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From a financial perspective, there is only one reason to own a home, and it isn't the reason most people think it is. It is NOT about deducting mortgage interest.
The reason to own a home is that by owning that home you "pay yourself rent" and that phantom income is tax free. Tax free. This isn’t immediately obvious to some people.
To illustrate the point, imagine two identical houses next to each other. You own one & live in it. I own the other & live in mine. Imagine our respective IRS Form 1040s. We each have income, deductions, and a tax obligation.
Now imagine that you own your home but rent it to me to live in. I own my home but rent it to you to live in. We each pay the other rent... and because these are identical houses next to each other, we each pay the same fair market rental rate which is the same dollar amount of rent to each other. Crazy, I know, but if you've read this far, you might as well continue.
Imagine our respective IRS Form 1040s. We each have income & deductions as before, but we each also have rental income (and some extra deductible expenses). But, because we each show more Adjusted Gross Income in the form of rental income, we each owe taxes on that extra rental income. Our lives are really no different between the two scenarios -- it is just that in the silly 2nd scenario we have extra income on which we pay extra income tax, so our after-tax situation is worse.
So what is REALLY happening when we own a home & live in it is that we "pay ourselves rent" in the amount of the fair market rental rate, and that rent is tax free!
Let's make this more concrete.
Let's say the fair market rent of a home in your neighborhood is $2000 per month. By living in the house you own, you "pay yourself" $2000 per month, yet you pay no income tax on that phantom income because it is, well, phantom.
While this argument is somewhat academic, it is one factor in deciding if it makes sense to own vs. rent.
a home generates no phantom income. it cost you the rent you are not getting on your invested money by you living there.
a home can cut costs, but it is still a liability costing you money. imagining it is paying you a thing is just the emporers new clothes.
has your income increased one penny taxable or not? noooooo it has not.
what you are trying to do is what corporations try to do . they cut expenses,fire people and then go see how much we made in profits? they are equating that savings to a profit from income. it is very different though.
that is why wall street looks at profits as well as revenue. you can only get those costs so low and the game is over , revenue or real income is limitless.
it may cost less then renting but it is still a liability. you can have hundreds of thousands tied up in that property and that money is generating zero income, it is housing you .
that is an expense and represents your cost of housing.
it may be even improving cash flow with reduced costs when it is paid off.
just imagine a balance sheet .. the home is on one side ,liability. the income side is blank.
it's is no different then if you switched electric suppliers and saved 1500 a year and are now going my income is up 1500 bucks.
nooooo cash flow may be better from cost savings but you are still getting the same income.
Last edited by mathjak107; 02-17-2014 at 01:36 PM..
It depends on the person as many have said. For me, where I live, my mortgage plus HOA, taxes, insurance and a small bit for maintenance is cheaper then comparable rentals.
I had a plan to have it payed off in 5 years (by the time I turn 50) but that got side tracked last year due to a disability but I intend to return to work and my new goal is to have it payed off by 55. At some point in the near future I'll move to FL and rent until me and my wife pay off this house and then buy another.
Unless I pay this house off really soon I can't really look at any increase in value as profit when I sell because I would have lost that in what I pay in interest. But I'll at least have the possibility in recouping some if I rent it out later before selling.
Overall, I look at owning a house as a "forced retirement" plan. I am paying my mortgage every month. That is money that in reality would never be put in a retirement account because it would have to go to rent anyway. In the best case, later on I'll have 2 houses including a payed off one bringing in rental income until I decide to sell it sometime in retirement giving me a couple hundred grand in cash (on top of normal retirement savings). If it is the worst case situation where I can't pay it off early and have to stay in this house, well then I won't have a mortgage or rent payment in retirement so that will be like giving me a monthly boost in retirement income. Win Win for me no matter how I see it.
I read so many articles that say renting is a better option than owning. Logically, owning makes more sense, but I see many people who buy a house in an expensive area and spend half their life paying off a giant mortgage. And of course that affects travel, leisure, kids, etc.
