My 1st Million At 33 - yes, you can do it too

Don’t you hate to hand off rent money to your landlord, helping him to pay down his mortgage?  The immediate reaction of paying rent is most certainly a waste of money.  But few people realize that paying mortgage interest to mortgage company is also a waste of money.  And still even fewer people realize that even when you pay off all the mortgage, having idle home equity in your home is still a waste of money.

To evaluate between renting and owning a home fairly, let’s look at two extreme cases in which you own a home.  The first case is that you get an interest-only mortgage, with 0% down.  In this case, instead of paying rent, you’re essentially paying equivalent “rent” through paying mortgage interest (minus any tax benefits that you will receive).  No principle of your mortgage balance will be paid down.  In essence, you’re renting the home from bank.

The second case is that you pay 100% for the home using all of your cash.  Even though you’re not paying mortgage interests to the bank, you are losing all the potential returns from your cash if you were to rent instead.  Whether you assume that you invest your cash in a bank CD, or in the stock market, it is for certain that you should be getting some money back for all the cash that you put into your house.  Again, an equivalent “rent” can be calculated in this case, by using the an assumed return rate, multiplied by the amount of home equity that you have in the house, taking out any taxes due, and divided the result by 12 months.

In most cases, it’s not 0% nor 100%.  But there is a definite cost, or an equivalent rent associated with owning a home for sure.  For obvious reason, if the equivalent rent of the house is higher than prevailing rent, then you are better off renting financially speaking.

Another thing that is so overblown about the financial benefits of owning a home is that the tax benefits are most of the time over-estimated.  Most people over-estimate their tax benefits by using their marginal tax bracket rate.  However, in reality, once you take into account of the standard deduction amount (now $10300 for married couple), you are not getting much mileage out of your itemized deduction beyond the standard deduction.  Of course, if your mortgage amount is huge, and/or you live in a state with high tax, your marginal tax bracket rate may be really the major determining factor for the tax benefits of owning a home.  Otherwise, more often than not, tax benefits of having mortgage interest and property taxes will not be as large as you would expect.

To help you assess the decision between Rent vs Buy, I have a couple of calculators that can help you assess all the necessary factors.  You can calculate the true tax benefits from my tax calculator which will calculate your taxes twice, with/without the mortgage interest and property taxes.  If you divide the tax benefits by the total amount of your mortgage interest and property taxes, you can get the average rate of tax benefits, instead of using your marginal tax bracket rate.  Note that you must include the tax benefits from your state taxes too, which is not included as part of the federal tax calculation.

My Rent vs Buy calculator can then help you to compare rent vs buy by experimenting various assumptions of rent inflation rate, housing appreciation rate, investment return rate, etc.  The calculator will assume that anything that you don’t pay into the house, you can invest and get a return using your assumed return on investment (ROI) rate.  If you assume a high housing appreciation rate, you are sure to find out that everything works out for the best for the case of buying a home.  It is especially true because buying a house is most often a highly leveraged transaction (through mortgaging).  The cost of your leverage is the mortgage interest.  When you assume a high appreciation rate, it gets multiplied by the entire value of the house, and will obviously result in high benefits for leveraged transaction.

However, personally I believe that housing market is close to peak, and will probably decline or stagnate going forward.  Therefore, I don’t advise to put an appreciation rate more than 3%.

The other thing to take note is that when you lock into a fixed rate mortgage, you’re essentially fixing your “equivalent” rent.  If you’re renting, your rent will most likely go up along general inflation, and the increase is up to the landlord’s decision.

P.S. If you have any problems running my java calculators, you can go to my finance calculators page, and follow the link there to install JRE so that you can run it.