When the Math Supports Buying Your Primary Residence Instead of Renting
To preempt the most frequent question that these types of articles prompt: I’m not talking about house-hacking arrangements wherein your home generates income from rental tenants. This is purely buy-a-house-and-live-in-it “buy” vs. “rent” something comparable. For more tips on renting affordably, check out this Rent.com article I provided a few quotes for.
Here I am again, negligently opening up the can of worms that is discussing the most emotional financial decision anyone ever makes in a country where home ownership is considered a blood oath rite of passage to adulthood and happiness. What could go wrong?
But I’m ready to invite the hordes of pitchfork-holding mortgage lovers back into my DMs once more, because today, we’re talking about when the math supports buying instead of renting. (The TL;DR is, it’s not as often as you’d think. I think this post will bring you to my dark side, because it allows you to live in your cake and invest it, too.)
Of course, this is a debate that’s heavily skewed in favor of home ownership in the US. And when the media publish headlines like this one—noting how homeowners’ net worths are “40x greater” than that of renters—it’s easy to assume causality where it might not exist. In this case, I fear we’ve got the causality exactly backwards: Being the owner of your primary residence does not make you a rich person, but a rich person is probably more likely to buy their primary residence.
I always struggled with the rebuttal, “It’s a personal decision! What’s best for you might not be what’s best for someone else!” because to some extent, I agree—but simultaneously, if the math can unequivocally prove that owning a home is going to cause you to lose money over time rather than make money, I have a hard time agreeing that it’d be what’s “best” for someone long-term in the financial sense.
For example, if you could rent a 3BR home for $2,400 per month (the cost of many of the 3BR homes we’re looking to rent right now in Fort Collins, CO) or buy that same home with 20% down and a $2,400 monthly payment (mortgage, taxes, insurance), I’d still opt to rent, and I’ll show you why below: It mostly comes down to the opportunity cost of my 20% down payment and the inevitable maintenance and repairs that would ultimately cost more. If I can live in it as a renter, I get the best of both worlds.
In this scenario, it’s because when you rent a home, your monthly payments are the maximum you’ll spend. When you own, your monthly payments are the minimum you’ll spend.
In short, I’d let the numbers tell me what to do.
If there were a situation where owning the home instead of renting it would get me farther ahead, I’d do that. It’s simply very difficult to compete with the average returns of the stock market, and virtually no real estate market in the world can compete over the long run.
Even the real estate market in an expensive metropolis like NYC has benefited from average annual increases of 2.83% in the last 10 years, where the stock market has returned an average 11.8% annually in the same time period. I don’t know about you, but I think I know which asset class I’d rather bank on if “ending up with more money later” is my goal.
“So if owning sucks so much, Katie, when the hell should I buy a home?”
Also known as: “That’s a lot of wasted rent money! Do you want my kids to suffer in silence in 800 square feet of rented squalor?”
I think renting has a bad reputation, and for no reason—the lenders and real estate agents will tell you that renting is throwing your money away (and then gently charge you a 6% commission and 3.99% interest for the pleasure of handling your money instead), when in reality, I think being a renter is a pretty sweet deal.
When my hot water furnace broke, someone came and installed a new one the next day. For free. When a small piece of metal fell down the garbage disposal and destroyed it, a nice man showed up that afternoon and put a new one in.
I just Googled “hot water heater” and the first search result was an item from Lowe’s that costs $1,562. Garbage disposals, on average, are about $300. And that’s just the product, not the installation and maintenance.
In short, I’m in no rush to quit renting. When drains clog, lightbulbs die, filters need replacing… I submit my request and my Fairy Godfather with a toolbox comes and makes everything better at no expense to me.
Know that that’s the attitude at which I’m approaching this conversation: That renting is not a bad thing. When you’re happy in your current situation, you’re less likely to make life-changing, money-altering decisions using your amygdala that’s been exposed to years of Architectural Digest and American Dream Real Estate Porn, and you’re more likely to look at your options objectively.
Let’s begin. Get out your notepads and your tissues and prepare for a wild ride.
