Dear Ney Ney,

One question that many people ask is if they should buy a home or rent. Many people think that it is a good idea to buy a house and view a house that they live in as an investment. Other people think that a home that you live in is an expense, not an investment, because it cost you money each month instead of paying you investment income. 

Like many personal finance question, the right answer depends on both the feelings of the person asking the question and their finances. So that you can make this decision yourself, let’s talk about the when you might want to buy a house and when you might want to rent instead.

First, let’s talk about the emotions that people feel when they consider buying a house. Most people who buy a house look at it as a home. They might want to buy a house in order to raise a family. They might want to buy a home because it makes they feel successful. They might want to buy a home because it makes them feel safe or secure.

Some feelings come from real concerns. If you rent a house your landlord might decide to sell it. Then you will have to move and your children might have to switch schools or move away from good friends. 

Some feelings are just feelings. You might want a big yard for your kids to play in because you did not have one when you were a kid. It might make you feel good to have a yard for your kids, but if you don’t there are still parks and playgrounds.  

Buying a house is a big financial decision. You want to feel good about the house that you buy. Take a minute to think about how you feel about the house and why you feel that way. The next time you question how or why you decide for or against buying the house you will be able to remind yourself why you made the decision.

Now let’s talk a little bit about the financial questions you need to think about when you decide between renting and buying. Keep in mind the financial questions are focused on a house you will live in, not one you are buying to rent out as an investment. 

The first step is to decide how much it will cost you each month to buy a house. Sometimes renting a house costs more than owning a house. Sometimes owning a house costs more than renting a home. Remember, when you own a home you have to pay for all the utilities and pay to fix anything that breaks. It may be that the mortgage, taxes, insurance, utilities, and maintenance costs are too much for you to afford based on your budget.

Some people look at a house you live in as a way to save money because each payment you make increases the equity you have in the home. When you sell the house you get this equity back, so the house acts almost as a savings account in a bank.

This can be a good idea if it is hard for you to save and invest in the stock market because you would rather spend your money. However, if you were not good at saving and investing then you probably wouldn’t have been able to save up your down payment.

An important idea to help you decide about if you should buy a home or not is called “opportunity cost.” The opportunity cost is what you cannot do if you do something else. For example, if you saved up a down payment and used it to buy a house, the “opportunity cost” is any possible increase of your down payment money in the stock market.

Let’s take a few minutes and compare the opportunity cost of purchasing a home versus keeping the down payment money invested in the stock market. 

The stock market, on average, increases, or returns, 7% per year. Houses on average increase, or appreciate, 3% per year. At first it might seem like it is better to invest in the stock market, Remember, though, that the appreciation is on The value of the whole house, not just your down payment, and each month that you pay your mortgage, you own more and more of the house.

Let’s say you buy a $100,000 house and you put down 20% to buy it, or $20,000. If you had put that 20,000 into the stock market it on average would be worth $21,400. Your 7% gain is $1,400. The house after a year will be worth $103,000. That is again of $3,000 on your $20,000, or 15%. On an investment property, where someone is paying rent to cover the mortgage and taxes and other costs, this is an equal comparison. In this example, you are living in the house and you are paying the mortgage.

Now pretend you got an $80,000 mortgage at 5%. Your monthly payment is $429.86. At the end of the first year you would have paid a total of $3,973.20 in interest, but also gained an additional $780.30 in equity, or ownership, of your house. 

So let’s take our original $3,000 gain, add $1,180.29 and then subtract $3,973.20. This gets us a first year actual gain of $207.9, or 1%. 

At the end of 5 years of owning your house, you will have paid a total of $19,230 in interest and gained a total of $6,537 in principle. The house will be worth approximately $115,927. That means your total gain would equal to  $15,927 in appreciation, plus $6,537 in principle, minus the interest of 19,302. That total is $3,162, or 15%. Since we got that return over 5 years it is closer to 3% per year. Over 10 years the expected average return goes up to 6.3%

The same $20,000 in stocks over 5 years would likely be worth $28,051. That is a gain of $8,051 or 40%, but over the same 5 years it is closer to 8% per year. It goes up to 9.6% per year over 10 years.

It might seem obvious that the stock market offers the better return than living in a house that you own. Like I said before, it isn’t easy. If you don’t own a home to live in you will still need to pay rent. The longer you own the home you live in, the better your return on the house as compared to the stock market. It is hard to predict the future, though. You might buy a house and plan to never move, then fall in love with a person and move across the country, or the world, to be with them.

If it is cheaper to rent you have more money each month to continue to invest in the stock market. 

These numbers don’t include costs of owning a home like taxes, insurance, and maintenance. They also don’t include the tax benefits you get from owning real estate, the taxes you pay when you sell stock, or the fees you pay when you sell a house. 

For example, when you sell a home you might pay up to 6% of the sales price to the real estate agents. For our example home valued at $115,927 after 5 years this is equal to $6,955. Our total return after interest payments over 5 years was $3,162 so this fee turns our 5 year gain into a 5 year loss of $3,793.

Also, home in some locations appreciate faster than other locations, and some types of home appreciate faster than others.

There are other opportunity costs to think about. What about using the down payment money to start a business? Businesses can provide a much greater return than the stock market, but many fail to be successful. 

I know these financial examples don’t give a clear answer, and that is because there isn’t one. The idea is to give you the tools to make your own decisions in the future. Even if you decide to buy, or rent, only based  on emotions you will still be better able to understand the impact of your decision on your finances. That understanding is a very powerful tool.

I love you.