Whether you want to buy or rent you need to determine how much of your money you want to spend on housing. In most cases it can’t be $0 and obviously cannot be unlimited either. Where you live will determine the low end of what you can spend. If the absolute minimal living conditions that you can tolerate rents for $1,000 a month then you now have your figure for the low end. To get the high end you should make a budget to track income and expenses. The more money spent on housing will subtract from retirement savings, food, travel, entertainment, and more. There is no correct budget that is right for everyone. You must determine your priorities when making the budget. Once you have an ideal amount to spend on housing you are halfway there.
Why total house payment can exceed rent, but still be Cheaper
Now if you decide to buy a house the total mortgage payment plus property taxes, insurance, and maintenance can actually be higher than than comparable rentals. This is because if the home is lived in long enough and the majority of it has been paid off, then you now have an asset that can be sold to offset the higher amount spent while living there. Conversely, If you were to rent you could invest the money you saved each month with the lower rental rate by not buying. So in the end if you buy a house you get some home equity, if you rent you have larger investment assets.
Before you run and buy the house of your dreams, understand that if you sacrifice other investments completely that you are non diversified. Having all or the majority of your wealth in a home can work out just fine under ideal conditions, but if housing lags stocks and bonds in the future, it could turn out to be an unwise decision.
Therefore, beyond just making a budget for how much you can afford to spend on housing it is important to include a significant amount towards retirement savings. If forced to spend less on your home, you can also have other diversified investments. This will allow a better chance of holding some asset’s that perform well overtime.
Homes are the least liquid Asset
Further it is important to Understand money in a house you live in is very illiquid. Stocks can be sold in minutes logging into your computer or even a cell phone. To sell a home, you must first find a new place to live, list your home for sale, find a willing buyer, and pass escrow to collect your money. As long as you believe you will live in the home for a long time, and have an emergency fund plus some diversified investments, then you are better insulated from loss, should you need to sell the house and move for any reason.
How to compare monthly rent to the purchase price of a Home
The New York times has a wonderful calculator to compare rental rates to home prices. You still have to give estimates for many unpredictable factors moving forward, but at least it takes into account opportunity cost in buying vs renting. Earlier I mentioned that it is possible to have a higher payment on a home you own vs rent and still come out ahead. Using the calculator can help you determine what these levels are. It will show what an equivalent monthly rental rate would equate to in terms of total purchase price of a home.
So buying a home at the right time, or accepting one with less features can actually save you money over renting long term. The problem is most of us do not know how much we really should spend, and find it all too easy to go well beyond our budgets. By setting a budget including healthy retirement savings and using the calculator you can determine an appropriate price to pay for a home.
Why buying a house Cash makes the most Sense
It may seem impossible to buy a home outright since mortgages are an accepted part of life in our society, it can be done.
First let’s think about some lifestyle considerations between renting and buying. When you think of the importance of being able to move for job opportunity, family, or relationships it really makes sense to rent during your early earning years. Most of your time is spent outside of the house at work, and when young going out on the town at night. When you are closer to retirement you will have much more free time and are generally more content to hang around the house. By this point in life one would usually be content to settle down in one spot so the need to move unexpectedly drops as well. Further, when working long hours and raising a family one would not have a lot of time to do home repair. Whereas, once retired or close to it there is plenty of time and satisfaction to be gained by working on your home.
How can it be Done?
There is a wide gap between home prices across the United State. If you happen to live and work in one of these area’s you can save very quickly. If you live in one of the more expensive area you can still achieve this, but it may take longer. However, if you can accept moving somewhere cheaper later in your career or retirement you can really do well to make the move. In either case the solution is to simply rent a place well below your means for a number of years. I know it is not as exciting as buying a large home that you will “grow into,” but it will save a ton of money. Those that buy a house upfront that is larger or has more features than they need today, just in case they need it tomorrow as just costing themselves more in interest payments. By living small and modest you can save much more money each month. If done long enough there may be the opportunity to buy a home without a mortgage when the time comes..
Mortgage vs Cash and then Rent
Even if we can sort out if it is better to rent or own, we still have a second choices as outlined above. There are strong opinions about whether you should buy a home with a mortgage or cash, so I think it comes down to what is right for you. I will highlight what I see as the big benefits below and include the pros to not buying as well. I did not list the mortgage interest dedication, because for the majority of people the standard deduction is higher anyways.
- If it is a non-recourse loan you have some protection in the event of a natural disaster destroying the home or choosing to walk away if the home goes down in value. In the stock market we can think of this as owning a put option.
- Helps stay diversified by only putting a small portion of total net worth into the home, and can possibly make more money in other investments.
- Significantly reduces living costs. More money to invest each moth elsewhere.
- Essentially earn the money saved on the interest rate. For instance if mortgage rates are 4%, by paying cash you are saving yourself from spending 4% of the purchase price for 30 years on a traditional length loan. This money can be looked at as tax free earning and is a higher rate of return than US Treasuries.
- Satisfaction knowing the home is paid for.
- Can move relatively easily and cheaply
- Will not lose money if the building is destroyed in a disaster
- Ability to rent the size and location needed at the time in your life to save money, but can still move to something larger when needed. Essentially assured that you are only paying for what your current needs are.