First, let’s take a look at how much it actually costs to own a home. I wrote a post awhile back that touched on the major stuff, but since then I’ve learned a little bit more about national averages and—sadly—it paints a slightly bleaker picture than my original assessment, which made home ownership look a little rosier than reality.
I’m going to quote pp. 81 in Quit Like a Millionaire by Kristy Shen for this breakdown, because she nails it:
“The problem is that owning a house costs money way beyond the purchase price. It costs money to buy, sell, finance, and appraise it, and to insure and maintain it each year, which we logically know but basically just dismiss when we’re digging deep for that down payment.”
Because the average American family lives in their home for 13 years (rather than for the full duration of a 30-year mortgage), we’ll use 13 years as our timeline (this average has increased from 8 years in 2010).
She proceeds to use national averages to break down what a $500,000 home would entail. For the sake of #JournalisticIntegrity, I’m going to verify those national averages using my trusty steed, Emperor Google, as we go.
First of all, a $500,000 home would suggest a $100,000 down payment (20% of its total value) to avoid mortgage insurance, which means you’d mortgage the other $400,000.
Keep that in mind for later. (And if you’re sitting there like, “But Katie, you don’t have to put 20% down!” You’re right. But know that the more you mortgage, the more you pay interest on, and you’ll pay an additional insurance fee for the pleasure of mortgaging more than 80%.) If your PMI payments are small and will fall off once your equity eclipses 22%, it might be worthwhile, but I’ll draw one line in the sand here:
Putting down less than 20% because you want less equity (and therefore, to pay less of an opportunity cost on locking up your down payment) is a very different decision than putting down less than 20% because you can’t afford to do so. The best time to buy a house? When you can actually comfortably afford it.
Kristy includes all the small fees (title search, recording fees, lawyer fees, etc.) that, for the sake of this exercise, I’m going to ignore to focus on the big picture.
Insurance
You have to insure your home. Kristy claims the average national cost is about 0.5% of the home value, per year. This gets paid annually. In my Google searches, the average looked to be closer to 0.7 - 0.9%, so we’ll say 0.6% as a happy medium and call it a day.
Assuming your home appreciates by the national average of 3% per year and you bump up your insurance accordingly, your insurance payments will look like this:
$500,000 (home’s beginning value) * 0.6% (insurance cost annually) * 13 years = $46,853 to insure your home over the 13-year period you live in it
Property Tax
In parts of states that have no income tax (like Texas), this can be quite the #PhatBill. The annual national average, according to Kristy, is about 1%. In Dallas, it’s 1.93%. But Kristy’s finding holds true; the national average is 1.07% based on what I found.
More arithmetic! Assuming your property taxes are recalculated by the county every year based on a new appraisal of a home that’s appreciating by the average of 3% per year… (though note that some counties re-appraise on different timelines)
$500,000 (home’s beginning value) * 1% * 13 years = $78,008 in taxes over the 13-year period you live in your home
So far, between insurance and property tax, we’re looking at $124,941 over 13 years (or $10,411 per year) in expenses in addition to the cost that you’re putting into owning the home, like…you know…your actual mortgage and the interest on your mortgage. Taxes and insurance are just the small waffle fries on the side of your spicy chicken sandwich, and they’re waffle fries that cost $10,000 per year on a $500,000 chicken sandwich.
Now’s probably a good time to state the obvious: This is why buying more home than you can comfortably afford sucks the life force out of your finances. It’s not just the home itself that’s more expensive upfront or every month, but all your add-ons cost more, too, because they’re based on the overall tax-assessed value of your property.
Someone who believes they can afford a $500,000 home should be prepared with an extra $100,000 ready for the next decade of guaranteed, inevitable basic costs like taxes and insurance (which is fine, if it’s important to you, but it’s good to go in with your eyes wide open).
