I’d like to help you understand how to analyze the decision of buying a home vs renting and investing your downpayment. Living arrangements are an important part of your plan for financial independence. What are the costs of owning a home and how does that affect your plan for financial independence? What’s better: buy vs rent and invest your downpayment?
The final answer is almost certainly going to come with a dash of “it depends”, but I can at least teach you how to figure out how to create your own unique calculation.
- Is the Best Investment You Can Make Buying a Home?
- Buying vs Renting and Investing
- Comparing the rate of return
- Historical residential real estate return rate
- Leverage in real estate investments
- Extra costs of real estate
- Refinancing to increase real estate returns
- Ongoing costs of real estate
- Real estate transaction costs
- Ongoing home maintenance and improvement costs
- Homeownership tax deductions
- Downpayment opportunity cost
- True Cost of Homeownership
- Rent and invest or buy?
- Buy vs Rent Pros and Cons
Is the Best Investment You Can Make Buying a Home?
My parents moved into their current house in 2002. This month, they’re finishing up a significant bathroom renovation and intend to put their house on the market for sale relatively soon.
And, don’t worry—I haven’t tried to convince them to use one of my recommended websites to sell your stuff to facilitate that transaction. My dad happens to have a realtor’s license.
My parents worked hard to pay down their 30-year-mortgage early in the last 18 years and they’ve nearly done it. As I described recently, they answered the “pay off mortgage or invest” question by making lots of extra payments toward their debt over the years.
My dad is often flabbergasted at the value of the house and how it’s risen since they moved in all those years ago. They keep the place spotless and maintain it well.
He’ll often flippantly mention:
“This house is the best investment we’ve ever made!”My dad
But I wanted to know: is that true? Is a house really an investment?
More importantly, how can you ask yourself the same question and figure out if buying or renting and investing makes better sense for you?
Buying vs Renting and Investing
At the end of this analysis, I want to answer the question: were my parents better off buying their house with a 20% downpayment or renting the same home and investing the downpayment. I’d like to calculate the total cost of ownership and compare that to renting and investing.
Comparing the rate of return
Let’s start off with the easier, initial question. Is residential real estate or the stock market a better investment? We’ll take a look at my parents’ anecdotal experience and then bring in historical context.
My parents purchased their house in 2002 for just shy of $350K. In 2020 it was worth just under $666K. Just glancing at the numbers it’s easy to see how that $316K increase in value, or potential profit, would seem like an incredible investment.
Update → In the late spring of 2022, my parents did end up selling their place! It went for $860K. They invested about $150K in refurbishment and renovations before the sale!
Over the 18-year timeframe we’re analyzing, the compound annual growth rate (CAGR) is 3.64% for this house.
We’ll use the S&P 500 index to represent “stocks”—I like investing in index funds vs individual stocks. If we took the same ~$350K and invested in the S&P 500 when they purchased the home in 2002, would the resulting value today be more or less than $666K?
Make your own guess before we calculate this!
On the date of their mortgage opening, the S&P 500 was at 1,153 points.
The S&P 500 was at 3,363 points on the date of their most recent property value estimate in 2020.
If they purchased an S&P 500 index fund with $350K in March of 2002 and left the dividends reinvested it’d be worth about $1.37M today. That’s near 4x more! The CAGR for the S&P 500 investment is 7.88%!
I don’t think it’ll be a surprise to most people that the S&P 500 beat my parents’ house in terms of appreciation, but we needed to calculate this in order to set up the rest of our analysis.
Historical residential real estate return rate
How has my parents’ property compared to the average residential real estate CAGR in the US? The St. Louis Fed exposes the data for the S&P/Case-Shiller U.S. National Home Price Index to calculate CAGR easily.
For the same 18-year period, the average home earned a 3.51% CAGR which was just behind my parents’ house’s 3.64% return rate.
The CAGR for the same home price index (HPI) going back several decades suggests this is pretty close to average which is about 3.9%.
