Is it wiser to buy a home rather than rent one? Home ownership has typically been considered the foundation of the American Dream. Lately, however, I have been seeing a lot of headlines claiming that renting is actually a smarter choice than buying.
Obviously, there are pros and cons to Buying vs Renting, but I am a little concerned that the reality is getting lost in the noise of the (online) debate.
Take this viral video for example. While it is funny and entertaining, it really fails to touch on the true benefits to be had from either owning or renting a home. So, in this post I’m going to compare these two options and offer some insight along the way.
First, let’s go over the advantages of home ownership in Orange County, CA.
Benefits of Owning a Home vs Renting
Tax Benefits of Owning a Home
The most immediate (and often overlooked) advantage to buying a house is the tax benefits. A lot of the costs associated with purchasing a home are tax deductible, which means you won’t have to pay income taxes on the amount of those expenses. These include property taxes, mortgage interest, and even a portion of your capital gains when you sell.
In the first several years of your mortgage, interest makes up a larger portion of your payment. This means that your tax deductions will be larger in the beginning and will gradually decrease over the next 30 years.
Are the tax benefits enough?
In order to determine whether or not you will come out ahead by buying, you need to take a look at your personal tax situation and determine what your standard deduction is.
Then, add up all of the tax deductions you would receive by purchasing a home. You cannot take both of these deductions, you have to choose one. So, if your real estate tax deductions are more than your standard deduction, then you will come out ahead in terms of taxes.
Oftentimes, the real estate tax deductions are enough to lower your income tax liability enough so that you will actually end up with more money in your pocket at the end of the year, than you would have had going the rental route; even though the mortgage payment was more than what the rent payment would have been.
Is Buying A House a Good Investment
A lot of new buyers tend to focus on appreciation being the main advantage to buying vs renting. But this should really only be considered in the long-term.
The problem with this is that no one really knows what is going to happen next in the market. If you are planning to buy a house this year in hopes that it increases in value next year, there is a real chance you could be disappointed. Buying real estate is a long-term investment; in the short-term, it’s just a gamble.
However, in the long-term real estate will generally increase in value, especially over a 30-year period. This happens because of population growth, economic growth, and of course, inflation. Land is a finite resource that increases in value as demand (population, econonomy, devaluation of money, etc.) grows.
One of the points I see brought up a lot is that because mortgage payments are larger than rent payments, there is an opportunity cost. The idea is that you could apply the monthly cash savings to an investment account and earn higher returns.
However, there are a few holes in this logic:
- Rent vs. Mortgage: Rent and Mortgage are not the same thing. A portion of your mortgage is going towards paying down your principle loan amount. Only the interest and tax portions of your mortgage can actually be considered “sunk costs,” and thus compared directly to rent.
- Returns: can your returns in the market beat your home appreciation returns? Maybe. But when doing this analysis, don’t forget that it’s not just about home value appreciation. You must also factor in the tax benefits lost by opting to rent rather than buy, and subtract that from the potential market returns.
*Also, keep in mind that to break even you would have to make a high enough return on the amount of “monthly savings” between mortgage and rent, to outpace the amount of appreciation and tax benefit from the entire mortgage payment (not just the part that is more than the rent).
- Savings: Are you really “saving” money every month by renting rather than buying? The payment is lower, but like I mentioned earlier, some people actually end up with more cash for the year after the taxes are done, even though their mortgage payment was higher. Remember, a rent payment is all “money gone,” but a mortgage payment is more complicated than that.
Benefit of Renting vs Owning
Cheaper in the Short Term
In Southern California, the fact is that a monthly rent payment will be smaller than a monthly mortgage payment for the same house. This means that from a cash-flow perspective, renting is easier than buying. If you are living in the home short-term, it is also cheaper than buying. This is because your payments consists of more interest than principle in the beginning.
Terrible in the Long-Term
Unfortunately, the idea that renting is cheaper can actually be a bit short-sighted sa it really only applies in the short-term.
If you pay a mortgage for 30 years, that payment stays the same for 30 years before going away entirely. Rent, on the other hand, will almost certainly increase over time. It will definitely be much higher by year 30 with no end in sight.
So by the time you pay your home off, you will likely have made back all of the interest you paid and then some in increased equity. Not to mention, all of that interest was also deducted on your taxes throughout the years.
The renter will be in the opposite situation. By the time you’ve paid off your house, a renter will have seen about 30 years of gradual rent increases! They paid a king’s ransom in rent over the decades out of their, “after tax” income (because rent IS NOT tax deductible). Also, let’s not forget that they will still need to continue paying rent for the foreseeable future.
In my opinion the only “real” advantage to renting is the convenience of it, which is undeniable. Renting is easy. The payments are easier to manage, someone else is responsible for maintenance, and you can move whenever you want.
Some more wealthy people prefer to rent for these reasons. The housing expense represents a small part of their income so they don’t mind that they aren’t getting all of the financial benefit they could, because they place a high value on convenience. However, these people usually do buy investment property though!
Conclusion: To Rent or Buy a House?
It is my opinion on the buying vs renting topic that purchasing real estate is a more prudent long-term financial decision than renting real estate in Southern California. There are still some cases where renting can be a better fit. However, these cases are generally exceptions to the rule.