Maintenance and repairs
Because we know hot water heaters break, pool filters go bunk, and 16-year-olds learning to drive plow through your front windows, real estate agents often recommend setting aside 1-3% of your total home value per year for maintenance. Conservatively, if we chose the lower end of the spectrum…
$500,000 (home value) * 1% per year in maintenance * 13 years of home ownership = $65,000 in maintenance and repairs
I’m not adjusting this one upward for appreciation, though I probably should—since technically homes “depreciate” over time (as in, they get progressively shittier and more outdated, requiring more and more work). If we’re being really pedantic, it’s not your home that’s becoming more valuable—it’s the land your house sits on. This is why the government allows real estate investors to write off “depreciation” on their properties, because even the Tax Man knows your house is getting progressively worse.
Keep in mind that’s not the fun and sexy stuff like kitchen remodels and installing bouncy castles in your basement. That’s pipes bursting, sprinkler systems breaking, accidentally flushing a dog toy down the toilet and replacing the septic system… if you want to do serious renovations on your home, that’s going to be considered as a separate expense.
Are you keeping track? We’re up to $189,941 on the upkeep, taxes, and insurance for our $500,000 home over the 13 years we live in it, or $14,991 per year in addition to our mortgage and interest.
That’s right—we haven’t even begun paying down the mortgage and interest yet! That’s an average monthly cost of roughly $1,249.25 that goes toward what we can call “unrecoverable costs,” or costs that don’t build any equity.
Think this maintenance number sounds like an insane estimate? Check out this DM I received over the weekend from a friend who’s always engaged me in healthy debate about my housing hot takes.
My intent today is to paint a mathematically sound and unbiased picture of the rent vs. buy equation, not to rely on anecdotal evidence and one-offs to convince you one way or the other. But damn, I feel like ALL we get most of the time is the rosy, white picket fence view of home ownership full of catered house-warming parties and custom drapes. It’s rare we get to hear someone in their twenties speak so candidly about when owning a home is NOT the American dream, so I wanted to include it.
Mortgage and interest
This is a pretty simple calculation, so let’s assign a national average interest rate.
According to BankRate, as of July 2022, the average U.S. mortgage rate for a 30-year fixed mortgage is 5.65%. This factor will seriously impact these numbers as you run them for yourself, so I suggest using the rates you’re actually approved for when you check this out for yourself.
As we know, we’re mortgaging $400,000 after putting $100,000 down.
Our principal and interest payment every month is $2,309, according to the built-in Google mortgage calculator with the “taxes and fees” toggle switched off.
(For reference, this is the number that most people see when they consider buying a half-a-million dollar home and think, “Well hot damn, I can afford $2,309/month for a house that big! Let’s pony up, baby!”
To be fair, this is probably the strongest selling point for buying a home: You lock in your fixed monthly payment for the duration of your loan, and in periods of high inflation, your debt benefits from the tailwind of being more or less “inflated away.” When we run the numbers for this scenario, we know without a shadow of a doubt what we’ll pay (toward our mortgage and interest) each month in 1 year from now and 15 years from now. It doesn’t change, as rent does.
But as you can probably see by now, that $2,309 doesn’t tell the whole story. To Kristy’s point, we wonder, “How much could all that other shit cost? Surely it’s not that big of a deal.”
In this $500,000 home example, on the conservative end of the spectrum, it’s an extra $1,249 per month, on average. That’s $2,309 for your monthly mortgage payment and $1,249 in taxes, insurance, and routine maintenance, or $3,558 per month. Remember: These are the fees we know about: taxes, insurance, mortgage interest, and maintenance are guaranteed unrecoverable costs of owning a home.
Now, remember we’re only living in this home for 13 years before selling:
$2,309 per month * 12 months in a year * 13 years = $360,204 spent in principal and interest payments for the 13-year period
If you’re like me, you’re probably like, Wait a second, that’s nearly $400,000. Does this mean I’ve almost paid off the home?!
Over the full 30-year term, a $400,000 mortgage would cost $831,240 total with a 5.65% fixed rate, $431,240 of which represents interest payments alone. That’s over the full 30 years, though; we know our hypothetical family (am I in third-person? First-person? I’ve lost track at this point thanks to the chaos this hypothetical home purchase is inducing on my pretend bank account) is selling the home after only 13 years.