Do you rent or own and why?
The key, whether you rent or buy, is to keep housing costs low as a % of gross income. I define that as 25% or less of gross income. Less is definitely better. People who are financially successful don't try to stretch their incomes to rent or buy places they can't afford.
I agree with mathjak. You are ignoring the opportunity cost of owning. The mortgage finance industry has basically suckered the entire country into believing that home ownership is the route to financial security. In actuality, it is a poor investment compared to others. If one has the self-discipline to take advantage of those opportunities, renting will usually prove more lucrative in the final net worth analysis.
while we see eye to eye on that the truth is the majority of renters neither have the skill or long term discipline to invest the money not put in the house elsewhere.
soooo they end up with a reduced income at retirement from lack of what should have been substantial assets in investments and are faced with the potential for higher housing costs.
while the homeowner had a huge sum tied up in the house they can generally make due with less income from less investments and lower housing costs.
like i said every single retiree discussion about the effect of a paid off house on their ability to retire says the same thing.
the fact their homes are paid for enabled them to retire and make their level of income work so they could retire.
I am likely a lifelong renter. I strongly disagree that owning is more logical. Historically, a residential property has returned about 1% above inflation, after factoring in all the costs of home ownership (homeowners rarely do). Equities return 7-9% above inflation. A renter who has the discipline to invest in the markets will likely acquire greater net worth than a similarly situated homeowner. In my own case, that has definitely proven to be the case.
I generally agree with this assessment. With the exception of equities returning 9% above inflation. 7%is the highest long term number I've seen, and I think it's best to be more conservative in one's assumptions.
The other problem renters have is they won't save and invest. There are exceptions, but not many, unfortunately. I wish this would change but I am not holding my breath.
The other issue is that renting and owning are really lifestyle issues. Either one can be fine, as long as ALL of the costs are considered and as long as those costs are a reasonable portion of one's income.
Yes, I agree that most people lack the discipline to save. As for the advantage of lower housing costs when retired, if I ever have to buy--and I hope I don't, I should easily be able to pay cash for what I need, so I will have avoided the drain of mortgage interest compounded over 30 years, plus taxes and all those other expenses.
Quote:
Originally Posted by mathjak107
while we see eye to eye on that the truth is the majority of renters neither have the skill or long term discipline to invest the money not put in the house elsewhere.
soooo they end up with a reduced income at retirement from lack of what should have been substantial assets in investments and are faced with the potential for higher housing costs.
while the homeowner had a huge sum tied up in the house they can generally make due with less income from less investments and lower housing costs.
like i said every single retiree discussion about the effect of a paid off house on their ability to retire says the same thing.
the fact their homes are paid for enabled them to retire and make their level of income work so they could retire.
think about it.
Quote:
Originally Posted by mysticaltyger
I generally agree with this assessment. With the exception of equities returning 9% above inflation. 7%is the highest long term number I've seen, and I think it's best to be more conservative in one's assumptions.
The other problem renters have is they won't save and invest. There are exceptions, but not many, unfortunately. I wish this would change but I am not holding my breath.
The other issue is that renting and owning are really lifestyle issues. Either one can be fine, as long as ALL of the costs are considered and as long as those costs are a reasonable portion of one's income.
We bought our house in 1987 and the payment was 467 bucks. Add the monthly taxes and insurance it was 642. We got a small two bedroom one bath house with 1000 square feet for 200 dollars more than what we rented a much smaller one bedroom for. A comparable apartment to our house would have been around 700 bucks.
NOW. Although we have refinanced for home improvements and other reasons, we never really used our house like an ATM. So, yes -- we still have a mortgage... but our mortgage is about the same. It's an adjustable, tied to the one year LIBOR and it's now 393.34. (after taxes and insurance -- 643.) At our last refi people kept coming in and asked us over and over if we were SURE we didn't want to pull cash out. Nope.
