Why I Rent (And You Should, Too)
By: Adam Parsons
Tags: Money, Investing, Economics, Personal Finance, Millennials

Money

The standard arguments against renting follow the lines of “you’re just throwing your money away” or “you’re paying someone else’s debt”. On the surface that may ring true, but if you look just a little deeper, those arguments don’t hold any water.

The main financial benefit of renting is that there is a cap to your housing expenses, at least for the term of your lease. (We’ll get to rent increases later in the article.)

Down payment

Per Investopedia, “According to the Case-Shiller Housing Index, the average annualized rate of return for housing increased 3.7% between 1928 and 2013. Stocks returned 9.5% annualized during the same time.”

By comparison, the average 10-year Treasury bond (risk-free rate) for the same time period was 4.9%.

Let’s do the math and look at three different scenarios.

You buy a $316,700 house with a 4.9% interest rate and a 3.7% price appreciation. You invest a 5% down payment at a 9.5% market return. You invest a 20% down payment at a 9.5% market return.

Other assumptions:

In scenario #1, you spend an additional 25% of your mortgage on home maintenance and improvement.

In scenarios #2 and #3, you rent instead of buy, with the average rent over 30 years equal to the 30-year mortgage amount. (Rents are lower in the beginning but raise over time.)

Scenario #1:

House value after 30 years: $941,900

Mortgage payments, plus maintenance: $756,365

Financial Benefit: $185,535 (if you sell your house)

Scenario #2:

Market Return after 30 years: $241,010

Rent Cost: $605,095

Financial Benefit: -$364,085

Scenario #3:

Market Return after 30 years: $964,055

Rent Cost: $605,095

Financial Benefit: $358,960 (in a liquid asset)

Since most people can’t afford a 20% down payment, you might be tempted to compare Scenario #1 to Scenario #2, which would lead to the conclusion that homeownership is the way to go.

That’s what I did. Twice.

Number of times it worked out? Once.

The problem is that you only make money when you sell your house, and then you need to buy another house to live in, which will eat up a lot of your profit.

Sure, after 30 years, you’ll probably downsize due to the kids moving out, but even a 2-bedroom Craftsman will set you back, even if it isn’t a money pit.

And then what, pay in cash (with nothing invested in stocks?) or take out a mortgage (and have to pay for another 30 years?) Either way, you might as well rent.

At least in Scenario #2, you have a quarter-million invested that will keep on making money.

Mortgage Payment

The term “mortgage” normally means the principal and interest to pay down the loan you have with the bank. What most people don’t understand is that those are just two parts of the full PITI payment.

Principal — the amount used to pay off the loan

— the amount used to pay off the loan Interest — the cost of obtaining the loan in the first place

— the cost of obtaining the loan in the first place Taxes — including property tax

— including property tax Insurance — homeowner’s insurance and PMI

In most cases, the taxes and interest are added to the base mortgage payment, with the extra being put into an escrow account. The taxes and insurance are then paid out of that account by the bank, without you having to write a check.

This might sound great, as you won’t have a chance to spend the money before budgeting for these payments. The flip side is that the full PITI payment is not normally advertised by realtors when showcasing a home.

Additionally, if you can’t afford a 20% down payment, you will get stuck paying an extra type of insurance called private mortgage insurance, or PMI.

This covers the cost of insuring your loan against default due to the higher risk the bank takes on in lending you the money since you can’t cover the full 20% down payment.

Remember, the banks never lose.

Let’s go back to our example house. The initial payment I used was $1680.81, which included merely principal and interest. Adding property taxes, homeowner’s insurance and private mortgage insurance means an additional $475 to the monthly payment.

Here are the updated 30-year totals.

Scenario #1 (Updated):

House value after 30 years: $941,900

Mortgage payments, plus maintenance, plus taxes/insurance: $927,680

Financial Benefit: $14,220

As you can see, taking the entire monthly payment into account changes things substantially. Yes, you can get the PMI taken off after you reach 20% equity in your house, but that will have little impact as it’s the smallest of the three additional amounts.

“What about annual rental increases?”, you might ask. Well, that is one of the few downsides of renting. Lease renewals will most likely have a slight increase, but then again, so does everything else we buy (thanks, inflation).

You can hedge against rent increases by signing the longest possible lease, locking in your rate. But in the end, the cost will rise. However, as we’ll see below, this cost will be negligible when compared to the cost of home maintenance.

Maintenance Expenses

Just like your car, a house has both regular and unexpected maintenance, with older homes requiring more of both.

The standard advice is to save 1% of your income towards maintenance, but that is for a brand-new home where everything works. If your home is 20 or more years old, then you need to bump that up to 4%, or even more.

Add to that this little nugget from NerdWallet.

About 3 in 10 (31%) homeowners say they don’t have money set aside for home repairs and improvements — a matter of concern, considering 44% of those who have purchased a home experienced their first unexpected repair within the first year after closing.

You know what you don’t need to worry about during your first year of renting? Unexpected repairs and improvements! All you need to do is call up the landlord and put in a work ticket.

And that’s just for the things that make your homework as it should. We haven’t even started about decorating or other niceties, aka home improvement.

Homeowners are spending more on home improvement projects than home maintenance projects. For every $1 spent on home maintenance, homeowners are spending an average of $5 on home improvements. - State of Home Spending Report

From that same report, homeowners report an average of 6.7 home improvement projects. If you’re a homeowner, think about all the little things that you just haven’t had the time to finish. That new door handle. Painting the basement. Upgrading the backsplash. Your home is in a constant state of flux.

Think about all the systems that you have in your house.

Building Envelope : Walls, roof, cement slab, fireplace and chimney, gutters.

: Walls, roof, cement slab, fireplace and chimney, gutters. Plumbing : Toilets, showers/tubs, pipes, septic tank/sewer connection, sinks.

: Toilets, showers/tubs, pipes, septic tank/sewer connection, sinks. Appliances : Washer/dryer, dishwasher, stove/oven, water softener, refrigerator, water heater.

: Washer/dryer, dishwasher, stove/oven, water softener, refrigerator, water heater. Mechanical: Furnace and air conditioning units, ducts, vents.

All of these things cost money as a homeowner, and all of them have a finite lifespan. No wonder Lowes and Home Depot have seen their stock price increase by about 330% and 450%, respectively, since 2005.

Moving Expenses

The average first-time home buyers only stay in a house for 12 years. If you do a standard amortization, you have barely paid off 25% of the principal of the loan when you are 40% into the loan term.

Then you’re going to up and move to another house, probably a bigger one. So whatever equity you have in your current house will be spent on the next one’s down payment, and that’s if you get your asking price. The market may have tanked, and you’ll get much less.

Then, once you move, you need to spend more money to furnish that bigger house, utilities are higher, taxes are higher, and so on.

Money isn’t the only cost that homes come with. The second element is time, something much more precious.