | March 20, 2008 3:10 PM

Yes, but if you're a single person your standard deduction is only $4,850--and you'd have to have a pretty small mortgage not to exceed that.

$5,550 for the '07 tax year. And speaking of which, April is coming up fast, so you might want to get on those soon ;-)

Posted by anony_mouse_ | March 20, 2008 3:49 PM

The 6% buying/selling point was accurate in effect, if not in description. The point being if your house does not increase by at least 6% when you sell it, you are out of luck.

Posted by renter | March 20, 2008 3:53 PM

Flat fee closing costs just mean that the actual closing costs get wrapped into the mortgage as a higher fee (usually 0.25-0.5% higher). Good if you're planning on flipping the mortgage in the short term, not so good if you're planning to stick with it for the duration.

TINSTAAFL.

Posted by MouseJunior | March 20, 2008 6:20 PM

substitute fee with rate in my previous comment. Oh, for the ability to edit comments.

Posted by MouseJunior | March 20, 2008 6:34 PM

There's also the fact that in some locations it may be very hard to find a place to rent, period.

(I ended up purchasing a condo because I was sick and tired of being jerked around by the apartment managers during refurbishment, noticed that at the new higher prices they would be charging I could probably find an equivalent mortgage, and went looking......)

Posted by grumpy realist | March 20, 2008 11:21 PM

For myth #3: It doesn't cost any more to buy than to rent, I have to say that from the ground zero of the bubble (Sacramento Valley, California) this has, in fact, been one hell of a myth.

If it cost the same to buy as to rent we would have purchased a house years ago. But until lately the cost of purchasing on a month-to-month basis has been three to four times the cost of renting— less, obviously, with an ARM or neg-am, but still more than the cost of renting the equivalent square footage.

In general it is true that renting and owning are pretty equivalent. But lordy lordy, the last seven years have been insane here.

And it still costs more to buy than to rent. You can bet that I'm watching closely, though. When that changes, I will be ready.

Posted by B. Durbin | March 28, 2008 4:34 PM