Buying or Renting?

Edric Cane  ©    CommonSenseMath.org.         

Our choice to buy instead of renting has been good for us over the years. It is what has most contributed to our financial security now that we are retired. There is no guaranty that it should work that way for everyone but there are good mathematical reasons why it is likely to work and has worked for millions of Americans. 

I’d like to look at those mathematical reasons by looking at the purchase of a $100,000 home. That number makes it easy to see what happens as a percentage of the purchase price. Those percentages remain valid whatever the purchase price. The dollar amounts, on the other hand, would need to be adjusted to the actual purchase price and multiplied by 6 if the purchase price was $600,000. I make the assumption that the property is held for 10 years. (I also round numbers slightly for convenience, in ways that don’t affect our judgment on whether to rent or buy.)

Initial situation:

$100,000 property. 10% downpayment of $10,000. $90,000 loan at 6% interest with monthly payments of $540. The initial equity in the house (what you own of your own house) is 10% , the $10,000 downpayment.

10 years later

What follows looks at how these numbers change after 10 years under realistic but very conservative assumptions. 

1. After 10 years, the $90,000 loan has been paid down to $75,000. That is a certainty. If the value of the property is still $100,000, the equity in it, what the owner owns of his property, is now $100,000 -  $75,000, = $25,000 or 25% of the initial price instead of the initial 10%.
2. Now, we make the assumption that the rate of inflation has been brought down to the 2% annual rate that the Federal Reserve  seeks to achieve. Of course, that may not be the case for any one year. There have been significant drops in property values, but over time, the rate of appreciation has been significantly higher than 2% per year. After 10 years of appreciation at 2% per year the value of the property is now $122,000. The loan balance is down to $75,000. The equity is $122,000 - $75,000 = $47,000. That is 47% of the initial purchase price, not quite, but almost 50%! 50% would be achieved with a slightly higher and more realistic rate of inflation. 
3. It makes sense to assume that the 2% inflation has also affected the cost of what we pay and the income that we make. Adjusted for inflation, the real value of our $540 monthly mortgage payment is now $443, almost $100 lower than the initial payment 10 years earlier. Yes, those payments are easier to make. On the other hand, it is fair to assume that what we would be paying for rent would also have kept up with inflation and be about 22% higher than it was  when we decided to purchase. Inflation has reduced the real cost of home ownership and increased the real cost of renting. 

So, 10 years after buying, under very conservative assumptions, we now own almost 50% of the initial price of our property and the monthly payments  are 22% easier to make than they were when we bought. Something similar or even better is what has happened to millions of Americans, and not just for 10 years but  over 40 or 50 years. It is the reason why so many have significant security in their retirement years. 

My wife and I moved and bought four times over 50 years. Buying and selling are expensive.  Buying was the right choice in spite  of moving. I never bought with the expectation that the value of our purchase would increase. I was not aware of the math. I credited my good luck. And there were ups and downs. There were hard times. I remember refinancing a home loan to pay off a $50,000 credit card balance. 

When we moved from Los Angeles to Northern California almost 20 years ago, I bought our current Northern California home for $425,000. The timing was wrong. It was at the top of the market and the property lost around $150,000 over the next year. But we sold our Los Angeles property at the top of the market, so even then, it was a wash. All this took place and played out into the general beneficial thrust described by the math and our current property has more than caught up. Even buying it at the top of the market was a better choice than renting.  

One number summarizes it all for me: we bought our first home 55 years ago for $21,000 with no expectation that its value would appreciate or be affected by inflation. 

Now we hear of the baby boom generation handing over astronomical amounts to the new generations, often in the form of real estate. We speak of communities where that transfer is not happening because they were not generally invested in home ownership. We deplore that the need to afford a  down-payment prevents younger generations from buying before reaching their 40s. But knowing the math may encourage would-be buyers, relatives, employers, lending institutions, the government (Yes, the Trump Accounts) to find ways to make it easier. It seems that Wall Street bankers know the math and are being asked not make it more difficult for others to benefit. 

There are many reasons why people rent and should rent, but the basic math I describe, with its simplistic example of a10-year ownership and its conservative 2% rate of inflation, underlines significant benefits of ownership that people should take into account when deciding whether to rent or buy.