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Where you live may be the most important decision you make. It not only allows you to have the lifestyle you want, but it can be a valuable retirement vehicle. On this page, we discuss the pitfalls of renting, the pride of ownership, and - the holy grail of wealth - owning with no debt.
When you rent a home, you have no stake in its upkeep. You pay to live there until you pay to live somewhere else. The landlord cares about the place. He must maintain it so that the next occupant will want to rent it. Meanwhile, you live there nicking the walls (you didn't mean to), staining the carpet (it was just an accident), and in general not caring. The landlord must be compensated for all this. There is the mortgage, repairs, depreciation, occasional vacancies, time spent, and just plain worrying. Who pays for this? You!
Let's do a numerical example. The landlord buys a home for $100,000 with an 8%, 30 year mortgage. He pays $734 per month on the loan. Add $100 for taxes, $100 for upkeep, and $100 for profit (otherwise, he would be better off working for minimum wage). He needs $1034 per month from the renter. Assuming that the average year has the home vacant for a month, he now needs $1128 per month. When you pay this, it is gone forever. If only you could keep this money. You would save $13,536 each year!
Now consider buying this home yourself. You pay the mortgage company $734 plus $100 for taxes, only $834 per month. You could pay $100 per month for upkeep, but if you take pride in your wonderful home, not much will break. Also, you do not always need to call the plumber. Visit the hardware store. What about the landlord's $100 profit? Keep it for yourself. Mortgage interest is tax deductible. This means that the government gives you back $187 ($100,000x8%x0.28 tax bracket/12 months). Your net outlay is $747 per month at worst, a savings of $381 over renting.
It sounds so simple! Why in the world does anybody rent? Allow me to suggest a few legitimate possibilities:
Please click on the above reasons (excuses) to see why you should try to own, anyway. If you are already convinced, keep reading.
Now that you have decided to buy a home, what kind of home would you like? There are three basic choices:
Once you make your selection, you should realize that whatever it is, you will eventually change your mind and trade it in on another home. For example, someone may buy a condominium, decide that it is too small, then buy a townhouse. Later, having children may dictate buying a small single family home, then a large single family home. Finally, with the children grown and gone, people may opt for a condominium again. There are five transactions here, and each one costs money.
To simplify our understanding of the cost of these transactions, let us assume that the cost of buying is about 6% of the price. This represents 3% for the points on the loan and 3% for taxes. Similarly, the cost of selling is 6%, the price of the real estate agent. Suppose you anticipate the following purchases. They will cost:
From the above table, we see that it costs $6000 to escape apartment rent and $93,000 to satisfy changing lifestyles. How can you get rich by throwing this kind of money away?
Let us try to mitigate that above waste. The cheap solution is to buy the condominium and stay there forever. Not appealing. A better solution is to skip some of these interim homes. Instead of the condominium, stretch your savings a bit and buy the townhouse. When the time is right, buy the large single family home. Make sure it is a rambler, so that you will not need to walk steps when you retire. This has a total cost of $36,000. You save $63,000.
Another way of phrasing the above strategy is to buy the most expensive home that you can afford. You may not need it now, but you probably will later. That will save you the expense of selling it.
Congratulations! You are now the proud owner of a wonderful home. You are painting and decorating it to rapidly turn it into your dream home. But wait! You have a 30 year mortgage. You must make monthly payments until the year 2027. What have you done to yourself?
Do not panic. In an apartment, you would have paid forever. You are now paying less than you would if you rented the place. But 30 years is a long time. What can be done to shorten it?
If you feel you can afford it, you should try to make prepayments on your debt whenever you can. As of this writing, the typical bank account pays 3% interest. If you have as much as $10,000, a treasury bill pays 5.5%. But an 8% mortgage paid down is like getting 8% interest. You do not receive the interest, but it is always there. You can refinance your loan or get a second mortgage and get your money back. There is some cost involved in this, but it beats a risky investment or some other investment in which you are not allowed to cash in for several years.
Types of Homes
Buying and Selling
Type of Home Purchase Cost to Cost to Total Cost
Price Buy Sell to Buy
Condominium $100,000 $6,000 $6,000 $6,000
Townhouse $150,000 $9,000 $9,000 $15,000
Small single family home $200,000 $12,000 $12,000 $21,000
Large single family home $300,000 $18,000 $18,000 $30,000
Luxury Condominium $150,000 $9,000 $9,000 $27,000
$99,000
Table 1. The costs of buying and selling homes
Paying off the Mortgage
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