Because interest is paid first in a mortgage, approximately $252,475 of your principal and interest payments so far would’ve merely paid the interest on the loan, meaning of the $343,891 of the “principal and interest” you paid, only $91,416 actually went toward paying down your principal on the $400,000 balance you mortgaged.
Let me repeat that, in a bigger font, for dramatic effect:
When you sell after 13 years, you’ll have paid (conservatively!) $189,941 in taxes, insurance, and maintenance, as well as $343,891 to the bank, but you’ve only actually paid back $91,416 of the original $400,000 amount that you borrowed (mortgaged). Which means you still owe $308,583 on the property.
Put simply:
You’ve paid $533,832 for $91,416 of equity (plus the original $100,000 that you put down) for a total cash outlay of $633,832.
In order for you to break even on this “investment,” your home will have to be worth $942,415 when you sell in year 13—not totally unheard of, but not something I’d bet $633,832 on, either.
How is this not the conversation we’re all having around housing? That’s insane!
When you pay down a mortgage, you mostly pay down the interest first. As you pay off more of your mortgage, more of your payments go toward your principal.
After spending $633,832 over the 13 years, we still owe on the remaining principal of our loan. Because so many of our payments were mostly interest, the portion we still owe is $308,583 in principal on our $400,000 mortgage.
We’ve already spent $633,832, all in. We still owe $308,583, which is the amount we’ll need to pay the bank after we sell.
Hopefully our home has appreciated. Let’s pretend we purchased a home in Dallas, Texas, where home values are appreciating in the top 10% of national housing markets.
In the last 10 years, homes in Dallas county have appreciated an average of 5.71% per year. If that held strong over the entire time we owned the home, it means over a 13-year period, our home would’ve appreciated from $500,000 to about $1,000,000.
Great! It’s doubled in value over that 13-year period, and looks like it’ll allow us to clear the breakeven value we needed of $942,415. But wait—we need to sell that house to make the profit, right? Right—and selling a house costs money.
When you sell a home, the buyer’s and seller’s brokers’ commission comes out of your (the seller’s) end, and it’s calculated based on the new value of the home (in other words, the sale price), not the price you paid 13 years ago. On average, the brokers’ commission is about 6% total, or 3% each.
So we’ll pay the brokers 6% of our $1,000,000 listing price, which is $60,000. Not bad, huh? That leaves us with our $940,000 in “profit” on our $1,000,000.
Except we know we needed to clear roughly $942,000 to break even. We know we’ve already paid $633,831 for our down payment, mortgage principal, interest, property taxes, insurance, and maintenance.
We paid our broker $60,000 for the sale.
We also still have to pay back the bank for $308,583 that remains on our mortgage principal.
All in all, what’s our net profit?
$633,831 (paid over 13 years) + $60,000 (broker commission) + $308,583 to pay back the bank on what we still owe = a total cost of $1,002,414.
It’s a good thing we doubled our money and made $1,000,000 on our sale in one of the fastest appreciating real estate markets in America, because after 13 years of glorious home ownership (and using all the average costs and rates), we’re at a slight net loss of $2,414.
Our profit on our home that we bought for $500,000 and sold for $1M 13 years later is ($2,414). That’s negative $2,414.
And we excluded certain expenses that don’t apply to every state, like land transfer taxes and lawyer fees.
We also totally ignored closing costs, which can easily exceed $10,000 on a $500,000 home or $20,000 on a $1M home (2% of the total value is common).
While two years ago when rates were just under 4%, you would’ve barely come out ahead—but now? Not so much.
And remember, our house doubled in value—that’s rare, statistically speaking.
This is why I wince when people DM me to rebut my housing argument by saying their property has “already appreciated” by $40,000 in the last 5 years. A $40,000 appreciation won’t even pay for the property taxes on some properties, let alone leave you any profit.
This is why I’m so hesitant to buy property
I know that if I can rent for even $2,300 per month (the same cost that our hypothetical family paid for their mortgage alone every month), I’ll have spent $431,051 in rent over 13 years if my rent increases by an average of 3% per year (which is customary).