In 1987, we earned about 36K together. Our wages went up, we had some setbacks like everyone (a job loss and long term unemployment) and then we started a business. The business flourishes. We're now making what we feel is a boatload of money. In reality -- it's barely middle class here.
BUT -- and this is a big but.... You can't rent a room in a crappy neighborhood for what we are paying in mortgage, taxes and insurance -- let alone a whole apartment. My house would rent for 1700 bucks a month.
And because we own a house, I can stuff a whole lot more money away into retirement and other investments.
So for us -- I truly believe buying a house was the absolutely right decision.
While many home owners can fund retirement after the mortgage is paid with quite a few available dollars the growth is usually but a fraction of what it would have been had those investments been made decades earlier.
The biggest benefit is cost savings once again. home value and ability to invest later on play only a very small part in most retirements.
i wish i had a dollar for every retiree who said it was their paid off home that let them retire. i would have been retired years ago on that.
Last edited by mathjak107; 02-17-2014 at 03:18 PM..
While many home owners can fund retirement after the mortgage is paid with quite a few available dollars the growth is usually but a fraction of what it would have been had those investments been made decades earlier.
The biggest benefit is cost savings once again. home value and ability to invest later on play only a very small part in most retirements.
i wish i had a dollar for every retiree who said it was their paid off home that let them retire. i would have been retired years ago on that.
I have been reading this thread and does your argument hinge on renting being significantly cheaper than buying? If they are equal are you saying you can invest money differently (instead of dumping it into a mortgage payment) because of the added costs of home ownership (maintenance etc...)?
I just am a bit lost. If it costs $1000/month to rent or $1000/month to pay a mortgage plus all other fees (taxes, insurance etc...) then where is the extra money coming from that you are earning a greater return off of? Wouldn't you still be able to invest the same (income - expenses which includes $1000 for living expenses in either scenario)?
In some areas renting can be cheaper and coupled with down payments and closing costs can create a decent kick off point for investing but more important my point is this.
Many with the means to buy have a choice of plopping down a big down payment or just paying cash and buying out right.
It is that choice that really alters the equation.
Folks get large amounts of money all the time through out life.Some sold other properties ,have inheritances,settlements etc etc and have quite a bit of dough to use.
Compared to single family homes other asset classes have grown by 4 to 5x the amount.
Financially speaking renting and investing would have resulted in far greater wealth in many cases.
But since most americans don't usually have that much money until later in life as well as suck at investing and having the discipline to invest , the house may be the choice for them.
Later in life after accumulating enough assets the choice of rent/invest or buy and live cheaper becomes a much more common decision.
My first investment property was a co-op in queens ny back in 1987. We put 20% down and plus closing costs came to 20k.
We got 850 a month rent and mortgage and maintaince ran about 1200.00 before depreciation and write offs. interest rates on mortgages were 7-8%
Turning a profit day one does not exist here.
Our tenant had quite a number of years to invest the difference in rent ,the down payment and closing costs before rents caught up.
She would have been ahead of us as a renter in her portfolio if she started one
.
That amount she managed to save would have been up 1400% today in nothing but an s&p 500 index fund. 1800% if she used the newsletter we do.
that is 300k-400k on that starting amount with nothing added after the rent = costs of buying.
by comparison the apartment is worth 165k today ,rents for 1650.00 and costs 900 in maintaince fees a month as an owner, mortgage is paid ..
it may be very close when you figure the total cost of housing owning vs renting /investing .
looking at the different scenerio i described if i had the full purchase price to put down and the tenant could have bought that apartment or invested that full purchase price elsewhere the tenant could buy a few apartments today after subtracting out all the rent.
We sold our house in 2003 and rented until 7 years ago when we bought a 2nd home we thought we would retire to in the poconos in PA. We live in nyc.
After 5 years we decided we didn't want to leave nyc and sold it 2 years ago.
Now we are happy renting and investing that money elsewhere.
Last edited by mathjak107; 02-17-2014 at 04:57 PM..
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