Personal Finances

The Debate Continues: One User’s Opinion on Renting vs. Buying

As with anything, there are pros and cons that change with every complicated variable involved.  The concept of buying being better than renting is relative to the context of each side of the equation at any given time.  No two situations are the same, but generally speaking, assuming certain conditions are already met, owning a home is MUCH BETTER for long term wealth building than renting.

In an article that I wrote back in 2008 on the SonoranHouse.com blog, I illustrated the financial benefits of renting vs. buying.  Here’s what one user had to say, along with my thoughts on the response:

WRONG… Renting is FAR better and Cheaper than buying a house.

Not so fast.  There are too many variables involved, and each situation is different, but the principle cannot be disputed.  Owning is a long term prospect.  Not short term.  In order to conclude that owning is better, one must assume that the property will be held for as long as possible.

1. The down payment is $20,000 OUT OF YOUR POCKET on day one. SO by purchasing a house you are immediately $20,000 POORER the day you buy your house. In contrast, you can RENT and only pay a SMALL deposit equal to 1 months rent and keep the rest of your $19,000 to use as a safety net to pay the rent with and live an easy STRESS FREE life knowing you have the rent covered for 19 months if it’s a $1K a month rental.

When you pay a deposit to a landlord, it is a fee that can never be recovered.  When you put money down on a house, you are instantly investing your hard-earned cash in an appreciating asset.  You are not spending the money.  Again, if your investment mindset is short term and you sell your home too quickly, you will certainly cut into your initial down-payment unless your property experiences unheard of appreciation in a short time period.  Not likely to happen again.  Buying real estate is a long term wealth building investment.

A rule of thumb for an emergency fund is 3 to 6 months worth of living expenses.  If your rent is $1000.00/month, you have 19 months of rent paid for, but that doesn’t take into account the rest of your expenses.  If a down payment on a house depletes your living expenses, they you are not ready to buy.  Your down payment should be above and beyond your 3 to 6 months.  So, if your expenses are $2000/month, you should sock away about $12,000.  The rest can be used towards your future down payment.  This all assumes that you are completely out of debt.  If you aren’t, then you shouldn’t be buying a house in the first place.  Most renters do not have this much money saved up and they live paycheck to paycheck, so they feel they NEED to have some sort of financial buffer to buy them time.

The problem with this is that they never get OUT of the rat race by behaving this way, and they never put their money to work for them.  They will live the rest of their lives working for their money.  What would be the difference between having 19 months of STRESS FREE living in a home that is appreciating in value versus apartment living with the same amount of a safety net?  The difference is that part of your monthly payment is being added to the home’s equity.  Some of that payment will be recovered.  NONE of the rent will.

2. The Tax Deduction is nonsense… You spend $1.00 in Mortgage Interest to deduct .10 cents off your tax bill. HARDLY a “savings” at all. Your still LOOSING .90 CENTS in interest!! WAKE UP PEOPLE!!

Tax Deductions are a poor excuse for people who are poor to continue to be poor.  The argument here is that it makes sense to pay the bank $1.00 in interest to avoid paying the government ten cents.  Obviously that is flawed thinking.  Spending 90 cents to save 10 is absolutely ridiculous.  That is why the largest mortgage anyone should be financing is a 15-Year fixed.  Obviously paying cash is the best way to buy a house.

3. When you own a house you pay PROPERTY TAXES each and every year. These taxes are about 1.5% of the value of your home or around $3000 a year. That’s $3K a year your LOOSING if you own a house.

Hmmm…let’s see.  Property taxes at $3000/annually, deductible at your tax bracket rate, or $12,000 wasted on rent.  Personally, I’d rather put the remaining $9,000 in growth stock mutual funds to offset the perceived loss, because by the time my $9,000 per year is invested over 30 years, it will pay the property taxes a few thousand times over.

4. When you own a house you pay Property INSURANCE on your house each year. This will be about 1% of the value of the home so figure $2000 a year on a $200K house.

I own a $200K home.  Taxes and insurance annually do not exceed $3000.00.  In fact, they don’t exceed $2000.00.  This has everything to do with location and tax rates.  Again, I’d rather cough up $2000/year for insurance than blow $12,000/year on rent.  So based on points 3 and 4, which add up to $5000.00, I’m still ahead with $7,000 invested annually in growth stock mutual funds.  Come to think of it, my down payment of $19,000 as used in this example will be reimbursed fairly quickly.

5. When you own a house you pay for ALL MAINTENANCE/REPAIRS/REMODELS. This means spending about 1.5% of the value of your home EACH YEAR to keep it in livable condition so figure another $3000 a year on maintenance/upkeep.

Nobody forces remodeling, so we’re going to remove that from the equation.  Deferred maintenance is a price that everyone has to pay for, whether you own, or you rent.  As the king of your castle, you determine what’s used on your property to improve and maintain it and you have a choice over the cost/savings realized from it.  By renting, you have no control over these things, and the cost of rent is at the discretion of the landlord, who can easily raise it high enough to force you out to make room for someone else as a result of increased management costs.  Owning your own home offers greater long-term housing security.