That sounds horrible, until you consider that my $100,000 “down payment” went into the stock market instead, and the difference between my cost to rent over 13 years ($431,051) and the aforementioned cost to own over 13 years excluding the down payment ($533,831) is $102,780. In other words, by not buying a home, I was given the opportunity to save and invest the additional $102,780 I would’ve spent on the house’s unrecoverable costs along the way.
If you pretend I had invested that amount (equally distributed as monthly contributions over the 13 years, at $659 per month), I would’ve made a decent amount in the market if you assume a 9% return before inflation, which is standard historically speaking.
$100,000 (initial investment in the market) + $659 per month incrementally over 13 years at a 9% annual return before inflation =
$488,095.
Subtract your amount spent on rent for your net profit: $431,051 spent on rent, and $488,095 in an investment account = a net profit of $57,044.
…as opposed to our net cost of roughly $2,500.
Of course, now’s a good time to remind us all that there are tons of assumptions baked in to this calculus (as there has to be, in order to do any sort of forecasting). We used average costs, average rates, average increases, and above-average appreciation on our home. If anything, I think this exercise was slightly more generous than it would’ve needed to be toward the housing camp, since it assumed no major repairs or renovations occurred (and healthy appreciation).
That said, it’s possible the average rent increases were too low, as some zip codes have seen rents rise more quickly than 3% per year on average (that said, some zip codes have historically seen rent increases less than 3%, so pick your poison).
It’s tempting right now on the heels of ahistorical rent jumps and housing appreciation since the pandemic to discredit all of this, but I’d argue that’s the exact wrong approach: The last 24 months have been the exception, not the rule.
Even with utilizing the tax breaks for home owners (deducting your interest from taxable income, etc.), the difference is stark, as 90% of Americans take the standard deduction since the Tax Cuts & Jobs Act raised the standard deduction in 2017.
I didn’t take you through that entire exercise to shit on home ownership, I did it so you’d believe me when I say owning a home is expensive. We used national averages of guaranteed costs to come to these conclusions, and you can run these same calculations using your own interest rates, mortgage amounts, etc. and Google the tax rates and insurance rates in your zip code for total accuracy.
These are the facts of the costs of home ownership; this is not my opinion. I have nothing to gain from shitting on home ownership, as I’m not a landlord. If it were more advantageous to buy a $500,000 home than to invest in the market, I would’ve bought the house already.
That exercise had to happen in order to set us up to ask this:
When does it make sense to buy?
I introduce you to Kristy Shen’s Rule of 150:
“Since the extra ownership costs are approximately equal to the interest of a typical mortgage over [nine] years, and the interest is approximately 50% of your mortgage payment during that time, you have to multiply your monthly mortgage payment by 150%. This is how much your home will actually cost per month, once all expenses are factored in. If that Rule of 150 monthly cost is higher than your rent, then it makes sense to rent. If it’s lower, then it makes sense to buy.” (Quit Like a Millionaire)
Let’s see if our example checks out. What was our cost breakdown over a 13-year window, excluding closing costs and major renovations?
$190,000 on insurance, taxes, and maintenance (the “extras”)
$343,891 on our principal and interest (the “main course”)
$190,000 ÷ $343,891 = 55%. So in our case, our “extras” accounted for 55% of our “main course,” the mortgage monthly payment.
Taking your mortgage monthly payment and multiplying it by 1.55 would’ve given you the total, all-in cost that accounted for insurance, taxes, and maintenance.
(That’s not including our down payment of $100,000.)
Let’s take the average between Kristy’s number (1.5x multiplier) and the number we found today (1.55x multiplier) and say the magic number is 1.53x.
Calculate your monthly payment on a mortgage you could get, and multiply it by 1.53. If your rent is more than that number, it makes sense to buy (assuming you have the down payment). If your rent is less, it makes sense to rent.
For example:
If we wanted to buy a home that costs $500,000, put 20% down and mortgage the remaining 80%, our payment is $2,300 per month. Unless our rent for something comparable currently exceeds $3,519 ($2,300 * 1.53), it makes more sense to keep renting.
