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 Bankrate.com 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 Bankrate.com 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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1 FinancialBondage.org

I agree. Renting is not wasting money. Your rent is cheap. One bedroom apartments near me start at $1000 a month at least. You are getting something for your money. A clean dry place to live, to keep warm, a roof over your head. So you are getting some value from it. Larry Burkett use to say if you can’t find a home within your budget (no more than 40% of your take home pay including utilities, insurance, taxes, everything), you would be better off renting the rest of your life than to get into a home that will swamp your budget.

2 Lakita (PFJourney)

Renting is not wasting money and it is not an indicator of success…which is why I believe so many people rush to buy a house.

People that say “renting is throwing money away” assume they are getting an immediate return, but as you illustrated, it will take 15 years before what you are throwing away on interest is less than rent…wow!

And that interest…yikes!!!

I’m not going to say I won’t have a mortgage in the future, but this certainly motivates me have a large down payment and accelerate the payments. No debt is good debt.

3 Kim

I crunched the numbers a few months ago and came up with the same conclusion. Unfortunately we are already in a house – we believed that renting was throwing money away. But now that we’ve seen the reality of it, we are making plans to pay off our home in ten years or less to minimize the damage. Then we plan on continuing to save money so that when we get our second house, we will pay cash only.

4 Mr Credit Card

agree with you on this. The other way to think about this is to save up to pay cash for your home. If this sounds extreme, then how about saving for a 50% downpayment and taking out a fixed 10 year mortgage! That way, you pay much less interest! Thing is if everyone did that (like it was more than a hundred years ago), then house prices will be more affordable and we would not have gotten into the mess that we are in now!

5 Financial Samurai

All depends on the rental housing stock vs. the homeownership housing stock. In San Francisco, the rental pool is quite run down compared to what you can buy. It’s just about quality of life.

Some go to the extreme and at 30 years old still live in their crummy 1 bedroom trying to save money. That’s not the way I want to live my life. Obviously, don’t go crazy buying what you can’t afford either! Balance.

The final consideration is your tax rate. If I have to pay a 45% blended tax rate on my last marginal dollar, it benefits me most to buy a place.

6 Matt Jabs

As far as wise financial decisions are concerned… “the final consideration” is actually just a matter of calculating the long term cost of buying against the long term cost of renting – there is no need to wonder which is a better financial decision.

7 BG

Well said FS! Houses become great deals when you have no mortgage on them — ie; free rent, though you have the ongoing costs of prop taxes, maintenance, insurance, etc. Once the house is paid off, it is much better financially than renting. As for quality of life, I agree — when we were in an apartment, we could barely get sleep due to all the noise, our cars were getting broken into (it was a gated apartment complex), and just the hassles of having neighbors on your walls, and ceiling.

When our child was born, we got out and bought a house. We plan on having our house paid off early (only 9 years start to finish).

As for the original article comparing a 626 sq foot apartment to a $165k house in Larado — that is not a fair comparison. Equity in a home (in TX) is protected from lawsuits or claims on debt (Homestead protection act) and there are other types of benefits of home ownership. As with everything, you get what you pay for.

Also, 30-year mortgages are just plain not good financial sense — unless you are paying it as if it were amortized like a 15-year.

8 LeanLifeCoach

Is there ever one choice that everyone should make? Probably not, but this is the best laid out argument I have seen for rent vs. buy.

The other factor that get built into the equation however is the size of the family unit. My family would never fit into 600 square feet. In our market I could rent a house but it would cost more than our mortgage.

9 Matt Jabs

Each person/family needs to run the numbers for themselves. Period. The main problem is that people rarely do, instead the majority will blindly walk into a mortgage… I am a perfect example.

10 Anthony

You make two good, unintentional points. While at your apartment, you have free access to a pool and a gym. On top of the larger mortgage payment, property taxes, homeowner’s insurance, PMI, and home maintenance costs, you have to consider the cost of a gym membership. If you want access to a pool, that may even cost a little more!

Having said that, I decided to buy a home two years ago. Even with all of the extra costs, I felt that homeownership was the most important thing for me and my growing family.

11 Matt Jabs

You felt that home ownership was most important… but did you run the numbers to compare beforehand? I didn’t, and wish I would have.

12 Mike Piper

To me it’s about rates of return. Calculate the rate you’d earn from buying a home (i.e., the “imputed rental dividend”), and compare that to what you think you could reliably earn via investing otherwise.

Then perhaps include some adjustment for any emotional/mental benefits of owning or not owning.

13 H Lee D

After the hell we’ve been though with our house, I am almost all for renting. But I’ve had enough issues with renting that I’m not convinced I want to go back…

I live in metro Phoenix. ASU is everywhere. ASU students are everywhere. I don’t want to live with college kids. I didn’t like living with college kids when I was *in* college, and I’ve grown up since then.

