In 2007 and 2008, property values nationwide dropped dramatically in sympathy with the banking crisis, mortgage crisis and the stock market crash. Never before had values of residential real estate fallen so far, so fast and in so many places. It seemed that one of the staples of American wealth was a lousy place to invest money. Which remains with the question, is renting or buying a home the better way to wealth?
During those brutal times, many investment advisers started suggesting renting a home was the way to wealth. Their theory was that if you invest your down payment money in equities, you would have piles of money in 20 years. Rubbish! These recommendations always come from people who broker your money into equities and are backed up by dubious math.
Some Simple Arithmetic
Let’s look at buying a $175,000 home — and renting one of comparable value. In most areas of the country, due to the down market (although values have had a nice rebound over the last seven years) and very low interest rates, your payment to own will be less than the rent for a comparable home.
If you bought a $175,000 home and put $8,750 down and negotiated the seller to pay most of your closing costs, you could get into this home for around $10,000 total investment. Your 30-year mortgage for $166,250, at 5 percent, would produce an $892 monthly payment. Taxes of $200 and insurance for $70 gives you subtotal payment of $1,162. Because you put less than 20 percent down, you will also pay mortgage insurance until you hit that 20 percent equity. This will give you a total payment of about $1,232.
Rental markets vary (look at www.rentometer.com), but in most areas of the country a $175,000 home will rent for $1,300 to $1,600. Let’s use $1,400 — or annual payments of $16,800 — with nothing to show for it but receipts. If you lease homes for 20 years and rents increase even a little, you will pay approximately $360,000 in rent and have nothing but rent receipts.
Consider These Variations
If you bought the home with the numbers described above, what might your situation look like? In 20 years you will have paid $295,680. You will owe $88,000 on your mortgage balance. But what if you had used the $1,400 that a home like that would rent for and paid down your mortgage balance by an extra $168 per month? In 20 years, your mortgage balance is only $18,500 — so your payments have created equity and wealth.
What about the increase in value of the home? I never try to predict the ups and downs of any market, but even with a modest appreciation rate of 4 percent, your $175,000 home is valued 20 years later at $389,000. The house is almost paid off (if you used that $1,400 rental payment) and is worth $389,000.
But what if the value increases less, stays the same or falls? Who cares? You had to pay to live somewhere. Whatever the value is, you own it free and clear and have only the taxes and insurance in your later years. Almost all successful retirees own their properties free and clear. If you are always renting, you create wealth for the landlord.
But Wait, There’s More
I didn’t forget the theory about putting your down payment money into equities. If that $10,000 grows at a strong 8 percent, it would grow to just under $50,000 in those same 20 years. This is a far cry from financial stability — or the equity in your home that you can access in several ways.
Even if you factor in the additional expenses of owning a home — say $50,000 for repairs and updates — most of that will be offset by your tax write-offs of your interest and property taxes.
According to the Federal Reserve, the average net worth of a homeowner is over $174,000 and average net worth of a tenant is $5,100. This is where financial theory collides with the realities of human nature. Home ownership is a natural forced savings and possible investment account that requires nothing but you to make your payment and enjoy your home. You also have the ability to alter the home as you see fit and are in charge of how long you stay. A home is where you will create memories for you and your family. The investment part is a bonus.
John Jamieson is the best-selling author of “The Perpetual Wealth System.” If you are interested in pure investment and cash flow real estate, visit Perpetual Real Estate Machine.
Original article courtesy of Daily Finance