6. In order to “get your money back” out of your house you will need to SELL your house. This means FINDING SOMEONE ELSE TO BUY IT. You’ll have to pay Closing Cost, Real Estate fees, etc. and it can take a LONG TIME to find a buyer. THEN even if you sell, you will have to live somewhere so you would have to turn around and buy ANOTHER house or do what most smart people do in the first place… RENT.

False.  As a long term investment, the asset appreciates and the value of the loan decreases over time.  If you paid cash, you have an instant money making machine creating passive income.  If you didn’t, you’ll eventually reach a point at which renting your home to someone else will generate positive income above what you owe on the mortgage payment.  The tone of point number six seems to emphasize the dependence upon cash in the bank to provide a safety net.  Obviously if you’ve been able to save $19,000, you’re making more than you’re spending, so the time that it takes to sell should be irrelevant unless you’re forced to move via relocation or other circumstance beyond your control.  It’s true that if you sell too early, you’ll erase your gains because you didn’t have a long term mentality.  There is so much more risk to buying a home when you borrow, but if you are able to pay cash for a home, then I’d say you’re living well financially.  One’s intelligence is not a factor determined by the decision to rent or buy.  One’s wealth, however, is.  If you want to get rich and live free like nobody else, then you’ll invest wisely.  Renting is not investing.

Owning a house ONLY makes sense IF you could pay CASH for it. Even then, your still going to “Throw money away” on Taxes, Insurance, Maintenance, and the excess bills that come from owning a house when if you RENTED many of those bills are included in the rent.

Paying cash for a home ISN’T THE ONLY time it makes sense to buy a home.  It is the BEST practice for sure, but you’re not throwing money away on taxes because your home is appreciating in value, and in theory, you’re renting that home out, collecting $1000.00/month rather than spending it.  Can you imagine how nice it would be to be able to put $12,000.00  less a few expenses every year without having to work for it?

The fact that there are additional bills when you own versus renting is also a false assumption.  Do the math over a long period of time.  Take the appreciation of real estate and the potential passive income from owning a rental and see where it would be in 30 years if invested wisely, long term.  Compare it to the real costs of owning.  Remember, we’re talking about ownership versus renting.  We’re not talking about owning a high cost property that has no potential to generate future income.  That would not be a wise investment.  Of course, you could just keep on throwing your hard-earned money away.  In fact…

…I’ll look forward to renting one of my properties to you because you sound like the perfect tenant.

Cash For Clunkers, The Final Deathblow

My recent article entitled Cash For Clunkers Is Absolute Ultra Stupidity was the most viewed article on my site on the day that I released my August newsletter, probably because of how provocative the title was.  I recently caught Blake Thompson’s @ramseyshow tweet which turned me on to the following video by Dave Ramsey, author of the #1 best seller The Total Money Makeover: A Proven Plan for Financial Fitness.

I read this book, well, I actually purchased the audio book and listened to it 7 or 8 times after listening to Dave’s radio program for about a year, and the book solidified all of the callers’ answers that Dave offered during that time by teaching me the theory behind what Dave teaches.  I highly recommend reading it if you intend to build wealth and become financially independent.

Have a look at Dave’s view on cash for clunkers:

There Is No Secret To Getting Rich

Think about it. There are thousands of millionaires. Some of them fell into it; some of them worked hard to earn it. Those who worked hard, probably still have it. The most powerful wealth building tool that you have is your income.

When you fill a bathtub, you plug the drain. If you don’t, all the hard work of pumping that water from the well is wasted as the water simply slips away through the plumbing.

There are two ways to change this situation. Increase your income, or decrease your expenses. You have far more control over a decrease in expenses than you do an increase in income, so don’t hope for a raise to get you on track.

So what does the cash flow of a wealthy person look like? That all depends on how you define wealth. Before you can be “rich” you need to adjust your lifestyle so your expenses are less than your income, and you need a clear, written plan.

This isn’t rocket science. In fact, here’s a little chart that I created that outlines a pretty good plan that will place you on the highway to wealth.

Assumptions

• You give to your church.
• You give as little as possible to the IRS every paycheck and save your annual taxes in your own interest bearing market rate account.
• You have ZERO debt, except for your mortgage.
• You have 3 to 6 months total expenses saved up for emergencies.
• Your salary is around the national average of $50,000.00
• Your mortgage payment is no more than 25% of your take home pay and is a 15-year fixed mortgage.

Based on the assumed $50,000 annual income, your monthly gross income is $4166.66.  You make enough to land you in the 25% tax bracket.  Your tax bill for the year at $50,000 will be about $8,688 or $724.00/month.

So, after taxes, you’re left with $3442.66 every month.  What are you going to do with it?

