The mad, mad world of homeownership

Like marriage and children, owning a home is one of those milestones that defines a good, wholesome, American adult. If you don’t do it, it’s one of those things that you’ll have to explain all the time. Why aren’t you married yet? Why are you a vegetarian? Why don’t you own your home? We fetishize homeownership.

There is no denying that there can be strong advantages to owing a home. A paid off home provides financial security in retirement. There are valuable tax incentives, and in the long term, a home is a reasonably safe place to protect your savings from inflation. For the less disciplined, it can also be a means of enforced savings. Putting aside these practical considerations, there is pride of ownership. It’s just nicer to own your space.

Nonetheless, owning a home is not always a sensible financial choice. In exploring this idea, it’s important to clarify the term “homeowner”. Few people actually “own a home”. Most “homeowners” are really “mortgagers”: parties to a legal contract whereby they can live in a home as long as they make regular payments to a lender. Mortgagers also have other expenses such as maintenance, insurance and property taxes. On the positive side, mortgagers earn some tax breaks. If a mortgager wishes to move, they must find another mortgager for the home. Depending on the market, this transaction will result in a gain or a loss, and in all cases will involve fees paid to real estate professionals to complete the transaction.

Similarly, renters are parties to a legal contract whereby they can live in a home as long as they make regular rent payments. Whatever they don’t pay in rent they can administer any way they want, including by saving and investing. Renters have no tax or maintenance to worry about, nor do they get tax breaks. If a renter wishes to get out of the legal contract, they must simply tell the landlord as stipulated in the rental agreement.

Viewed in this way, mortgaging and renting are just alternate ways of determining cash flows and making investment decisions. Mortgagers pay interest to the lender, renters pay rent to the landlord. Mortgagers put their savings toward principal. Renters, may save nothing at all or may save and invest aggressively. Renters pay no maintenance, insurance or tax for the property, nor do they get tax breaks associated with mortgaging. Renters have more flexibility to move on a moment’s notice. Mortgagers are tied into their property, especially if they have borrowed a large amount and the market is down.

Which option is better depends on many factors: relative property and rental prices, interest rates, expected appreciation in housing prices and yields in alternative investments, need for flexibility, tax breaks, expected maintenance, how much “pride of ownership” is worth, etc. All told, it is true that mortgaging is better in many cases (see here or here).

The problem is that it is not better in all cases, yet there is a subtle, pervasive pressure to buy, buy, buy. As just one example, consider how, even though it’s impolite to ask about others’ finances, it’s still perfectly normal to ask an acquaintance if they own or rent (and to express disinterest if the answer is “rent”). Pressures like these drive people to astronomic levels of silliness. Even in inflated markets in which the benefits of renting are far greater, we still see people tripping over themselves to outbid the other, while leveraging themselves to the hilt to do so. Put simply, people are competing fiercely to overpay for something that few of them can afford.

If this article is unromantic, if it kills the magic and excitement that surrounds buying a new home, then it’s been successful. Remind yourself that there are hundreds of thousands of dollars on the line, that emotion can do a great job clouding judgment, that a fool and his money are soon parted, and that no matter how extravagant your house, if the bank owns it, you’re not wealthy.

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5 Responses to The mad, mad world of homeownership

  1. Duke says:

    I have owned 4 homes. I made payments on the first one for a short period of time but found the cost of money tilted the ownership balance. Things look drastically different when a mortgage isn’t involved. It is rarely beneficial to mortgage rather than rent unless you’re in a crowded metropolitan area (like Seattle) where price escalation is way above average inflation. Most places are not like that.

    Investment mavens tell us to borrow heavily on mortgages so our capital can be invested elsewhere. Right now mortgage rates are around 4.5%-5.5%. Try beating those rates on investment. CDs pay essentially zero. Over the last 20 years the stock market hasn’t done any better. It crashed to 6,000 a couple of years ago. The truth is, you cannot get a better return than mortgage rates. You are better off not borrowing the money.

    The much heralded mortgage tax deduction isn’t valuable either. If you’re in the 20% tax bracket it means you get 20% of the interest back. You are still flushing 80% down a rat hole. Why not refuse the mortgage and keep 100%? Wasting 80% isn’t much of an investment strategy.

    Saving the money to pay cash is the answer. It can be done by anyone in a position to afford a home. After all, no one actually GIVES you a mortgage. You are simply borrowing against future earnings. It is hocking your future to avoid saving money in the present. Avoiding that trap means living economically until the money is saved but the reward is massive.

    Home ownership was once a progressive process. People lived at home or in very cheap rentals until they had enough for a small house. They would improve the home (while saving more money) which allowed them to afford a larger one. Over time it progressed in a series of upgrades until they finally had the home they desired. It might take 20 years but along the way they outright owned each home at low cost and were upgrading as finances allowed.

