The dream of home ownership is as American as hot dogs, baseball and apple pie. At least that was the theory until the great recession that ruined home ownership for millions. With the economy mostly recovered, mortgage interest rates at all-time lows and rents rising, is it now better, once again, to own or rent.
Homeownership levels continue to fall with the level of ownership hitting a 50-year low last quarter. Currently only 62.9% of households are owner-occupied. Ownership levels are highest for seniors, and at an all-time low for millennials at 34.1%. The decline is due to several factors
On strictly financial basis, using a five-year period of ownership and making some basic assumptions (your mileage may vary), renting versus owning is nearly a wash, with homeownership slightly less expensive:
Monthly Payment $1,350.00 $ 954.83
Taxes/Insurance 20.00 400.00
HOA Assessments 0.00 100.00
Maintenance 0.00 250.00
Monthly Costs $1,345.00 $ 1,704.83
Down Payment $50,000.00
Five Year Cost $80,700.00 $152,289.80
Less Interest on Down Payment (2%) ($5,204.40)
Less Increase in Value (3%) $(39,818.00)
Less Principal Reduction/Equity $(69,105.00)
Interest Expense/Deduction $520.40 $(7,636.80)
Plus Costs of Purchase/Sale $28,185.00
Total Cost $75,495.60 $63,915.00
This chart is based on a $250,000 home, a $50,000 down payment, an association payment of $1,200 a year, rent averaging $1,350 a month over five years, maintenance costs of $3,000 per year, a sales price of $278,750 after five years, plus the renter investing the $50,000 at an average of 2% and the homeowner’s home value increasing at a rate of 3% per year. Given these factors, the savings over five years is approximately $12,000. This includes costs of purchase of $5,000 and costs of sale (including a real estate commission of $23,185).
Longevity: Determining whether to rent or own is dependent on several important factors. First, how long do you plan to stay in your next home has to be determined, because one of the best benefits of home ownership is tied to longevity of ownership. Our sample favors renting through year three, with each year thereafter supporting buying.
One key factor tied to longevity is how mortgage loans are front loaded with mostly interest. Fixed Rate Mortgages are amortized to provide a fixed monthly payment over the life of the loan. Initially the payments are mostly interest, with only a small amount going to principal. A typical $250,000 house with a $200,000 loan will only have principal reduced by $19,000 if sold within the first five years. It takes nearly 20 years to reach a 50% reduction in the loan balance.
Tax Deduction: One benefit of homeownership is the ability to deduct mortgage interest paid on loans to acquire and improve the home. This can be worth thousands in tax savings during the early years of a mortgage. However, many people do not have enough deductions to make itemizing their taxes worthwhile, and this benefit is lost if the homeowner cannot itemize their taxes.
Maintenance: One drawback of homeownership is the requirement of maintenance of the home from lawns, to painting, to repairs and replacements. Renters mostly rely on the landlord to handle maintenance, repair and replacement costs. Homeowners have to bear the full cost, which can be very expensive. A new a/c system costs over $2,000, and a new roof can run from $7,500 to $30,000 depending on whether its shingle, cement or barrel tile roof system.
Down Payment: The down payment is the largest bar to home ownership, especially for younger and first time buyers. Typically, the down payment is twenty percent of the purchase price. This is a large sum that may be difficult for many to accrue, and even the three percent down payment on an FHA loan may still act as a bar when coupled with closing costs that easily exceed $5,000. Renters only usually need first last and security, which is far less than the full down payment, but can be equal to the FHA down payment. Taking the twenty percent down payment and investing in an indexed fund instead of buying can often result in a substantial gain versus homeownership, which has seen both large value increases and decreases in recent years (the S&P has returned 78% over the last five years).
Portability. Renting is for a fixed term, customarily for one year. Many leases provide a right to terminate early for a two-month rent penalty (an attempt to make this a Florida law did fail). This ability to move quickly is often better for single and married couples without children. Having to move for a career opportunity as a homeowner can mean carrying a mortgage and paying rent on two places until the first owned home is sold.
Given the initial costs, down payment, the burden of maintenance, the loss of the ability to move quickly means that the decision to buy instead of rent can be difficult for many people, especially if they are likely to need to move in less than five years. Committing to longer term ownership is when the decision becomes in favor of homeownership, ultimately saving money in the long run.
Michael J Posner, Esq., is a partner at Ward Damon, a mid-sized real estate and business oriented law firm serving all of South Florida, with offices throughout Palm Beach County. Michael specializes in real estate law and business law, and can help sellers, buyers landlords and tenants with their real estate issues. Michael can be reached at 561.594.1452 or by e-mail at firstname.lastname@example.org.