HPI varies around the country. Since they purchased their home, the US went through a massive housing crunch in 2008-2009.
You can easily calculate your own CAGR via Moneychimp’s CAGR calculator.
Of course, this is a very simplified comparison between index funds and a primary residence. We’ve ignored multiple key factors:
- Real estate often uses leverage
- Housing has additional expenses
Before diving into how additional housing expenses affect the primary residence vs stocks equation, let’s look at using debt—leverage.
Leverage in real estate investments
Simply put, a mortgage is by far the most common form of debt the average person will use to amplify an investment. This amplification through debt is leverage.
If you put $70K down on a $350K house, you’ve only invested 20% to obtain the underlying asset and its growth. If the home value goes up 10% to $385K, your investment is worth $35K more whether you paid in full or not.
It’s the increase relative to your initial investment that matters.
You stand to have a 50% gain over your initial transaction cost in the leveraged scenario!
Of course, the risky part is that if the house were to lose just 10% in value, you’d stand to lose 50% of your initial investment!
Debt can increase rate of return
Let’s reanalyze our initial rate of return calculation for the house which suggested that it earned a $316K profit off of a $350K investment over 18 years.
If we only put $70K down but still earn the same $316K profit after paying the remaining $280K debt balance from our $666K sale, our CAGR rises to a whopping 8.73%!
That beats long-term CAGR for the S&P 500 stocks.
Again, this is a simplified explanation with 0% debt interest.
While it’s not something I’d do, you can use leverage (margin) to invest in stocks as well.
Mortgage interest rates’ impact on rate of return
As you near paying off your mortgage, your rate of return will decrease as you have more of your money tied up in the asset but still earn the same growth on the asset.
Let’s make this quantified comparison of primary residence vs stocks a little more realistic by including the effects of leverage and the related interest on the debt. Let’s assume a 20% downpayment ($70K). In March of 2002, the average 30-year fixed-rate mortgage had an interest rate of about 7% which we’ll use.
|Year||Debt ($)||Interest Paid ($)|
We can see from the table above that while the home value nearly doubled over 18 years or so, almost $310K of interest would be paid with a 7% mortgage.
Meanwhile, just a bit over $100K of the original debt would be paid down.
Extra costs of real estate
So far, we’ve ignored these additional housing costs:
- Realtor fees
- Transaction fees (transfer taxes, title, etc.)
- HOA fees
- Maintenance, improvement
- Property taxes
These expenses can really add up as we’ve revealed in our own annual FIRE budget, making the actual principal and interest payment look small.
Not to mention the fact that interest rates these days are near historic lows. My parents have refinanced their initial mortgage at 7%. (And if you’re curious, check out my article on when you should refinance—even a 1% rate decrease might make sense to take advantage of!)
Let’s try to account for some of these larger expense factors and also add refinancing into the equation.
Refinancing to increase real estate returns
Let’s assume a refinance occurred about midway through the payoff period with a newly refreshed 30-year fixed rate mortgage at 4% in early 2012. The fee for the refinance itself would have been around $5,500 which we’ll include in the total interest paid column at the refinancing point.
Let’s take a look at our mortgage table again.
|Year||Debt ($)||7% Loan ($)||4% Refi Loan ($)|
Our initial 7% mortgage sits at a total cost of $180K from the start of 2012 onward.
Getting rid of the higher interest loan at 7% really juices returns. The mortgage refinancing would cut their total interest paid so far from $310K to $262K.
Ongoing costs of real estate
But what about some of those housing expenses? Property taxes are probably the element most folks would like to see included.
Here’s the tax history for their property:
|Year||Property Taxes ($)||Tax Assessment ($)|
That’s $107K worth of property taxes they’ve paid so far on their place!
What about HOA fees? Their current HOA fee is $119 per month. Over the course of their ownership, it has averaged $101 per month. That’s another $22,422.