The key to following this model is applying it to whatever income situation you are in.  Whether you make $25,000 or $90,000.  Granted, your tax bracket will change the calculations, but the model should remain the same.  If you are unable to do this, then you may have an income crisis, or you’re spending WAY too much money on things you don’t need to be spending money on.

This model is obviously a guideline, and can be modified to suit your particular situation.  I’d love to hear your thoughts on this and why you may agree or disagree with the structure.  Spending in this country is out of control, and there’s a serious lack of financial discipline being exercised in our lives.  Writing out a plan for your money, such as this, will help open your eyes to what you really can and cannot afford.

It’s a Bottom Line Issue

A recent post on raincityguide.com got me going about the bottom line when it comes to short sales.

The article, written by Ardell, touches on the apparent importance of the assets that a property owner may have that could affect the bank’s decision regarding whether or not a short sale will be approved.

At present, there’s no guarantee that any lender will approve a short sale, ever.

Just because the value of a property is obviously less than the amount owed, that does not mean that the seller’s lienholder is going to approve the short sale.

Consider this.  If a property owner has a net worth of $1,000,000.00 and they decide to quit paying their mortgage, what happens?  The bank forecloses.  It doesn’t matter if the seller has money or not.  They have made a decision to walk away, and one thing is certain…if you have a home with a mortgage and you quit paying it, the bank will foreclose.

So, when this seller, who arguably is walking away from a moral obligation, decides to attempt to sell the property to reduce their potential deficiency liability and potential income tax liability for current market value, which may be less than what they owe, would it, or would it not be in the bank’s best interest to allow the short sale?  If they don’t allow it, will they waste money on the foreclosure process, and lose money when they list it for sale for less than market value?  They will.

Ardell’s Auto Metaphor

You lend your friend $10,000 to buy a car. He decides to sell it when he still owes you $8,000.  He tells you someone is willing to pay $5,000 for the car and he wants you to take $5,000 as payment in full.  You look at his offer, you find out he he has $15,000 in a savings account.  You find out the blue book value for the car is $6,500. The person who wants to buy the car for $5,000 is getting impatient wating for an answer. What would you do?

My answer?  It doesn’t matter to me whether or not my friend has money in the bank.  The only thing that matters to me is how much the car is worth on the open market, and how much is being offered.

The what you may be missing about this example is the fact that my friend has made a decision to eliminate a debt, and he’s going to do it one of two ways…he’ll either a) let the car get reposessed, or b) try to sell it for as much as he can and ask for a forgiveness of the remaining debt.  True, he may no longer be a friend, but that’s what he’s doing.

So, what do I do?  Well, in this case, the car should sell for $6500.00 based on Kelly Blue Book private sale.  I as the lender now have a few options.  I can a) take the car back, or b) agree to sell it for the offering price, or c) require that my friend find a buyer willing to pay market value.

Perhaps the cost of repossessing the car, reconditioning the car, licensing and registering the car, and re-marketing the car will exceed $1500.00, the difference of market value and the current offer.  In that case, I would be an idiot not to take the offer.  I as the lender, will make smart decisions in mitigating my loss, which means that I would in fact approve the sale.

If all of my costs to resell that car are less than $1500.00, then I would deny the sale and require a higher price.

Should you just take the car and try to sell it for the $6,500 or better, so that you can still collect the amount your friend owes you after you sell the car?

This is a classic example of the tug of war that we face with lenders between the concept of Loss Mitigation and Collections.  At this point, I’m not interested in collecting.  I’m interested in preventing further loss, because I know that my friend is not going to pay.  So, I want to get the car OFF of my books as quickly as possible for as much as I can possibly salvage with as little time invested as possible.

If I am concerned with collecting, knowing that my friend has the money to satisfy the debt, I will surely become bitter at him for not paying, and then I will do something stupid, like refuse to agree to mitigate my loss, which in the end will eat up time and energy, and money.  Give me my $5000.00, get the headache out of my life, and let me put that money somewhere it can begin earning again.

Is it possible to short sell more than one home of the same owner who has plenty of money in the bank but has chosen to walk away from their obligation?  Yes.  Is it right for them to walk away?  That becomes a moral question that the seller would have to ask of his self.

Bank executives understand loss mitigation, and they don’t care about each person’s personal financial situation.  They care about 3 things and 3 things only.

1. Is the owner walking away from the property?
2. What is the market value of the property?
3. What is the current offer?

Anything else has zero bearing, from the bean-counter’s perspective.

Some second lenders (junior lien holders) will hold up the sale of a property because they just want to get back at the seller for not paying.  This is a ludicrous path to follow, because it gains them nothing.  If the senior lien holders were to behave the same way, then ultimately they lose more than if they allow the short sale.

Do lenders have to approve short sales?  No, they do not.  Would it be better if they did?  Yes, but only if it means avoiding foreclosing on the property, which is something that the bank cannot prove the owner has actually decided to allow.

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