I like to listen to music without worrying about the volume. I like practicing my drum set and trombone. I like dancing and jumping rope. I can’t do these things in an apartment without being a significant nuisance.

While there is an argument that if something breaks, it’s the landlord’s problem to fix it, it also gets fixed on the landlord’s schedule and, in my experience, in the cheapest (shabbiest) way possible, if it gets fixed at all. While I don’t like forking out money for repairs, I am glad to be able to choose to have it done well so it doesn’t need to get done again and again and again. (This is a similar problem with home warranties.)

Your place might be different, but the in-complex gyms that I have had access to would not deter me from belonging to a gym. They also don’t have group fitness classes, and the pools at apartment complexes are typically not lap pools – they’re play pools – which would not suit my swimming needs. Can’t realistically train for a triathlon in a play pool. Especially not when you’re sharing with your neighbor’s kid’s birthday party.

Finally, I am looking to start a business, but most apartment complexes will not allow you to run a business out of an apartment. It will have a significant amount of foot traffic, so it’s really not a “I hope they don’t notice” kind of thing. The expense of having an off-site place of business is more than offset by owning my house, even being on the brink of upside down.

At this point, we can’t realistically get out of our house anyway – we bought at the wrong time, and the Phoenix market is still declining – so it’s a moot point. I’d consider renting a (smaller) house if we got out of here … but I’d need to do some hard interviewing of the landlord first. And my gym membership is pretty cheap (renews at $49/year), so I’m not worried about that expense.

14 Matt Jabs

Everything you say in the last paragraph is what I would have responded with. If the point were not moot:
1. Consider renting a house.
2. ALWAYS do thorough research

15 karyn

We have three, soon to be four, children, so we need more space than some. I haven’t seen any homes with rent that is cheaper than our mortgage and we have the benefits of land and privacy. That said, we lived in and sold two fixer uppers and we left this house as unfinished as possible in order to pay a good size down payment. Luckily my husband can do most construction work himself and it has saved us loads of money.

16 Matt Jabs

Yeah, each situation is different. Karyn, did you ever seriously investigated the rural rentals with land and higher square footage? I know I haven’t… this interests me because if I rent I would prefer rural with acreage too if financially possible.

17 karyn

The rentals we briefly checked out were all in our little town and houses that were much smaller than ours rented for as much or more than our mortgage. Then, we briefly investigated renting our current home while we living overseas and the amount that was suggested for renting our home was at least 500.00 more than our mortgage. Unfortunately, a lot of the rural rentals available around here are poorly maintained trailers. We do have a good mortgage rate, we put down a big down payment as mentioned above, and we don’t have PMI or an escrow – so that helps keep our mortgage low. I would love to be able to make extra payments but that’s not possible yet. I do like your point of not blindly assuming you should own a house as soon as possible. I would prefer our children live with us a little longer and save up for a down payment rather than jumping into ownership prematurely.

18 Mrs. Money

Great points! We bought a house three years ago. I don’t think we were truly ready. I think we qualified for more of a mortgage than we should have. BUT I knew enough to make sure that I wouldn’t stretch myself too thin. Sometimes I wish we were renting again, but other times I love our house so much that it outweighs that. I am really impressed with what you are doing!

19 Kevin@OutOfYourRut

Brilliant analysis Robert! Another consideration is the income tax benefit. I wrote a post on this on my site (Tax Benefits of Homeownership – Three Reasons Its Over-rated).

Most people assume that if they pay $12,000 per year in mortgage interest and $3000 in property tax, they’ll have $15,000 in tax deductions. On that number, if your marginal tax rate is 40% (fed + state), you’ll save on the order of $6000 in income taxes. Nice deal, IF you could get it.

The IRS gives married couples $11,400 as a standard deduction. The tax benefit is on the difference between the interest and taxes and the standard deduction. You’ll only get a write off on $3600 ($15,000 – 11,400). At 40%, the tax savings is only $1440, or $120/month!

And it only gets worse after that!

IMHO, the attraction of home ownership in the past few decades has been appreciation. Take that away and the whole idea of a house as an investment collapses. Look at all the buy vs. rent posts all over the web (I have a couple too). The “conventional wisdom” is changing with the times. Which is a good thing, as LeanLifeCoach wrote above, there’s no one solution that’s right for everyone.

