Maybe you’ve asked yourself, “Why would I buy a home and make higher payments when my rent is much lower?”. Good question. For some, that is the best way to go. Every situation is different. Sometimes the best way to figure it out is to get out a piece of paper and a pencil. Make two columns: Rent and Buy.
RENT
- Generally lower payments.
- Little or no responsibility.
- No repairs.
- Generally easier to move from location to location.
- No need to worry about a drop in home prices
- You get to retain your cash
BUY
- Full tax deduction of your mortgage interest and property taxes paid by you. The government makes part of your payment.
- Appreciation of home value over time.
- Freedom and quality of life. You can do what you want because that place is yours!
- A source for emergency cash or credit.
- For many people, their equity represents most of their retirement money.
NOW HERE’S THE MATH
On the average, homes appreciate about 5% a year. Average is the key word. If you are worried about home prices over the next year or two, don’t buy a house. In some years prices will rise, in others, go down. On the average over time, figure a 5% increase. The figure will vary from neighborhood to neighborhood, and region to region. 5% may not seem like very much. Sometimes stocks appreciate much more, and you could earn over 6% with the safest investment of all, treasury bonds. The beauty of home ownership is that your money is highly leveraged, unless you pay cash for the home. For example, let’s say you bought a $200,000 house with 10% down and got a 90% loan. That means you put $20,000 down. At an appreciation rate of 5% annually, a $200,000 home would increase in value $10,000 during the first year. That means you earned $10,000 with an investment of $20,000 based on the new home value of $210,000. This is because the 5% increase was on the $200,000 of the home, not the $20,000 you put down. Your annual “return on investment” would be 50%. ($10,000 is 50% of $20,000) Of course during that time, you are also making mortgage payments and paying property taxes, along with a couple of other costs. These are expenses and you have to deduct those. But since the interest on your mortgage and your property taxes are both tax deductible, the government is essentially paying part of your costs. For example, assume your initial loan balance is $180,000 with an interest rate of 6%. If your first payment were January 1st, your taxable income would be $10,800 less at the end of the year due to the tax benefit. Paying the property taxes reduces your taxable income another $2,000 or so, depending on your location. Your taxable income in this example is reduced by $12,800.
So what is the bottom line with all of these numbers? If your combined tax bracket is 28% (talk to your tax preparer on that one), you get $3,584 “cash back” at the end of the year. Only homeowners get this benefit. The other benefit, as mentioned above, is appreciation. Your property gained $10,000 in value. That’s your money! Renters don’t get anything, but their landlords do. All of these numbers have the positive effect of reducing the real cost of homeownership. Over time, buying a home is one of the best investments you can ever make.