If your rent for something comparable is, say, $3,520, and you could own that same piece of property for $500,000 (and you can’t fathom living in anything that costs less than half a million dollars), then it makes more sense to buy than to keep renting.
I was curious what a Zillow search had to say about this.
I didn’t go deep into detail, but I was curious what rent is like on $500,000 homes near me. So I did a little digging:
I found a $495,000 3BR home in the M Streets down the street from me.
The estimated payment for principal and interest after putting 20% down? $2,545 per month.
In order for buying this home instead of renting it to make sense, we apply our 1.53x rule:
$2,545 * 1.53 = $3,893. If it costs more than $3,893 to rent this home, it would make sense to buy it instead. So how much does Zillow estimate it would cost to rent this home?
$2,514 is the rental “Zestimate.” That gives us quite a bit of breathing room before we hit our upper limit, $3,893.
In fact, this example (on this home that was on the market for two hours when I found it) is hilarious because the rental cost is lower than the monthly all-in to own it. It begs the question: Why would someone buy this home instead of putting their $100,000 down payment in the market (and investing the $300 difference in the monthly cost)?
We’ve already seen that even in hot markets like Dallas, the appreciation can’t come anywhere close to beating the returns the stock market can offer once you factor in the full picture of costs. And in this case, hilariously, you can still live in the same f***ing house! And invest for hundreds of thousands of dollars in profit!
It’s not like I’m suggesting starting your family of 5 in a studio apartment: Just run the numbers and see if owning or renting a home makes more sense in your market. Even if you’re going to come out with a net loss, you might be OK with that if you’re really interested in long-term stability. Not every decision has to make financial sense—but you should know that it doesn’t before you sign on the dotted line for a mortgage loan whose name loosely translates to “death pact.”
If you’re stressing out about getting a down payment for a house because you can’t imagine renting for any longer… don’t. In many cases, it’ll be more cost-effective for you to rent that home anyway and invest instead. You get all the perks with very limited downside, as long as you’re not in an area where rents have a history of double-digit annual hikes. (Again, the last 24 months have been the exception, not the rule.)
This article should show you (step by step) how to calculate these same numbers for yourself based on (a) where you’re renting or considering buying, (b) how much you’re spending currently, and (c) the cost of the home you want to buy.
As one of my favorite personal finance accounts on Instagram put it:
Renting conservatively > Buying luxuriously
Renting luxuriously < Buying conservatively
Buying a small 2BR home that’s well within your means will end up being better in the long run if you’re currently renting the penthouse at the W downtown. The problem is that most people don’t go from the penthouse to the tiny home—they go from the 1BR apartment to the 3BR home.
I think this Arrested Development clip says it best:
How to buy a home if you’ve decided you need to
I understand wanting stability for the sake of your children. I lived in the same home my entire life for the 18 years before I went to college, and my parents sold it around the time I turned 25.
The key to buying a home—even when you recognize it’s going to be a less optimal path than renting and investing—is buying something that you can comfortably afford.
My definition of “comfortably afford” and your lender’s definition of “comfortably afford” are probably pretty different, because I don’t stand to make a percentage cut on your purchase (unlike your lender). In other words, this advice is mathematical and unbiased in nature. I have your best interest at heart and stand nothing to gain from your decision.
What’s “comfortably afford” mean, mathematically?
If your 20% down payment represents less than 25% of your total net worth and the total monthly payments (mortgage, taxes, insurance, interest, maintenance) represent less than 25% of your take-home pay every month, you can comfortably afford it.
For example, in our $500,000 home example above, you’d need to have $400,000 in assets total, so after your $100,000 down payment, you’d still have $300,000 left over.
Knowing that your all-in monthly payment costs are about $3,500, you’d have to be making at least $14,000 per month after taxes in order to be considered “comfortably” affording that payment.
On the other hand, there’s nothing comfortable about draining your savings account for the down payment and spending half your income every month on your monthly payments (and as you can see from the prior hour of your life you spent reading this, there’s almost no point—it’s not likely to end up a good investment anyway).
