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“Who said that you should buy a
house?”
How many times have you heard that? Turns out that
could be a very bad advice. Here is why:
Every
year, thousands of Americans jump into homeownership for the wrong
reason, usually pressure from friends or family. It turns out that a
lot of them could actually save money by renting. As the Wall
Street Journal wrote in a 2001 article, “Contrary to popular
opinion, renting can often be the better alternative, especially if
there’s a chance you’ll stay put less than five years.” There are
many good reasons to buy a house, but most of them are not
financial. The investment potential and the tax savings associated
with homeownership are often overstated, while the costs of
homeownership are frequently understated. Instead of feeling
pressured to buy, you should choose the
housing that best suits your
lifestyle. If you value convenience, amenities, flexibility and
superior
locations, you probably ought to
rent.
Here are 9 myths on
buying vs. renting
MYTH# 1: I’ll reduce my tax bill
if I buy a house.
The
biggest homeownership myth in the country is that owning a house is
a huge tax break. If your mortgage interest and other qualifying
expenses aren’t more than the standard deduction ($9,500 for
joint filers, $4,750 for singles in 2003), there is no tax
advantage to owning. That’s one reason why only 34% of all taxpayers
itemize. Even if you are able to deduct your mortgage interest and
property taxes, remember that depending on your tax bracket, you are
still only saving no more than 10 cents to 35 cents in taxes for
every dollar you pay in mortgage interest. |
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Reality Check:
Assume you buy a $200,000 house with a 5% down-payment at a 6%
interest rate. Your total net tax savings, assuming you are in
the 28% tax bracket, is a mere $514. That’s right. You will be
able to deduct $11,336 in mortgage interest, but you would have
gotten a $9,500 standard deduction without buying. So your tax
savings are $11,336 minus $9,500 times 28% tax rate, which
equals $514. Once you factor in your maintenance and repair
expenses, your tax savings could quickly disappear. Maintenance
costs often run between 1% and 2% of your house’s value
annually, depending on the house’s age (See Myth# 3).
Assuming a conservative 1% maintenance cost, you may have to
spend $2,000 to save $514 in taxes.
Reality: A majority of owners reap no annual tax benefits
from owning a house.
MYTH# 2: Paying
rent is throwing away money. I could be building equity.
During
the first five years, more than 80% of your monthly mortgage
payment is interest. And nearly one third of all homeowners move
within five years, before they start building any real equity. Add
in the money they spent during that time on maintenance, taxes,
insurance and the costs to buy and sell their house, and most
would have saved money by renting.
Reality Check:
Assume you buy a $200,000 house with a 5% down-payment at a 6%
interest rate. After five years of mortgage payments, you will
have paid $55,152 in interest and only $13,196 in principal. In
addition, you will likely have paid between $10,000 and $20,000
in maintenance and repair (see Myth# 3) to earn that
equity. Chances are you could earn more than this in a number of
investments that are more diversified and less risky than
putting all of your eggs in one basket.
Reality: For the first five years of ownership, you are
simply giving away money to the bank.
MYTH# 3: My
mortgage payment will be less than my rent.
Few
prospective owners truly appreciate how expensive annual
maintenance on a house can be. A Wall Street Journal
commissioned study concluded that “almost every house, no matter
how recently or expertly built, is a money pit.”
On average, you should expect to
spend 1% to 2% of your house’s value annually on maintenance.
For a $200,000 house, that means $2,000 to $4,000 a year for
maintenance. And that doesn’t include property taxes, homeowner’s
insurance or any home improvement, decorating or landscaping you
decide to do. Owning also requires a different kind of budgeting
discipline. You need to be prepared for the unexpected, like the
furnace that needs to be replaced, the roof that needs to be fixed
or the leaking basement. Renters, on the other hand, have the
convenience of knowing exactly how much their housing is going to
cost them each month.
Reality Check:
Writing of her experiences as a new homeowner, one columnist
said, “Taking care of your humble abode can be so time-consuming
that the American dream can turn into a nightmare.” “I’ve been a
homeowner for only six months, and already I’ve spent thousands
of dollars beyond my closing costs and down-payment...but most
of the expenses, unfortunately, I won’t ever recoup.”
Reality: Your mortgage payment is just the beginning. The
“hidden costs” of ownership can add up to thousands of dollars
a year.
MYTH# 4: As an
owner, my housing costs will stay constant. I won’t have to worry
about rent increases.
Your
mortgage payment is just part of your housing cost as an owner.
You also have to factor in the cost of property taxes and
homeowners insurance, both of which have been rising significantly
in recent years. Homeowners saw annual property tax hikes
averaging 4-5% — for a total increase of 18% — between 1997 and
2001. And homeowners insurance rose 7% in 2003 and is
expected to increase another 8% in 2004. Since 1999, average
premiums have skyrocketed 26%. And if you have an
adjustable-rate mortgage, your costs will rise if interest rates
go up.
Reality: Only your mortgage payment will remain constant.
Other costs can go up every year. And if you have an adjustable
rate mortgage, your monthly payment can rise too.
MYTH# 5: Investing
in a house is a safe investment.