Over the course of 18 years, their home insurance has run an average of $1,140 per year. Total cost: $20,520.
Real estate transaction costs
Transaction costs when selling a home will vary from person to person. I’m going to give our scenario the benefit of the doubt in the calculation.
We’ll assume my dad, with his realtor license, will sell the home himself to cut the 3% fee that is typical for a listing agent. They’ll still need to pay the buyer’s agent 3%.
If they were to sell around $666K, that’s another $19,998.
Transfer taxes vary as well, but we’ll lump them in with title insurance, escrow fees, attorney fees, and prorated property taxes. 1% is a common rule of thumb, which is $6,659.
Ongoing home maintenance and improvement costs
Consider that the average maintenance and improvement cost for a home is 2% per year. You can cut some maintenance and improvement costs by not being fearful of DIY projects. Nonetheless, home maintenance and improvement costs are estimated at $126K in this scenario!
I know they’re working on a bathroom renovation right now I suspect will ring in at $20-30K!
Homeownership tax deductions
Back in 2002 the standard income deduction every married couple gets on their federal taxes was $7,850. People without itemized deductions would claim this standard deduction. In that year, they were certainly paying more on their property taxes, mortgage interest, and state income tax so they would have itemized their taxes. These state and local taxes (SALT) would have been deducted from their income to reduce their tax liability.
The value of tax deductions for owning a home are highest in the beginning of ownership because you’re paying the most interest at the start of the mortgage. For example, we know that by 2003 my parents paid about $15K in interest on their loan. This along with the property taxes for the year ($3,891) would have resulted in an itemized deduction of about $19K. That’s about $11K more than the standard deduction.
If we assume their federal and state tax rate combined was about 32%, the tax deduction was worth about $3.5K in year one!
However, this number would have shrunk when they refinanced since they were paying less interest and the standard deduction has kept increasing.
Let’s use 2013 as another snapshot to test the tax deduction value. With the newly refinanced loan at 4%, they would have paid $9,435 in interest. Their property taxes were $5,947. The standard deduction in 2013 for them was $12,200. Without any other deductions, their itemized deduction would be $3,182 over the standard deduction. If we assume the same ~32% effective tax rate, the tax deduction on their house was worth $1,018.
With the Tax Cuts and Jobs Act of 2017, the standard deduction is now $24K for married couples. SALT deductions are also limited to $10K! Like many couples who own a single home and don’t have many itemized deductions, they’ve taken the standard deduction since at least 2018.
Overall, I’ve estimated their tax deduction for owning their home as worth $36K.
Downpayment opportunity cost
Lastly, we need to account for the opportunity cost of the original downpayment. The 20% they put down on the loan to secure it would otherwise be invested over their 18 years of ownership.
We know from our earlier discussion about this home’s price appreciation vs the stock market that an S&P 500 index fund would have increased more than four fold. In fact $70K invested then would be worth $274K today with dividends reinvested!
The growth, $204K, is the opportunity cost of the downpayment being locked away in this house for 18 years.
Adding opportunity cost into their homeownership cost calculation treats the analysis like it happens in a vacuum—as if alternatively, they could have lived at some other place free of charge.
True Cost of Homeownership
What has been the true total cost of home ownership in my parents’ scenario?
|Income tax deduction||36,144|
|7% Loan Interest||(179,637)|
|4% Refi Interest + Fee||(82,338)|
|Maintenance & Improvement||(126,000)|
|Initial Downpayment (20%)||(70,000)|
|Downpayment Opportunity Cost||(203,727)|
|Total homeownership cost||(416,216)|
It’s incredible to look at this real estate investment that has increased in value from $350K to nearly double at $666K yet because of all the expenses associated with owning your own home, it can be a pretty bad investment.
But the truth is, my parents didn’t buy their primary residence with an eye for it to be strictly an investment.
Assuming the sale goes through at the price they expect and without any last-minute repair needs, it’s cost them $416K to live there for 18 years. Over 222 months, that’s $1,875 per month on average.
