Is it better financially to own or to rent your own home? Most people would assume that its an easier answer and that if you can pull it off, homeownership is the way to go. You're about to discover a very unique perspective on this topic and a very surprising outcome. There are many factors to consider when contemplating becoming a homeowner and most people are unaware of many of the hidden expenses that await owning a home. Meanwhile, renting a home gets a bad rap but in many situations can be surprisingly beneficial. Discover if you should own or rent your own home in the below video (or if you prefer to listen to it, here's a link to the podcast:
Rent or Own?
Now, where this all got started was I recently did a video on personal finance wisdom. In there, in passing, I quickly dropped in that for many people, it's actually a better deal financially to rent their own home as opposed to own it. That created quite a controversy in the comments section. In some side, they had some people thinking that I was absolutely crazy. Other people were calling me a genius. It depended on the person's perspective and in those comments, I didn't have enough room to really explore this topic like I can here.
Why Renting is Usually Better
Let's start with why I believe that for most people, renting is a better deal than owning, but then I'm going to through a lot of other angles and different things that you need to consider in your own situation. It's probably pretty unique for a real estate agent like myself who sells properties to people that I fix up and resell and those kinds of things that I'm so pro rental, but it's because of all my years in this business. I've seen what happens and that's what I want to talk about here.
Assuming your rental is set up as a normal standard lease, you know what your monthly payment is going to be every month. Whereas when you own, this is a variable expense. You have no idea what could come up tomorrow that you may have to pay for. I'll give you an example. I went on a family vacation. I came back and the air conditioner, the little drip pan that drips the water ... We have 2 different air handling units in this property, one is upstairs, one is down. The one upstairs, the drip pan got clogged and water seeped out and it leaked. It became a $2,000 expense to fix the whole darn thing. Poof, $2,000.
If you're a homeowner, you know what I'm talking about. It's like a bottomless pit. There's always something going wrong. That's part of home ownership. Well, what happens is when you're renting, you don't have to concern yourself with that, the landlord does. Now, the landlord may not always fix up what needs to be fixed up but the burden is typically on them. First, you get the variable expense and that ends up being pretty darn huge.
When you rent a home, you tend not to want to go improve it because you don't own it. You're not tempted to repaint, to put in new floor coverings, to put on an addition. When you own a home, you want to fix it up. All of a sudden, you take out home equity lines of credit to rebuild the deck and you do all sorts of things. Home Depot and Lowe's do really well as retailers because as homeowners, there's a temptation to want to fix it up. Whereas when you're renting, there's no temptation there.
Default Investor Landlord
Right here, we're already starting to see the savings but there's more to it. Now, this is where things get interesting. In most cases, if you're in a certain price point and that usually is a nicer home in a nicer area, either medium to medium upper, nicer parts, typically this is lower total cost than owning. So often I hear the lament, "Well no Phil, because the landlord passes on the expense to the tenant so the rental rate is higher to cover those expenses." I have discovered that's not usually true.
Now, certain areas are different but in a lot of situations, the landlords that you are renting from, if you're at a decent home in a decent area, they're not a professional investor. They're an investor by default. Maybe they moved out of that home to buy a new home and they couldn't sell it or they were too greedy to drop the price low enough, so they rented just because they have no other option. Maybe they inherited the property and they're leasing it out.
I have found, again working with friends, family, other clients over all these years, so often I have found that the rental rate here would be 1,200 but when I look at the value of the property as well as the cost of taxes, insurance, HOA, this thing ends up having a monthly payment of say like 1,400 when it's all said and done. I know that that may sound counterintuitive but so often, I see where the landlord either A, is losing a little bit of money each month or B, they have a low enough loan so that they're monthly payment may only end up being say 1,100, I'll put a 1 there. It's only 1,100 because they have a low mortgage but if you came in and bought it, you'd have to come in and probably you may not have a humongous downpayment so therefore, your payment would be higher. Does that make sense? I hope I didn't totally confuse you there.
Low Down Payment
You do have to have a first month's rent, maybe first and last month's rent. Here, you're going to have a significant downpayment and even in today's world of creative loans, there's always at least a 5, a 10%, sometimes with FHA, it's 3 and a half percent but still that can be a substantial amount of money depending on the size of the property. This typically has a lower amount down and so not only you're saving money without having to put the money as downpayment but your total cost usually ends up being lower on a monthly basis, almost always. It's pretty wild. Again, some situations are a little bit different where it's a higher cost to rent than it is your total cost to own. You can run that math on your own. That's just one of the spots, too. You got to keep the fix up and variable cost in mind as well as you start to look at that, as well as the significant downpayment.
