Renting vs. Mortgage and A Solution for Mortgage Free Home Ownership

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The Lie – Renting is throwing money away

Although I am currently debt free I do not own a home, have no immediate plans to buy one, and have been renting an apartment for nearly 3 years now.

You may remember a past discussion on the topic of renting before buying a home, and while there are many factors involved in the renting vs. mortgage debate, today let’s hone in on one common misconception that often drives people into the arms of mortgage lenders:

“Renting is just throwing money away”

Well intentioned friends like to remind hapless renters like myself how much we have “thrown away” in rents over the past several years.  They are also quick to point out that had we only bought (a.k.a. mortgaged our lives for) a home, some of our rents paid would now be counted toward our net worth calculation as equity.  In reality this is misleading at best.  Actually, avoiding a mortgage has provided us an opportunity to build more equity while renting.  To prove my point let’s compare a hypothetical mortgage against my current rental housing situation.

The Truth – Renting cost vs. mortgage cost

According to borrowers in Laredo, TX with credit scores over 700 can borrow $165,000 on a 30 yr fixed note for about 5% – if they put 20% down.  I don’t know a lot of first time, prospective mortgage slaves with $33,000 in their pocket.  Heck, many may be hard pressed even to have credit scores of 700 or higher.  So we will go with the default numbers in Bankrate’s payment calculator: $165,000, for 30 years, at 7%, with no down payment.  That is enough to buy a house about twice the size of my current apartment in the same neighborhood.

I currently pay $700 for a 626 sq ft, 1 bedroom apartment in a gated community, with a pool and a gym.  We are trading up to a larger house in this example, because that is what most people do.  Few go looking for a 600 sq ft house, as they usually leave apartments for more space.  Feel free to run these numbers with a more expensive apartment or cheaper house; the results should be similar.

Here is a snippet of the Amortization Schedule (click image to see the full amortization schedule.)

Our imagined loan results in monthly payments of $1,097.75.  At the first payment, only $135.25 goes toward principal. After one year of payments the equity, according to amortization schedule, would be $1,676.09 not $13,173.  As you can see… that’s not a whole lot of equity.

We THREW AWAY almost $12,000 in the first year with a mortgage; my apartment only costs $8,400!

Also, by the time the loan is paid off, $230,189.68 has been thrown away in interest paid to the bank.  That is more than the price of the house!  Mortgages steal from your future standard of living. Sure… you will get into a house sooner, but think of all the things you could buy with $230,000 if your house was already paid for!

The Solution – Build more equity while renting

The snippet amortization schedule above shows the initial & final payments on our imagined loan.  It also shows the turning point where the money I through away on interest is less than the money through away on rent.  Notice it is 15 years in the future.  That means I could rent for 15 years before buying a house and still come out money ahead, and maybe save enough to buy a home with cash.

The loan payment is $397.75 more than my current rent.  Instead of making the larger payment to a bank, I continue to pay my rent and put the difference into an Capital One 360 savings account labeled “Personal Equity.”  At the end of one year, I will have $4,773.  That is more than double the equity I would have with a mortgage, and it is also a liquid asset in MY bank account… accessible without having to sell my home or qualify for a HELOC loan.  You build your personal equity faster as you save money, I like to think of this as mortgage pre-payment.  :-)

My own personal equity grows by $875 with every paycheck.  I will have $22,000 by the end of the year.  I am also looking for a cheaper apartment, and probably will spend less than $165,000 on a house.  If I maintain my current standard of living, as my income increases so will my savings.  Eventually I will be able to buy a house with cash in the time it takes most people to pay off a car.

Final Details

You might notice I didn’t account for the mortgage interest tax deduction.  I wanted to keep the math simple, so I also left out costs for home maintenance, property taxes, or private mortgage insurance that more than offset the tax break.  These forgotten expenses will only add to the savings a renter can accumulate while those paying mortgage continue to pay, pay, pay.

For this to work you will need to secure housing below your means while you save to afford something better a few years down the road. This concept of sacrificing now to benefit later is a fundamental building block of sound personal finance.  Renting indefinitely without saving will never get you into a house, but paying a mortgage guarantees that you throw away money on interest.

There will always be a few areas with no available rental housing, but most people should be able to find a decent rental while they save for a home.  However, most people choose a mortgage over renting because they refuse to live below/within their means for a few years… never realizing how much it actually costs them in the long run.

What Do You Think?

I encourage you to visit and try out their amortization calculator with prices from your area.  If you rent, take note of the difference between your current rent amount and a mortgage payment.  How much personal equity could you build in a year?  If you already own a home, try the pre-payment calculator to see if you can pay that bugger off early.

Do you believe people could ever be completely free from mortgages?  If not, why?

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