Does the adage “don’t throw your money away on rent” really make sense?

A co-worker recently told me he wanted to buy a house so that he could avoid throwing his money away on rent. This got me to thinking about whether or not that statement actually made sense. So I decided to look at how much my wife and I pay in “thrown away money” that we wouldn’t pay if we were in an apartment instead of a house.

Initially there was the $2,000 that we paid in closing costs, costs that we would not have incurred in renting another apartment.

Then our monthly costs are:

$749.42 in mortgage interest
$ 46.00 in homeowner’s insurance
$286.00 in property taxes
$100.00 extra beyond the cost of utilities in an apartment
———-
$1181.72 total

So at the least, my wife and I pay $1181.72 each month in thrown away money. This money is the exact same as rent. I did not include the equity in that number, just interest. And these costs are all before repairs or upkeep (like lawn care or cleaning).

But after 15-30 years, the interest payment will go away and I’ll own the house completely and then I’ll be ahead right? Well, I’ll still be paying the $432 in other costs (which is still like rent).

But at that point I will also have $180k that is “stuck” in my house. If I take that $180k and instead invest it in an index fund and assume only a 6% return, then I can make $10800 a year. If my apartment rent would normally be $600/month then after subtracting the $432, I would be paying $168 more to rent an apartment. Or $2016 per year more difference to rent an apartment instead of living in a house. So if I live in an apartment instead of a house, then I can make $10800 – $2016 = $8784 each year before compounding.

Now take that $8784 each year and compound it at the 6% for 20 years and you end up with about $300k. That’s huge!

So by buying a house you are actually giving up money each year versus what you would have renting an apartment.

I’m not saying buying a house is bad or wrong. I love my house, and my back yard. And I like that no one can kick me out of it (except for the government, but that’s a different beef entirely). I’m just trying to point out that the conventional wisdom of “buy a house, don’t throw you money away on rent” isn’t necessarily true.

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6 thoughts on “Does the adage “don’t throw your money away on rent” really make sense?”

  1. Flawed analysis… you fail to factor in the annual tax savings and it's compounding effect going forward… which is also "huge" over the life of the mortgage.

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  2. Thanks for pointing that deficiency out.I left tax considerations out because it didn't seem to have much effect on the final total, adds some complexity, and because the taxes factor is highly individual since it depends on all your other financial situations, but I can speak to my own as an example.The standard deduction for 2007 for married filing jointly is $10,700, so only deductions over that amount matter. My taxes and interest are the only deductions I have that can be itemized.My interest for the year is (749.42 * 12) $8993.04.My taxes for the year are (286 * 12) $3432.That’s a total deduction of $12425.04. The difference from $10,700 then is $1725.04.My marginal tax bracket is 25%, so a reduction in my taxable income is a savings of $431.26 this year.As I pay off my mortgage and pay less and less interest and more and more principal, that $431.26 per year will drop to $0. This happens for me over the next 10 years since that’s when my interest and taxes will not be worth more than the standard deduction.So at the most the tax benefit to me is (10 * $431.26) $4310.26. Compared to the $300k discussed above, or even the annual savings of $8784 above, that's a fairly small amount.

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  3. You ignored he fact that your mortgage will stay the same for 20 years while your rent will go up. In the short term you will save money to invest and grow, but in the long run you will save less or lose money when increasing rent is considered.

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  4. You make a good point about rents rising over time, which would be due to the effects of inflation.Inflation will also raise the value of the house by the same percentage as the rent, which raises the real estate taxes, insurance costs, and maintenance costs by the same percentage.And inflation will also increase the values of equity investments in the stock market.So I think that means that overall you can ignore inflation since both sides (renting vs. owning) will be roughly equally affected by it.The main benefit of renting over buying seems to be that you would normally rent less space than you would buy.But that reminds me of one of the limitations that owning a home brings with it, that investing in the stock market might allow you to avoid. Your major investment in your house is highly concentrated and not at all diversified. Think of all the things that could devastate the value of the house that are not covered by normal insurance. The house could get mold, or the foundation could crack. The neighborhood could go downhill, or the major employer in the area could go out of business. How sure are you that your area will be the same 30 years from now?True you might get lucky and buy into the next Beverly Hills, but you might also buy into the next slum and end up selling at a loss. In either case though we are really talking about speculation.But that brings to mind another pitfall of owning. If the house goes down in value while you still have a loan balance, you could very well end up owing money and be upside down on your mortgage. That’s not possible with renting an apartment and investing the rest in the market. You could definitely lose it all in the market, but you won’t end up owing.To be honest, I’m surprised this particular topic has garnered so much more interest than the others I’ve written about in the past. It’s similar to when I wrote about new cars versus used cars.

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  5. Tax benefits are a fallacy for many American homeowners. Not only does the amount of interest go down as the loan amortizes, the standard deduction goes up every year. As a result, many taxpayers (myself included) discovered that if we put 20% down and paid the loan down aggressively we had zero tax benefit relatively quickly (like 2 years into the loan).

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  6. You also fail to point out that when you own property you can increase the value with sweat equity. Making cost-effective improvements can increase the value when it comes time to sell. However the main reason why we chose to purchase real estate as the primary investment tool is that we feel like we can control the outcome better than with stocks or mutual funds. We can raise rents, we can improve the property, etc. When you look at companies like WAMU, World Com, Countrywide, etc. a small-time stockholder can't have an impact over executives' pay packages, accounting blunders, flawed products, lawsuits, etc.Additionally, if you look at lifetime renters I would be very surprised if you found many of them with large stock portfolios. At least a mortgage is a forced savings plan that most people otherwise wouldn't be able to have the discipline to put into other investments.

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