Now, you may be saying, "Wait a minute, you're signing a lease. You have a 1 year commitment." True, but I have been a landlord for a very long time and if a tenant moves out of a property, they're gone, it's very hard to sue them to get the rest of the rent money. Now on commercial real estate, you can do that. In residential, they move out of the property, they're out and that landlord can try to sue them for the money that's lost because they just bailed prior to the end of the lease, but it's hard to get that money.
This is a huge commitment, huge commitment. If you get a mortgage and you own the property, you've got a big commitment on your hands. I've used this phrase for so many years and it's very, very true in a lot of cases. Buying a home is like going to jail. It could be really easy to get in but it can be really difficult to get out. When you own a home and you try to get out of it, you have to sell it or you can lease it back out. Either way, you've got to do something to get yourself out of there and cover payments and easiest way being to sell.
Problem is selling your home is not always easy and this is a very important point right here. There are transactional costs for buying and selling a home. These transactional costs end up really adding up. Let me put here no, there's no transactional cost here. No trans cost. Let's talk about all these transactional cost are. Number one, when you buy the property, there are going to be closing costs above and beyond the purchase price. Now, you sometimes can get the seller to pay for them but let's just use the amount 2%. When you buy a property, your closing cost tend to be a little bit higher than when you sell. Let's say 2% when you try to buy. That's an extra cost just for you getting the privilege to buy. It usually comes in the form of recording taxes from the county, title insurance, and all sorts of other fun stuff. If you ever seen a settlement statement, you know what I'm talking about.
Then when you go to sell, typically people use a full service listing. Now, if you really know what you're doing, you can do a flat fee listing. Either way, you're still going to be at least 3% but for most people, they're going to be at 6% in sales cost when they go to sell it. Now when you go to sell, you're going to have some closing cost. We'll call that 1%, and you may even have to do a bit of fix up because they do an inspection, they may find some problems with it. Let's call another 1%.
Together here, these transactional cost are 10%. Here's why that's so critical. When you buy a property, if you want to get out of that thing after a year, let's say you bought it, you realize it was a bad area of town, a train drives by every 14 minutes that you didn't know about, you hate your neighbors, all kinds of reasons you want to move out, your property has to sell for 10% more than what you paid for it just to break even. Did you ever think about that? 10%, that's a huge number.
One of the big keys of being a homeowner is that you have to live in that property long enough so that hopefully this thing goes up by 10%. Did you know that over the past hundred years, Robert Shiller who is a economist at Yale, he has proven that single family homes do not appreciate but they literally keep pace with inflation which ends up being about like 2.8, call it 3%. Typically, houses go up by about 3% a year but they're not going up in appreciation, that's just the fact that your dollar bill is losing value. It's called inflation. They're going up and you probably asked the question why are they going up to keep in pace with inflation. That's because the cost of a builder having to pay for the employees, the materials to build the actual property. The land itself is not actually typically going up either.
This really comes down to material and labor cost that go up over time and that's how it gets ... Don't get too confused on that. Point is when you look at the number 3% and you look at the number 10%, you need to be in that property a minimum of 4 years just to break even or get a little bit of potential benefit from being a homeowner. Interesting, huh? Now, you might be saying, "Wait a minute Phil, you're forgetting about 2 key items of being a homeowner." Number one would be, and hopefully we've got some room here, so I'm just going to put 10% next to transactional cost because I need some more room. This could be a benefit here. First of all, you can get debt pay down, debt pay down, meaning a portion of your mortgage payment actually goes toward the principal of the loan.
Debt Pay Down
Have you ever seen on a statement how much goes toward the principle in the first couple years? Very little. Maybe a hundred dollars a month. Very, very little goes toward the debt pay down in the first couple of years. Now, as the years progress, all of a sudden, that gets a little bit better. Again, we're starting to build up to where it's valuable to be a homeowner versus to rent and we're getting there as you can tell. Debt pay down is there. It exists. It's not bad. It beats poke in the eye.
Interest Tax Deduction
Now this is interesting. In the United States, not in Canada, in other countries, but in the United States, the interest on your mortgage is tax deductible. Meaning, it reduces your overall income that you're paying taxes on. That can be very beneficial but not for everybody. In fact in many cases, the standard deduction the IRS gives outstrips or is better than if you did an itemized deduction and you included interest tax reduction. Interesting, ain't it?