    People have lost all concept of this approach. They want a huge luxury home straight out of school. They aren’t willing to save and they refuse to buy starter homes. They want it all NOW and go deeply in debt to get it. It is generally accepted one cannot buy a home without a mortgage. This is nonsense. I have bought four. My father owned 6 and he never borrowed a penny.

    That’s why the comparisons of ownership verses renting are flawed. They assume you cannot save money. They assume you can invest above the rate of return your mortgage charges. They assume the tax savings are significant. They assume your home will appreciate above inflation. None of those assumptions actually have any merit. They should be giving you the cost of ownership verses renting if you buy a small fixer-upper house for cash. Track this situation over time as you upgrade to a luxury home. That scenario looks a lot different.

    • You make some great points, especially the historical perspective about home ownership being a progressive process. There is certainly a sense of entitlement today. People want and feel they deserve only the best. We can all get caught up in it.

      As you rightly point out, the sound decision depends on many factors such as mortgage rates, potential returns in alternate investments, volatility in housing and alternate markets, etc. You also rightly point out that the decision is region-specific and that it is important to be frugal and save aggressively.

      The only point I disagree with is that saving to pay cash is *necessarily* better. Whether you’re mortgaging or renting (and saving/investing) you’re “throwing money away” either to interest or rent. We still need to decide which is better. If you consider rent-never-paid as income, there are certainly cases in which income can exceed your costs, including debt service, after a few years (or even initially). In these cases, mortgaging can be financially best. (It is never best to borrow excessively for a house that will never turn a profit, as in over-inflated urban markets.)

      The two rent-vs-own calculators I linked to are actually pretty good. You can adjust all the parameters that are of concern to you. They calculate what you’re left with after subtracting the costs of selling your current house, so, even though they are limited to a single purchase, you could track the upgrading scenario you propose with multiple uses of the calculators.

      • Duke says:

        You make good points. I didn’t mean to imply your calculators were inaccurate. I wasn’t clear, but my gripe are the ‘experts’ who keep repeating home finance dogma until most people accept it as true.

        Probably the biggest problem with rent vs ownership is they don’t compare apples to apples. They look at average home costs verse average rentals. An average home is 2,200 sq feet or so while most apartments are less than 1,000. Homes have yards and garages but apartments do not. They do not compare the cost of renting that home because they are not typical rental units. The rent verses owning equations end up being a large house with a yard compared to a small apartment. They are not comparable. If you look at rental homes instead, they will be in less desirable parts of town because the better places do not allow renting. Again, you are not comparing the same situation.

        Another important aspect is the fixed cost of home ownership. If you pay cash, the cost of your home is locked in concrete. Your only variable living expenses will be insurance, maintenance, and taxes. These usually increase at the rate of inflation and are minor costs compared to renting. Rent, however, will double every few years. For example, the day you buy a home it may cost $200 per month to maintain. Rent is, say, $1,000 per month. In 10 years your home will cost about $300 per month but rent will be $1,500. What started as a $800 delta between renting turned into $1,200 within a decade.

        In my experience, if you look at comparable homes (i.e. same size with yards and garages), it is more expensive to rent than buy. This makes sense because the landlord had to buy the house the same as you would and therefore has similar costs. The only time rental looks good is by comparing apples to oranges. If you compare a 1,000 sq foot apartment with a large house it will naturally be cheaper. It costs less to compact multiple small housing units into a building complex than assembling single occupancy houses of twice the size with associated property.

        the actual cost of rent vs own is pretty much a wash if you have a mortgage. Although the costs are about the same, your living situation is not. A house will be much larger and probably in a better neighborhood. You will have a garage instead of a parking lot. You will have a yard. Houses also entail upkeep not present in apartments. Many people don’t want to mow grass, paint, or repair a house. It’s a trade-off. For the same money you can have a larger place with upkeep or a much smaller apartment without upkeep.

        Paying cash shifts the balance towards ownership from a financial perspective but the upkeep questions remain. Houses are also millstones around your neck. You cannot pick up and move. When the market is down it may be nearly impossible to sell a home. You can always leave an apartment.

        I cannot stand living in apartments. Owning a home is my only option. I minimized the cost by paying cash but I realize it’s not the only solution. Other people don’t mind the cramped living spaces and lack of privacy in apartments. How they tolerate the noise is beyond me but stereos thumping at 1 am doesn’t seem to bother them. Others don’t want to spend time on maintenance. I understand.

        Owning verses renting is a complicated topic as you so rightly mentioned. There are other considerations besides cost. I am just amazed at all the misinformation out there by supposed experts. No wonder so many people have trouble making informed decisions.

        • You make many good points as well, and I agree that buying is best in most markets. I’m still convinced that in my local market it is not (even keeping in mind all the refinements you have suggested). We could go back and forth indefinitely about the details, but I think that what’s important is your last comment about misinformation and the trouble people have making informed decisions. You’re clearly informed, thoughtful and have made decisions that work for you. That’s great. I fear that many people will never stop to think seriously about things and will just go with the flow… and the flow, as you point out, is full of bad information.

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