Really, I don’t think that’s a bad deal! But, is it an investment? No. Their asset has cost them money, it’s not something they were able to rent out to produce cash flow and the appreciation wasn’t enough to overtake the expenses.
Someone looking to retire early through real estate investing would analyze the situation from a perspective of rental rates, my parents just wanted a place to live that would increase in value, too.
Rent and invest or buy?
Let’s come back to my original question: would they have been better off, financially, to rent and invest their downpayment or to have purchased their home as they did? We’ll analyze that opportunity cost of the downpayment as an actual second scenario.
The estimated rent for their home currently is $2,900 per month. There happens to be a very similar house available nearby that this rate so we’ll assume it’s accurate. Rental history for homes in the area back in 2002 shows monthly rent rates around $1,950 per month. We’ll estimate that as an average of $2,425/month over the same 222 month period.
We know that had they invested $70K in the S&P 500 (or even better, a total US stock market fund like VTSAX or VTI), they would have earned $203,727 over the initial $70K. Typically, renting a home requires 1-month of rent as a security deposit, so we’ll subtract that from our $70K investment. $68,050 invested would be worth $266,102 (earnings of $198,052).
|Rent & Invest||Buy|
|Initial cost ($)||(1,950)||(70,000)|
|222-month cost ($)||(538,350)||(537,917)|
|Investment earnings, stocks||198,052||0|
|Investment earnings, home1||0||395,428|
|Security deposit return||1,950||0|
Note: Under the “true cost of homeownership” section above, we declared the total cost at $416K. That’s much more than our net cost to “buy” in the table above ($212K). That’s because opportunity cost shows itself on the other side of the equation as investment earnings for “rent & invest”. There’s some great discussion about this in the comments below if you find it confusing.
Strictly financially speaking, given rental rates for similar homes, buying was the smart move for them.
The decision to buy their home instead of rent and invest their downpayment put them ahead by about $128K over their 18 years of homeownership.
Buy vs Rent Pros and Cons
As an investment, your primary residence is very unlikely to produce a positive return once figuring in all the expenses related to homeownership. On top of that, unless you rent out a portion of your primary residence, you can only rely on appreciation (which tends to be 3-4%/year in the US) to increase your total investment value.
The story is much less clear when you begin to analyze buying property to rent out versus investing in the stock market, but that’s an analysis for another time.
Your primary residence is almost certainly a liability. Nonetheless, as the old saying goes, you need to live somewhere. Even with all the expenses associated with homeownership, it may be smart to include it in your plan for financial independence. That’s extremely dependent on the myriad variables involved with your decision between renting or buying. If you’re quantitatively analyzing that decision, NYT has an excellent comparative rent vs buy calculator.
In tighter housing markets, rental rates should reflect the underlying costs of homeownership pretty well. In that case, consider the pros of renting vs the pros of owning. Perhaps that’s more relevant to your decision that the strict financial costs.
- Housing flexibility
- Less responsibility for maintenance
- More liquid assets
- Housing security
- Easier to mold your home to your liking
- Asset appreciation possibility
There are many more detailed differences between the two approaches.
I think that for most people, much of the decision simply comes down to housing availability within a particular location. Many want to live in a particular place or neighborhood and the availability of rental units or purchasable units may be limited in that location.
Ultimately, the most important thing you can do to help yourself to achieve financial independence is to run your own analysis and create a plan. For your own specific criteria, renting may be the smarter choice. For others, buying could be the ticket. It’s not a one size fits all question. Use the buy vs rent and invest criteria outlined in this post to help make your own smart decision on the path to financial independence.
What do you think drives people to decide to rent or buy? Which is healthier for those on a path to financial independence?
Let us know in the comments!