On the surface, you're like, "Oh, man. Tax deduction for the interest." As we talked about, it's mostly all interest, not debt pay down so maybe this ends up being like 700 a month you're paying and more in interest. That can be a pretty good tax deduction, right? Sure, but your standard deduction's probably bigger than that for most people. Again, you talk to your accountant. At some point, when you're making a ton of money and you got a really, really expensive house of huge interest, then maybe that's different. For most cases, you aren't probably going to use your standard deduction on your taxes, not itemized and this would fall in the itemization. Interesting, right?
Short Term Vs Long Term
For these reasons, I feel like it's almost always a better idea for people to rent. Now, what I talked about was this idea that short term, it's better to go rental and then I've mentioned this idea of long term maybe better to own. One thing I want to point out is this, mortgages in home ownership, statistics show that people tend to stay in their mortgage for 3 years and the average person stays in their home for 5 years. Watch this, we talked about how you have to be in your property for almost 4 years just to break even because of all the transactional costs.
Well, the average person lives in their home for 5 years so the average person is moving, changing jobs, transferring within 5 years anyways. Even crazier is they refinance within 3 years so their debt pay down starts all over again. You always stay in this realm of a very low pay down and high interest on a mortgage as far as the breakdown of the payment and since the standard deduction cancels this thing out, these things have almost no value.
Tips for Homeowners
If you are going to own your own home, you need to think in terms of long term, long term. That is so critical here. Now, the benefit of owning is permanence, permanence because guess what a huge issue of renting is, uncertainty. What happens if that landlord decides they're going to sell the property? They're tired of losing money, 200 bucks a month for the last 5 years. They want to sell the property. You have some uncertainty as a tenant that that landlord might stop making mortgage payment, they may just want to sell the house at the end of the lease, so there is some uncertainty.
You get permanence when you own but you have to be looking at this from a long term perspective because if you don't live there at least 4 years, you probably won't even break even of what you paid for from the expense standpoint or even just cover your bases, so you have to be in there. That's why we say 5 years. Let's just use round numbers, 5 years where you would stay in that thing at minimum.
Now here's another big thing that rentals can't give you. If you're a real estate investor and you watch my videos, you may know how to go about the process of potentially buying a property lower than what its existing value is at the moment at which you buy it. That is really key. If you know what you're doing, you can do this.
Now it sounds good on the surface but here's what I've discovered all my years in working with friends and family, everybody else who's just, "Phil, I want to buy a home and I want to get a great deal on it." They have discovered the best deals make for lousy homes. They tend to not have the right number of bedrooms, they don't have the right layout, they don't have the right this, the right that. What happens is if you're trying to buy a home and you have a spouse involved in the decision, I have found over the years it's so hard for people to buy homes with instant equity because the instant equity deals tend to not be the ones they want to live in for all kinds of reasons. Again, it just comes from experience. This isn't theoretical. I've watched this happen.
What ends up happening is the people look for a great deal, they find some great deals, but they don't fit what they're looking for and they end up going to the MLS, they ended up buying a retail home, they ended up buying a brand new home, they just throw their hands up in the air and buy the home they want and ended up paying for a retail value. This is a myth, in other words.
My Personal Situation
My wife wanted permanence. She did not want uncertainty. I wanted to rent. Let me just assure you, I wanted to rent, she wanted a home. Now, we decided to pick an area that we wanted to live and we knew we'd be there for the long term and also I was absolutely adamant that we'd get a tremendous amount of instant equity or we were not going to buy and that was the bottomline. It took 2 and a half years for me to find the home that I live so I ask you the question, do you have the kind of patience to look for the right home for 2 and a half years? Maybe not. That's how long it took me to find a home with great instant equity that my wife actually liked, had the pool, it's on the water, it had all the things that she wanted, 2 and a half years for me to find it. If you can have a long term perspective, you can get instant equity, you have the luxury of permanence.
Now there's another thing that's really cool about home ownership. It only happens in a few states, one of which is Florida, the other which is Texas and I think there's a few others, homestead. What's homestead? Well, when Florida was first becoming a state as well as Texas, they were trying to encourage people to move there so they put this law in place that said if you own a home, if you get in trouble criminally, anything happens to you, the one thing that nobody can take away from you is your home and they called it homesteading. You get the power of ownership without every having to concern yourself of potential loss, assuming you don't have a bunch of debts that you have to pay off like in a bank loan or you could just tell the bank in secret I'm not putting them in there because it's homesteading.
A Secure Life
What happens is you have these potential criminals and other people like OJ Simpson, they moved to Florida and they bought these huge estates right before he got to really big trouble legally. Why? Because you put this property in a homestead which you have to live in the home and it's not always easy to get this designation, you've got to do a couple of things right, but there's power there. One benefit is if you owned a home and you paid all cash for it, it's a cool place to stick some money because if it's homestead, it's a secure place. I'm not giving you legal advice there but it's pretty powerful stuff right there.