Owning is the right decision for some, but hopefully we’ve moved away from the convention that everyone should own. A lot of people are in trouble right now precisely because they bought into that marketing pitch, and the whole financing industry is stuck in the mud for trying to make it happen…

20 Mom

I bought a house in 2005 after years of renting. I did a lot of research before I bought the house as to the quality of the neighborhood, property taxes and resale activity. I crunched numbers as to what I felt I could afford. I considered my age and the necessity of maintenance like snow removal and lawn care. It was a tough decision because I always liked the freedom of renting because all of the associated problems with owning a home were someone else’s headache, including paying the property taxes. I even got a small tax break because I could claim some percentage of my rent toward a property tax credit. However, the drawbacks of renting became quite obvious as well. One has no freedom to make improvements; even simple ones like changing a room color. If the furnace breaks down, one is at the mercy of the landlord to act quickly to get a repairman on the scene. Having pets is usually out of the question. You have minimum privacy because one is separated from the neighbors by thin walls and they can sometimes be very inconsiderate at best.
I made the decision to buy my house with the awareness that in order to avoid paying more than twice the price of the house in interest over the course of 30 years, I would need to pay extra on the principal balance every month. That is the way to beat the rap of infinitesimal increments applied to principal with the associated mega payments to interest. With as little as an extra $100 per month, I can pay off my mortgage in 15 years and save something like $50,000 in interest. Those are not exact figures but you get the idea!

21 Mrs. Frugal

Great article. After 7 years of homeownership we are renters again and let me just say, it’s a relief! We plan to buy again one day, but only with a plan:

1. Save up for a large down payment
2. Buy less house than we can afford
3. Build in extra payments from the beginning to pay off the mortgage early
4. Own free and clear by retirement

22 Matt Jabs

It is worth mentioning that as American’s we think we “deserve” to own a home… that is a fundamental thinking problem!

Who deserves to buy a home then? My opinion is… someone who actually has the money to. Keep in mind that I bought with zero down on my home… so I am not an example to follow – but I still have an opinion, and that opinion is stronger now that I have already been through mistaken decisions. :-)

23 Kevin@OutOfYourRut

That thinking that exactly what landed us in this housing slump/mortgage meltdown. I believe Henry Cisneros, the then secretary of housing under Bill Clinton, who declared that it was the right of every American.

I was on the inside of the mortgage business at the time, and we all KNEW that not everyone should own a house.

24 Ted

We bought our house before the housing crash. We refinanced just before we were screwed (yeah for bad advice from our mortgage broker for a 3 year arm). Since getting into our house 5 years ago, we have replaced the washer, dry, heater, and A/C. And now we can get just what we owe out of our house now (luckily). I really wish we would have rented. The rental market here (suburban Chicago) is great as many homes for rent have been owned for more than a decade meaning the mortgage is low and the rent is low. We could rent a larger house for less than what we pay now in mortgage, taxes, association dues, etc.

But, there is something to say for owning your own home and being able to do whatever you want with it. We are thinking of moving in the next 2-3 years and we will seriously think of renting a house.

25 Neal

Great discussion.

My experience tells me that owning a home can be a forced savings of sorts. If you save on rent and invest – great. Many don’t do this. They may have low rent…but then the spend the rest rather than invest. In those cases, the forced savings element of buying works. And if you take a look at the facts on the ground, most people who do achieve financial freedom own their own homes.

This the reality that I’ve observed at least. I still believe that owning real estate is one of the best ways to achieve financial success.

26 Robert Espe

That is a common argument, but if we look at the numbers in my example above, one would spend over $230,000 in order to force themselves to save $165,000. That is a net loss of over 100%.

27 Financial Samurai

Agree. Generally renters who can’t afford espouse renting, while homeowners espouse homeownership.

To each their own.

28 DB

I believe that this is one decision that MUST involve factors beyond purely financial. I grew up in a house – a home – in the country. Lots of space to roam, to play, to grow. When I moved out at age 19, I rented a home in a nearby city for six months, then an apartment in another nearby city for nearly three years. When I had my first son at age 23 (way too young, but I digress…) I absolutely had to get him out of that apartment and into a home away from the city.

We extended ourselves and bought a small home on five acres of wooded land. It was tough – I worked two, sometimes three jobs, went to college, my wife stayed home, eventually worked while I was home – it was tough! BUT, our sons (four of them!) grew up with the freedom to roam, to play, to grow – safely, just as I did. Seven years ago we sold our home and bought another nearby, on 20 wooded acres, with a creek and a barn. Being mortgage-free is within sight, and we will live on this land and in these woods until we die. Our grandchildren will one day run through this forest and catch minnows in the creek.

If we had waited until we could pay cash for our first home, our kids would have grown up in a small apartment in the city. Things would have been much different for them! I wouldn’t trade the freedom we feel on our own land for a million dollars!