30 replies on “Buy vs Rent and Invest: Planning for Financial Independence”
Great analysis. I think buying your primary residence makes sense if you know exactly where you are going to live in the next 10-20 years. I don’t see buying a home as an investment. It’s an emotional decision and it gives you peace of mind. Valid enough reasons to fork out the funds if it fits your budget.
Yep, one thing that was reinforced for me while working through all the details of this analysis is that the “right decision” is going to be very different from person to person and situation to situation. There’s so many variables involved that setting any blanket statement about renting (and investing!) vs buying is counterproductive.
My dad says the same thing about his home being the best investment he’s ever made.
As for us, we bought our house in 2015. It’s currently appreciated about 100k in those 5 years. But I don’t see us ever selling to reap the appreciation. We’ll rent it out when we move, and that’s the day I’ll call my home an investment.
We’ve recently crossed over to the renting is better camp. There’s so many big and small expenses that go with owning a home, like you mentioned in your piece, that it can get frustrating after a while. Seems like every month we’re spending more than we budgeted just for upkeep–money that could have gone into the stock market. Not to forget the “time” it takes to keep the place looking good. Funny thing is these home expenses weren’t a big deal till we “financially awoke”. Once FIRE was on the table we could definitely see the drag home ownership is on our savings rate.
Nice break down.
I’m glad I’m not the only one that heard that piece of questionable wisdom growing up! 🙂
The labor involved with this analysis of buy vs rent and invest would be a whole new section! I think that’s where homeownership starts to fall behind frequently. There’s a lot of work you can skip (if you don’t like it!) when renting, even ignoring all the financial aspects.
A home is a good investment for many regular people because it’s a form of saving. If they don’t put money into the house, they’d just spend it.
For investors, it makes a lot more sense to invest instead of paying down the mortgage. Historically, the stock market is a better bet.
Yep, good summary. I think it’s especially true that part of what makes a home a good financial investment for many people is the forced savings part.
We like to analyze opportunity cost as the alternative being VTSAX or similar. In reality, many people would just spend the money on some other luxury or want instead of investing.
There’s a lot of value in that mortgage payment having equity in it as a form of forced savings.
Great overview – I love case studies. You covered the tax deduction piece well and the Tax Cuts and Job Act you mentioned is certainly an even bigger consideration going forward. Opportunity cost is also often overlooked, so I like seeing that.
I was talking to my friend in Chicago last week and he was telling me he bought a new place for about 525k. I looked it up and property taxes are $8,700. I sometimes consider that “rent” to own a property.
My actual rent is $12,000 annually in a different market. To be fair, his place is bigger and nicer (different priorities), but property taxes alone are a big deal.
Again, I like to oversimplify things, but the fact that he is willing to pay 72% of my rent in taxes alone is uncanny to me.
Speaking of property taxes, that and other ongoing ownership costs (insurance, maintenance, HOA fees where applicable, etc) are all often overlooked when folks think they’ll payoff their home and not have to worry about ongoing monthly costs.
Overall, our principal and interest represents less than half of our total budgeted housing costs!
This is good stuff, most of my financial mistakes revolve around housing as someone who owned four homes during the span of this analysis.
“Many want to live in a particular place or neighborhood and the availability of rental units or purchasable units may be limited in that location.”
That statement is really the only reason I might buy a house again, now that I’m an early retiree, I am choosing to live in places that have a “paradise tax” and almost everything is either owner occupied or a short term vacation rental. Rental inventory is tough to come by.
Yep, as a kid, we bounced around homes a whole lot prior to this period. Every couple years. I have no doubt that all the transaction costs destroyed a lot of their equity early on.
There’s a stigma with renting, or was, which seemed to drive them to buy each time.
But, this most recent home seems to have worked out well. They’re working with a realtor out in AZ now as they’re trying to put plans together for their next home in retirement. Hopefully it’s a smart decision! They’re looking at pools, that paradise tax seems to be creeping in. No rental units on the table!
