We need to talk. More specifically, we need to talk about one of the most common myths I see making its way around the personal finance world. That myth is:
“Renting is throwing away money.”
Multiple times per week I hear from people who want to buy a home because they’re worried they’re throwing away money by renting. Maybe they heard this from their parents, or maybe it was strangers on the internet.
In this article, I want to clear up that misconception by showing you how renting is definitely not throwing away money.
Is Renting Throwing Away Money?
Why people say that renting is throwing away money
Before I talk about why renting is definitely not throwing away money, let’s cover the reasons why people think this is the case.
1. Your mortgage payment builds equity in your home
Every month when you pay your mortgage, a portion of your payment goes toward your principal, meaning the amount you initially borrowed.
Your equity is the difference between your home’s value and the principal you still owe on your mortgage. And so as you pay down your principal, your equity in the home increases.
2. Homeowners benefit from rising home values
The real estate market may ebb and flow, but home values generally increase over time. As a result, many homeowners are able to sell their homes for more than they paid for them, resulting in a capital gain.
I’m not going to argue the validity of either of these statements. It’s absolutely true that paying your mortgage builds equity in your home and that your home’s value is likely to rise over the years. But in the next couple of sections, we’ll talk about why those things don’t matter as much as you might think.
The return on investment of homeownership
It’s true that home values have consistently increased over the years. Since 1940, home values have increased an average of 5.5% per year.
Depending on your investing experience, you might think 5.5% sounds pretty good. But what about when you compare it to other investments?
According to the Securities and Exchange Commission, the stock market sees an average annual return of about 10% per year. That’s nearly twice as much as the increase in value of a home.
So just how different are those percentages?
Let’s say you invested $100 per month for 30 years into an investment with a 5.5% annual return. After 30 years, you’d have more than $87,000.
But if you had invested that same $100 per month into an investment a 10% return? Because of compound interest, you’d end up with just shy of $200,000 — more than twice the return on a 5.5% investment.
It’s also important to note that the amount you pay for a house is far from the only investment you make into it. When you account for all the other expenses, it’s likely your returns from the increase in value are completely wiped out.
Let’s do the math: Renting vs. buying
It’s easy to think you’re throwing away money by renting because the money you pay each month doesn’t build equity in your home. But let’s look at an example that might change your mind.
Closing costs aren’t an ongoing expense of homeownership, but they make up a substantial cost in the first year. Closing costs run between 1% and 3% of the home’s purchase price. For a home priced at $335,000, your closing costs would be $3,350.
Let’s say you rent an apartment for $1,500 per month. You’re sick of throwing away money renting, so you buy that $335,000 home with the monthly mortgage payment of $1,500.
But that entire $1,500 doesn’t build equity in your home. In fact, in the early years of homeownership, most of your monthly payment goes toward interest. If you have an interest rate of 3.5%, then about $11,622 of your payment goes toward interest in the first year.
Note: I found these numbers using Bankrate’s mortgage amortization calculator for a mortgage of $335,000 and an interest rate of 3.5%.
Next, let’s talk about property taxes. Rates vary depending on where you live. But according to the U.S. Census Bureau, the average household spends about $2,471 on property taxes each year. We’ll use that for the purposes of this example.
Another ongoing cost of homeownership is homeowners insurance. The cost will vary depending on where you live, the size of your home, how much coverage you want, and many more factors. According to ValuePenguin, the average cost of homeowners insurance is $1,445 per year.
Finally, let’s talk about home maintenance. As a homeowner, you’re responsible for any repairs that need to be done. There’s no more landlord to call.
Unfortunately, it’s impossible to predict how much you’ll spend on maintenance each year. However, experts recommend planning for about 1% of the cost of your home. On your $335,000 home, you could expect to spend $3,335.
Renting vs. buying: What’s the verdict?
People like to argue that renting is throwing away money. But as you can see, there are many expenses of homeownership that don’t build your equity in the home. Let’s compare how much money you throw away renting versus in your first year of homeownership.
As you can see, you “throw away” significantly more in your first year of homeownership than you would renting. And sure, closing costs are a one-time cost rather than an ongoing one. But even if you eliminate that cost, you still throw away more money per year owning a home than you do renting.
Owning a home vs. real estate investing
None of this is to say that you can’t make money from real estate investing. In fact, It’s important real estate can be incredibly profitable. But your primary home is not an investment property.
When you purchase an investment property, the increasing home value isn’t really where you make your money. You make your money by renting out the property and bringing in passive income each month.
Is renting better than buying?
You might be reading this article and think that I’m saying homeownership is a bad idea or a waste of money. But that’s not remotely true. In fact, my husband and I are saving for a home right now.
We want to own a home because we love our community, and we want to become a more permanent part of it. We want a space that’s truly ours. We want a yard where our dog can run around and where we can entertain friends.
There are also many reasons I love renting a home. I love that I don’t have to mow the lawn in the summer or shovel the snow in the winter. I love that if an appliance breaks down, my landlord replaces it. I love that if I want to move, I can do so with very little notice, because I don’t have to sell a house first.
There are many great reasons to own a home, and there are many great reasons to rent. But the benefits of homeownership aren’t financial.
We’ve all heard the financial myth that renting is throwing away money. And while there are many great reasons to own a home, thinking that you’re saving money isn’t one of them. In fact, as we figured about above, you actually throw away a lot more money by owning a home.
The good news is that you can make the right choice for yourself, regardless of what your parents or society told you.