Now, one thing you can also do is when you own a home, you can get a HELOC. What's that? It's a Home Equity Line of Credit. Let's say for example you own a home outright or you have a ton of equity, you bought it with a ton of instant equity, you can instantly create a home equity line of credit and then you can do deals with that money. Here's the cool thing about that HELOC, it's tax deductible. If you aren't getting your standard deduction which you are itemizing your deductions on your taxes, you can use the HELOC interest that you pay and that's tax deductible. That's pretty sweet. I can assure you, I use a HELOC to do some of my deals and I get the interest deduction. It's really sweet.
If you're in Florida or Texas and maybe a couple other states, you can get homestead. If you got some equity, you can do a HELOC which can be really helpful in doing other deals, parlaying that money in your investments. I'm a real estate investor, so my investments and those types of things. It does give you this permanence and it goes back to this rule, you've got to do it long term. There's a couple of little caveats too. I've sometimes gotten the response, "Well Phil, with renting, you have to have good credit, you got to have a job, those sorts of things." Well, I think in most cases, that's true. If you put out enough applications, you'd be surprised sometimes you can get hooked up with a decent situation even if you don't have your credit or your job is unstable.
With owning, you could do a creative transaction. You could talk to a motivated seller. If you watched my videos, you could potentially structure a creative deal. That is absolutely true. You can definitely do that. Very few people pull it off and I go back to this concept of the best deals tend to be the lousy homes you don't want to live in. If you have to please a spouse, a significant other, that's always been the most difficult. If you are on your own, you're probably able to live in filth or just a property that's not all that perfect. You can fix it up along in the way, you can put your own sweat equity into it, you can do all sorts of things, that's fantastic. If you can, that actually a huge benefit of owning.
If you can structure a creative deal, you may not need to have these 2 things. You can structure a creative deal directly with an owner and if they're completely motivated, they don't ask you about your credit or your job history. That also is the same for renting as well. If you call enough rent signs, you'll eventually deal with a landlord that just needs to fill the property and they don't really care about your application but you got to make a bunch of phone calls either way.
One more item on this owning list and that is you could do a plex, a duplex or triplex or quad, so you could live in one of the units and then rent out the others. Once again, great idea in theory but so few people end up doing it for a number of reasons. Number 1, if you live in the property and you're also landlording, sometimes you get to close to your tenants and when you get too attached to those tenants, too friendly with those tenants, they give you the sob stories, they don't pay the rent but they have such a good excuse because I just had a car accident and all these things happened. All of a sudden, you're paying all bunch of money, maybe they throw parties next door from time to time. Maybe they're just weirdly banging on the walls sometimes.
In theory, it sounds great to own a plex where you have your tenants in the same property and they're basically paying your rent. In practice, very few people pull it off. That's certainly another great idea for owning your own home versus simply renting is that you can have somebody else pay your rent, if you will, by structure in that way. Now you can also do one of these on a lease purchase or I should say lease purchase or a master lease and you may want to lease all 4 units of a quad from an owner and then you just sublease the other units and pay out the rent as well. You could do it that way. That's kind of a quasi between renting and owning. For me, again like my personal situation, it depends on your situation but I have wife and kids, they're not going to want that. They're going to want their own home with a white picket fence and all that kind of stuff.
There is one more benefit to owning a home well over renting potentially. I don't know if you call this a benefit or not. If you don't pay your rent after a period of time which depends on the sophistication of the landlord but 30 to 60 to 90 days, you're out. They take you out. If you own a home and you have a mortgage and you don't pay that mortgage, it can take that mortgage company 6 months, a year, 2 years, I've seen 6 years, I've seen it with my own eyes, 6 years to get somebody out of the property and kicked out. If you own a property, you have the benefit of potentially if the world, if everything hits the fan, that you can live there a little bit longer, maybe another 6 months or a year longer.
Now there's still that huge level of uncertainty if you haven't made your payments because maybe that foreclosing attorney gets his butt on gear and he foreclose a lot faster. That is a slight edge right there but that's not very sustainable. You're going to be able to get away with that once then your cred will be destroyed or if you get a creative deal, hopefully you're able to get out of that deal and sell it or something. You don't want to destroy somebody else's credit, whatever you could do to avoid that kind of thing. It's not a sustainable concept but it is actually true in the real world is that if you don't make your mortgage payments, you can stick that a lot longer than if you don't make your rent.