Great analysis but you lost me at the argument of RENT vs BUY. The total cost of home ownership was just determined to be $416,216. Immediately following, you calculate the cost to be $212,489 over preceding the 222 months. Also, its seems that you excluded the cost of the seller’s agent in the total cost of home ownership as well, would I estimate to be the same $19998.
Please let me know if I’m missing something in my interpretation. Alternatively, would you consider updating your analysis after any necessary corrections? It’s such a great analysis!
Hey Sandy, thanks for stopping by!
No, you’re right in so far as that transition between the $212K and $416K cost is confusing. I actually struggled with this quite a bit when writing it out, having Jenni re-read it, then re-writing to try to clarify.
The key is in the opportunity cost.
In the initial look at cost, we’re looking at the total cost of homeownership. This would include the fact that your downpayment has an opportunity cost–you could invest it in the stock market instead of the equity in your home. In this case, that’s $70K which would have turned into $274K over the period we are analyzing ($204K opportunity cost). Opportunity cost represents the difference between the true cost of homeownership analysis, which is done in a vacuum (as if the alternative was to live somewhere for free), and the comparative analysis of buying vs renting and investing.
But why is there no opportunity cost when comparing homeownership to renting?
Well, when you analyze the opportunity cost of something, you’re implicitly setting up a comparison.
“I bought new socks for $10. The true cost of the socks isn’t $10, but rather, it’s the potential of having invested $10 in the stock market/my house/savings (wherever the money would have gone).”
I’ll try to break this down to a simple scenario so it makes more sense:
I have $100, my whole net worth, invested in stocks.
If I bought socks, it’d cost me $10 plus the fact that I’d lose out on $10 being invested where I know in the future that $10 investment would eventually be worth $15. The cost of the socks is $10 (price) + opportunity cost $5 = $15.
The difference is $15 between the two choices.
In this case, you’re creating a comparison where option 1) is buying the socks for $10, and option 2) is investing in the market with $10.
But if you compared the two scenarios, you wouldn’t say that the socks cost $15 and the investment option would have resulted in a $5 increase to net worth–the difference being $20 between the two, which would be wrong.
You’d say that the socks cost $10 (their true expense) and the investment option would have resulted in a $5 net worth increase. The difference being $15 (ding ding, the true cost from above). If you still included the opportunity cost in the socks ($5) as part of their total cost when comparing them to the investment value, you’d be doubling the opportunity cost (which is on the other side of the equation as the $5 investment value increase).
Does that help it make more sense?
Seller’s agent fees
So far as seller’s agent fees, because we’re looking at a specific experience (my parents’), where my father is a realtor, there’s no seller’s agent cost–he’ll put his own labor in to avoid that fee. (I mentioned that a bit before that true cost of homeownership table: “We’ll assume my dad, with his realtor license, will sell the home himself to cut the 3% fee that is typical for a listing agent. They’ll still need to pay the buyer’s agent 3%.”).
For other folks, you’d want to include the typical 3% fee in your analysis.
Thanks again for the great question!
thanks so much for responding so thoroughly and quickly.
One other point I think worth emphasizing is that real estate is rather illiquid and that you may find yourself needing to sell in a down market, carrying 2 mortgages, dealing with vacant periods if you do opt to rent your home waiting for a real estate market recovery, along with the lack of diversification relative to what you can achieve in the stock market.
Speaking from personal experience, the home that I built in 2001 has not appreciated significantly, if any since the economy of my town has declined. This lack of appreciation has been relatively consistent year to year. In REAL terms, my home has lost value. I am glad I didn’t pay it off early and instead invested more heavily in the stock market.
If your parents shared the same misfortune as I do with respect to “location, location, location”, their monthly expense of home ownership would have gone up considerably…if my calculation is correct, up to $3298 per month!
Unlike the stock market, where one is generally not required to sell a large value of assets at a time when they may have depreciated, one may find themselves needing to sell their home do to unforeseen life circumstances (relocation due to loss of job or transfer, divorce, death, illness, retirement). No one can predict when the stock market will outperform real estate during a specific period of time. I think it is important to consider your home a place to live and not necessarily an investment (unless perhaps you live in California).