House
prices are not a one-way escalator going up. They can also go
down. Predicting whether a specific house in a specific market
will appreciate is very difficult. As financial columnist Jane
Bryant Quinn noted, “any single (house) sale is as much a lottery
as trading stock is”. If prices do fall even slightly and
you have taken out a low- or no-down-payment mortgage, you could
find yourself owing more on your house than it is worth. Plus,
experience suggests that even in a booming housing market, you’d
probably earn more on your money in stocks than in
real estate. According to the
editors of SmartMoney magazine, “compared with the average
share prices or even bond returns, house prices plod up at a very
slow rate: since 1979, about 4.4% a year. If you can’t do better
than that in the stock market, you need to fire your broker.”
In 2001, Harvard University’s Joint
Center for Housing Studies found that “in many places at many
times, and for many holding periods during the past 15 years,
renting made better financial
sense than owning.”
Reality Check:
“In
short, this investment (homeownership) is not a slam dunk. For
decent returns on any home, you need either stupendous luck or a
holding period long enough to amortize your many costs.”
Reality: There are very few risk-free investments and a
house is certainly not one of them.
MYTH# 6: I can’t
afford not to buy with these low interest rates.
It
sounds counterintuitive, but low interest rates can actually make
housing more expensive, not more
affordable. How? Well, if low rates bring a lot of new buyers into
the market, housing can turn into a seller’s market. Now that
there are more prospective buyers competing for the same houses,
sellers can demand higher prices. So, interest rates may be low,
but they haven’t made housing more affordable if they have also
pushed up sales prices. Plus, if interest rates increase, the
seller’s market could quickly turn into a buyer’s market. If you
paid the peak prices commanded during the seller’s market, you
could find yourself having to sell your house for less than you
paid for it if higher rates reduce the number of prospective
buyers. The lesson here is that while interest rates matter, you
should not feel compelled to buy just because they are low. You
may be overpaying for that house just to lock in a low rate.
Reality:
Low interest rates may actually serve to
make buying more expensive.
MYTH# 7: I know
I’ll make money on my house because I plan to stay there at least
five years.
Most
people who buy a house plan to stay there for a long time, but
many end up moving sooner than planned for job and personal
reasons. Short-term homeownership can be a costly proposition. The
cost of a round trip into and out of homeownership can be as much
as 10% of a house’s sale price. If you move in a few years, those
costs could easily exceed whatever equity and appreciation you’ve
realized. In a worst-case scenario, you might have to write a
check in order to sell your house. Or you could find yourself
needing to either sell your house at a loss or forego a superior
job opportunity elsewhere.
Reality Check:
According to one research report, buyers who sold within four
years paid, on average, 19% more as owners than they would have
paid as renters. If you think there is any chance you may be
moving again within the next several years, renting deserves
serious consideration.
Reality:
Nearly one third of all homeowners
move within five years and many end up losing money.
MYTH# 8: Buying a
house will force me to save and help build a nest egg for
retirement.
Mortgages can work like a forced savings program. Instead of
paying rent, you pay your mortgage and build up equity, assuming
you stay long enough to cover the costs of buying, maintaining and
then selling the house. But remember, nearly one third of all
owners move within five years, before they start building any real
equity. But even if you stay, is this really a wise investment
strategy? First, it’s risky. It’s like putting all your wealth in
a single stock. Second, over time, you are likely to earn a better
return in the stock market (See Myth# 5). The editors of
SmartMoney magazine came to the same conclusion in a February
2002 article. They wrote, “For most of us, building wealth with
our residence is a slow and inefficient process — if it works at
all. It’s especially hard in this era of low inflation, simply
because the underlying asset, your home, typically doesn’t
appreciate very quickly… The fact is, when it comes to outsized
returns, equities win walking away.”
Reality Check:
“Forget what your friends say. Owning a home is hardly the best
way to save for retirement. How do we know? We ran the numbers.”
Reality:
This is a risky and unwise investment
strategy.
MYTH# 9: I know
buying is better for me because I used an online “Rent vs. Buy”
calculator.
An
economic analysis of the leading calculators found numerous
problems. Some fail to include basic costs like maintenance,
insurance or property taxes. Others leave out the transaction
costs of buying and selling a house. Almost all of them assume you
will itemize your tax deductions, when only 34% of all taxpayers
actually do. Most do not factor in the returns you could earn by
investing your savings instead of using it as a down-payment. The
end result is that consumers who rely on these tools may make one
of the most important decisions of their lives based on misleading
data.
Reality: Most of these calculators are overly simplified
and seriously flawed.
RENTING IS THE WAY TO GO
RENTING IS EASIER.
Apartments offer maintenance-free, hassle-free living.
RENTING IS MORE FLEXIBLE.
When
you rent, you can relocate for job opportunities without incurring
the cost of selling a house.
RENTING IS LESS RISKY.
When
you rent, instead of tying all your wealth up in a single
investment, you can invest in a variety of stocks, bonds and
mutual funds. In fact, you can still invest in real estate through
Real Estate Investment Trusts (REIT), either individually or in
REIT mutual funds.
APARTMENTS
OFFER A LIFESTYLE ALTERNATIVE.
Today’s
apartments offer amenity packages that rival — and often surpass —
single-family houses as well as access to new technologies that
may be unaffordable in single-family houses.
Apartments often are located in
neighborhoods with convenient access to transportation,
employment, retail and entertainment.
RENTING OPENS DOORS..
Renting
allows you to use your “down-payment money” for other investments,
to start a small business, to travel, or even to change careers. |
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