29 Robert Espe

DB,
I appreciate your perspective, I also grew up in the country and value the freedom that such an environment provides. But we can not allow things that we value to supplant wisdom. You say you wouldn’t trade your land for a million dollars, but my point is that if people will be willing to delay gratification for a few short years (certainly not the 18 it takes a child to grow up), they will not only own a home, but be a lot closer to having a million dollars as well. I plan to be able to buy a home in cash in under 5 years. And that as a single income married man.

30 H Lee D

But if you had a kid NOW, buying a house in 5 years doesn’t give you space for your kid to roam, which is obviously highly valued by DB. It’s not a matter of delayed gratification (in his case), it’s a matter of choosing the environment he sees most fit to raise his kids. It’s not renting a condo vs. buying a house all in the burbs. Apartment in the city to five wooded acres is huge.

For many people, your thoughts would be true, but in his case, I disagree with you.

31 Kevin@OutOfYourRut

Robert, I agree. Many of the positive owning experiences were in homes purchased 20-30 years ago, when housing was much cheaper in real terms. This kind of analysis wasn’t necessary back then.

The real question is what do we do today, with the set of parameters we’re now working within. Owning is much more expensive now than years ago. With the housing bubble, every government agency or related business that could has increased their fees or added “required” services to the price of buying and maintaining a home.

The risks of owning are far higher now than in the past. The price risk alone is enormous, and a complete variable. Owning requires a certain level of certainty that doesn’t seem to be in the mix anymore–just look at careers! I think that’s why so many of these threads even exist.

32 Robert Espe

I feel like I do need to clarify, since many people seem under the impression it is the “owning” part I am against. I am very pro-homeownership. I’m just anti-mortgage, which isn’t really owning. Renting your whole life would also be unnecessarily expensive. I want a nice place to live, and I don’t want to spend more of my limited life energy than I have to in order to have one. I expect it will take me about 5 years to get one, but it can be done without debt, and we’d all be richer for it. 5 years of sacrifice vs 30 years of sacrifice makes sense, but most people don’t realize the 30 year cost.

33 BG

Robert — well said. Renting for life is much better than a mortgage for life. The trick is to get out of the mortgage as fast as possible, and own the home outright — that is where the benefit of ‘home-ownership’ is easily seen.

34 Neil

Most people might trade up when they buy, but the added expense of the larger space is increasing their standard of living. In order to provide a legitimate rent v. buy calculation, you have to compare two similar properties. People buying more house than they need is a completely separate issue from buying vs renting.

I don’t have my spreadsheets in front of me at the moment, but I’ve shown myself that buying is the better option at the end of the day. The driving factor causing that is that rents increase over time, while interest payments decrease, eventually going to zero.

Now, you’ve got a fantastic savings rate, which will let you buy a home for cash in a relatively short amount of time, if that’s what you choose to spend the money on. But you have that savings rate not because you rent, but because you’re willing to live in a small apartment. You are trading a lower standard of living today for a better standard later (when you may own a house without ever taking on a mortgage). Opting to borrow money to buy a house today would be to make the opposite calculation, trading future standard of living for a better standard today.

Both are valid choices, and but they are completely independent of the rent vs buy question.

35 Budgets are the New Black

I related to FS’s remark about renting vs. buying also affecting quality of life. As a military family, we have moved a LOT and have run the gamut of rentals: apartments; houses; “stairwell housing” — and have purchased two homes, one of which we currently live in.

We had no business buying this home, if you look at the numbers. We didn’t have 20% down and so have a 2nd mortgage. (The very next thing we’ll tackle on our snowball!) The payments for our primary and secondary mortgages roughly equal what we would have paid in rent for a “decent” home for a family of five, in a decent neighborhood. However, when you add in home repairs and improvements, etc., I know we do not break even.

But I still have a hard time being sorry that we bought instead of rented. The quality of homes we looked at for rent simply wasn’t of the same caliber as the ones for sale that we could “afford” as a family of five. Our primary focus when house hunting is an excellent school district and a safe neighborhood. What few rentals you find that meet these requirements simply pull a higher rent.

Despite all this, the next time we move (and we will move again) we will likely rent, and we will make a point to try to rent as well below our means as possible to allow as much savings as possible. Our hearts may want to be homeowners, but our heads now tell us that delaying that desire and refocusing our financial priorities will benefit the whole family much more in the future.

36 Matt Jabs

Cool, our 2nd mortgage is next in line for our snowball too… I can’t wait to slay this puppy!

You NAILED it with this comment:

“Our hearts may want to be homeowners, but our heads now tell us that delaying that desire and refocusing our financial priorities will benefit the whole family much more.”

37 Mr Magoo

This is an OK analysis, but doesn’t include the larger SQFT that a house usually comes with, along with the higher standard of living in a house.

If the author wants to live in a singlewide trailer for 15 years while he saves for a house, that’s fine. But it’s not for everybody.

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