My pleasure! Part of the point of our writing here on TicTocLife is to have meaningful discussion, challenge our own viewpoints, and develop community. Questions like this are key to that, thank you!
You’re absolutely correct about liquidity and risk for a down market. While things eventually worked out, I remember my parents had a plan to buy a new place when my father got a new job, in the new city, and then my mother would stay behind (with me), to sell the old place. They planned to have two mortgages for only a very short period.
Well, the housing market decided to take a turn leading up to it all, but they were already committed to the move because of the job contract. Cue the ensuing value loss and extended time carrying both mortgages.
And, you’re right about appreciation being key to homeownership having any underlying investment value!
I’m currently in the throes of future planning and the thought of selling my place and buying another fills me with dread – because of the maintenance.
The best thing about homeownership, for me, is that your landlord can’t just up one day and terminate your lease agreement and force you to move. And as an owner, you have more control over getting the repairs done. Some landlords aren’t too swift on getting repairs done in a timely fashion. It’s more than inconvenient to go several days without a working refrigerator, water heater, actual running water or air conditioning/heat.
Those are the things that kind of scare me away from renting. They also give me ideas of questions to ask of a prospective landlord; how they handle repairs and how old their unit’s components are.
Yep, I think you hit a good point about a negative side of renting. To point a finer point on it: renting introduces another variable, a third-party, to the mix. They could: kick you out, suddenly raise the price, or bring a terrible maintenance/repair record.
Glad thinking through the details after reading this has helped you identify some good questions in your future endeavors!
And thanks for coming by!
As many other commenters have pointed out, for most people a home will be their greatest investment because it will be their only investment. In my view it really has to be a rental property for it to fall in the category of an investment. But, you do have to live somewhere, and having a mortgage payment as opposed to cutting a rent check each month means you are contributing toward the eventual ownership of an asset. Enjoyed the detailed breakdown!
Indeed, many folks’ investment portfolios wind up being heavily overweight their primary residence’s equity. That can wind up being a smart idea if the interest in the housing debt exceeds the expected return on investments (stock market). At that point, I’d argue for the least expensive home you could possibly live in, though. That way you’d have some money to invest in growth assets.
That’s part of the problem with the simple idea that you have to live somewhere: you do, but there’s a wide spectrum of places you can live. Homeownership isn’t inherently a good idea, especially if the alternative that a person would choose is renting at a lower net cost. It all depends on a whole bunch of factors, though!
Thanks for coming by IF, and welcome to (im)personal finance blogging world! 🙂
Including a breakdown and comparison of all the costs associated with acquiring property and real estate is very helpful. This is by far, the most in-depth article I have seen on the “buy vs. rent” topic and I hope people stumble upon this and read this to help them make a more informed decision about one of the biggest financial investments they might make in their lifetime.
Hey there, thanks for the supportive comment! I’m glad you found it helpful. Indeed, as people make the decision between rent and invest vs buy, there’s a ton of information they need to be informed—a lot of calculations that are difficult to make. We hope this is a useful primer on how to get the ball rolling!
Thanks, Chris. I am a prospective first-time home buyer trying to do as much research as possible, and this was the first post or breakdown I have found that properly illustrates the trade-offs and opportunity cost on both sides of the equation.
Apologies if I missed it or this is a rookie question, but I’m struggling to find the sources for the $537,917 cost for 222 months of owning the home. In the same way you included the footnote breaking down the sources of the “investment value, home,” would it be possible to do the same for the other fields in the table?
Hey Jon! Thanks for coming by and ASKING when you aren’t sure about something! Key to gaining new knowledge which opens up the door to spreading such useful wisdom 🙂
The $537,917 total cost is derived from the data in the section above it (“True Cost of Homeownership“).
