Is home ownership worth it? Despite the claims of a strange minority of self-proclaimed gurus and online influencers, home ownership can be a big winner over the long term. As long as you plan to stay in your home for a long enough time, the economics of home ownership versus renting is highly favorable. If you’re thinking about buying a home or are in the middle of the process already, I encourage you to look through the following analysis of the buy vs. rent decision.
Buying vs. Renting: Making It Apples-to-Apples
Comparing the monthly cash flow expense buying vs. renting can be misleading. Some big adjustments must be made to set up a fair analysis:
- First, while buying a home involves making a large upfront down payment and principal payments over the life of your loan, all these payments are actually investments not expenses from an economic point of view. When you eventually sell your house, a portion or all of your gains may be tax deductible.
- On the other hand, as a renter you don’t have to pay a down payment, which you can invest instead (though gains would be taxed). And you don’t owe property taxes, more expensive property insurance, or the “hidden” costs of home ownership like repairs and maintenance, which many buyers neglect to consider.
I capture all this in the cash flow projections underlying the following illustrations. They model the true economic cost of buying and renting to show how many years it takes for buying to break even with renting across different home price appreciation scenarios:1
First, notice the present value is always negative. That’s the cost of living! But which has a lower present value cost to you? That’s the question. Over the long term, the investment component of home ownership tends to offset enough of your shelter costs to make buying superior to renting in most scenarios.
Clearly, the future path of home prices significantly affects the ultimate economic outcome vis-à-vis renting. The longer you plan to stay in your home, the more bad luck you can weather. In fact, on a long enough time horizon, even buying at the top right before a 2008-style housing crash still comes out ahead. And if a more benign (and probably more likely) scenario plays out, buying breaks even with renting much, much earlier.
Shorter Holding Periods
Now, if you are planning to move in the medium term—the classic strategy of beginning with a “starter home” and upgrading over time—then timing is more important. You really must think things through. In an unlucky scenario, renting may end up having been better over your short stay. That doesn’t mean don’t buy, but it does mean know what could happen and formulate a plan for when things don’t go according to plan. That’s what I help my clients do.
Why Is Home Ownership So Likely to Be Economically Advantageous?
At today’s interest rates, renting will likely cost less than maintaining a mortgaged home—optically. But as I mentioned, a portion of your mortgage payment is a potentially recoupable investment not a permanent transfer to a landlord’s pocket. So usually, the economic cost of home ownership is lower.
What’s more, with a standard fixed-rate mortgage, your loan payment stays the same and then goes away completely at payoff—usually right in time for retirement. This leaves a valuable asset you can leave to heirs, tap in an emergency, or use to pay for end-of-life care.
Meanwhile, as a renter you are subject to the whims of your landlord at each lease renewal. In our illustrations above, I only assumed a modest rent inflation rate. But when my wife and I were renters, we remember our apartment complex routinely demanding 6% increases every year. And that was when inflation was low! Now, we always negotiated it lower and were successful because the landlord didn’t want the expense that comes with unit turnover, but I’m sure many folks don’t realize you can try to negotiate or face a hard-nosed landlord. So I could be understating the true inflation risk of being a renter (and the corresponding benefit of being a homeowner).
Other Home Ownership Considerations
There are other potential costs/benefits to owning a home above and beyond your total house payment besides assumed maintenance:
- Difference in the quality/size of the home
- Any HOA fees/amenities
- Change in utility costs from moving to a larger/smaller home
- Change in commuting costs/length
- Change in childcare costs
- Quality of schools
- Change in carrying costs moving in with others
- Home improvements or furnishings
- Quality of the neighborhood
- Culture and environment in the area
I’ve excluded all these because they’re specific to you and the property you purchase. But I would try to quantify these or otherwise factor them in when helping you build out your own personalized analysis. If you’re preparing for an imminent home purchase, I’m happy to run through an overview of the economics and cash flows of your home purchase plan in a free consultation (and then go even deeper in a planning engagement).
Eric R. Figueroa, CFP®
I am a Folsom, CA, fee-only wealth manager serving the Greater Sacramento area, California Gold Country, and the nation virtually. I offer financial planning and investment management, specializing in impact investing and personalized values-based investing.
All content presented in this article is for informational purposes only. Materials presented should not be interpreted as a solicitation or offer to buy or sell a security or the rendering of personalized investment advice, which can only be provided through one-on-one communication with a financial advisor. The content reflects the opinions of Hesperian Wealth LLC (HW), except where cited, which are subject to change at any time without notice. The information contained herein has been obtained from sources believed to be reliable, but the accuracy of the information cannot be guaranteed. All information or ideas provided should be discussed in detail with a financial, tax, or legal advisor prior to implementation.
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1 Here are the assumptions underlying our hypothetical analysis:
- Home value: $467,000, the latest quarterly national median sale price
- Rent assumption: $2,300; low-end of typical rent range on Zillow in the Sacramento area for an equivalent property
- Buyer: married couple, California residents
- 20% down payment
- Mortgage rate: 30-year fixed rate at 6.50%, sourced from the latest Primary Mortgage Market Survey® published by Freddie Mac; weekly data as of February 23, 2023
- Closing costs: 3% of home value
- Marginal ordinary income tax bracket: 22%
- Property tax and insurance rates are taken from Zillow for the Sacramento area. Property tax increases with inflation; insurance rates adjust with home value projection. Note, property tax and adjustments to it can vary greatly state to state and municipality to municipality. I would use the relevant data for your situation in a personalized analysis.
- Renter’s insurance: $360 per month; increases with inflation
- Maintenance costs are 0.5% of the value of the home annually for the first decade, 1% annually for the next decade, and 1.5% annually after that
- Inflation: 2.24%; latest 30-year breakeven inflation reported by the Federal Reserve
- Rent inflation: 2.83% (historical inflation-adjusted rent inflation since 1954 from TradingEconomics.com plus the inflation assumption)
- Discount/investment return rate: 3.93%; the latest 30-year Treasury yield per Treasury.gov
- Mortgage deductibility: We assume the client does not itemize or have enough deductions to push part of their interest payments above the standard deduction everyone already receives. For clients that can receive part or all of this tax benefit, home ownership is even more attractive.
- Agent’s fees at sale: 6% of home value
- IRC Section 121 permits qualifying homeowners to exclude up to $500,000 in gains on selling your home.
Home price appreciation scenarios:
- Home prices appreciate at 2% above inflation annually as they have for the last 20-plus years in most parts of the country.
- Home prices only appreciate by a more conservative 1% above inflation annually.
- We experience a sharp “adjustment” in home prices down 6% in a year followed by 1% above-inflation appreciation after that. A decline of this magnitude or more has already played out in some metro areas.
- We experience a drawnout housing crash in which home prices fall 2% a year for the next five years and then appreciate by 1% above inflation thereafter.
- We experience a 2008-style housing crash that sees home prices fall 6% a year for the next five years and then appreciate by 1% above inflation thereafter.
Join me for a consultation to see your plan’s math and annual cash flow chronology.