You’ll notice that the table total is (416,216), though this includes some elements that aren’t appropriate when doing a comparison of the cost for renting. For example, this includes the initial downpayment (which is a separate line item in our rent vs buy comparison table already), the $203,727 opportunity cost which is irrelevant in the context of comparison (as explained in this comment), and of course the home sale and tax deduction value. Agent fees and closing costs aren’t included since in the context of a rent vs buy comparison, I’m not including the cost to sell the property.
But if we just look at the elements of direct costs one would incur when owning (and comparing it to renting) in this specific scenario, they’d be:
7% Loan Interest: (179,637)
4% Refi Interest + Fee: (82,338)
Property Taxes: (107,000)
HOA Fees: (22,422)
Home Insurance: (20,520)
Maintenance & Improvement: (126,000)
Let me know if that clears it up! Thanks for coming by, don’t hesitate to ask questions or feel like a rookie!
I’m glad to see this article. It’s a question that puzzled me for a long time.
But there is one thing, 70K investment in the stock market, income is to pay tax (income 20% and income tax), and housing has calculated the annual property tax. And the interest is tax deductible.
I hope it was helpful! 🙂
As far as taxes and real estate, they’re talked about in the article under the “Homeownership tax deductions” section which addresses interest tax deductions, SALT, related limitations (the average American doesn’t itemize taxes anymore due to the raised standard deduction, etc.).
Regarding taxes on profits in the stock market, that will vary widely depending on individual situations which is why it’s not addressed in a significant manner for this article—however, I do deal with that more in a related article you might be interested in: When to Pay Off Your Mortgage or Invest Extra Capital.
The article addresses the general idea that in 2020 you could earn about $100K of capital gains as a married couple and not pay any taxes on this income—given a rather standard tax and income situation for a early retired couple. For long term capital gains, tax rates are much lower than on regular income—you don’t pay both income and capital gains taxes.
Best analysis I’ve seen of this question! Thank you!
Hey Greg! Glad to hear—and I hope it was helpful in your own analysis! Cheers.
So I’m summary, was it better for them to buy than to rent and invest? Generally speaking, is that typically how it goes?
Overall, I believe it’ll have worked out better for them to have purchased. Coincidentally, their house is going on the market this weekend. So, I’ll have a pretty clear answer quite soon!
I recall reading a study that found, for the average buyer, it took about 7 years before purchasing made more financial sense than renting for the average property/transaction in the US. That was inclusive of things like transfer taxes, real estate agent fees, rent deposits, etc.
On an individual level, it’s really going to depend on the local real estate market. Above-average property appreciation can really crank down that timeline before it makes more sense to buy.
One other consideration is the taxes on capital gains would affect your investments whereas their house, being a married couple, would fall short of a taxable increase in value. Add another $30k to the loss column for rent and invest. I’ve noticed everyone brings up homeowners insurance but renters insurance is never considered in the equations, is that because it’s not required? Luckily my mortgage with taxes included is still less than an equivalent 2 bedroom apartment by hundreds, I could invest over $500 a month that would otherwise go to rent. I know this scenario isn’t true for everyone though.
Thanks for your comment. Indeed, capital gains taxes could apply to either transaction (whether selling your house or investments at a gain). For the most part, exceptions to capital gains taxes on homeownership are probably more likely to apply (so your point stands).
But, I’d also argue that most folks on the road to FIRE do a whole lot to reduce or eliminate capital gains taxes on their investments. I know that it’s something we’ll almost entirely avoid.
So far as insurance… Home owner’s tends to be required by the mortgage lender (and most homeowners have a mortgage). As you pointed out, with rental insurance not being required, it’s less often purchased. Naturally, it’s also less expensive since the insurance is for your stuff as opposed to the whole underlying asset (the house).
Sounds like you’re in good shape, JD! I’m sure this balance between home costs and rental rates is changing significantly just about everywhere right now. Rates are trending up quickly and of course rentals will follow.