Should I Buy A Home? Part 3: Consequences
Continued from Part 1: Preparation and Part 2: Process
This is about the long term consequences of the decision to buy or not to buy a home, and economic benefits analysis into whether you should want to buy. In order to answer the question of whether it's better to buy or rent and invest the difference, you need to compare the costs and benefits of owning to the costs and benefits of renting over a comparable time frame. If you know you're moving in three years or less, it can be hard to come out ahead, just due to transaction costs. On the other hand, if you've got the wherewithal to turn it into a rental property after any future move you already know you're going to make, that can make the owning calculation move decisively in favor of owning. Be advised, all the headaches of being a landlord are greatly magnified if you're not within easy commuting distance to keep an eye on the property yourself. Also, if you cannot achieve positive cash flow on a rental property, odds are good that you should sell it. This isn't a blanket recommendation, just a rule of thumb.
Now it happens that I've programmed a spreadsheet to answer the "buy or rent" question in a time dependent manner, which is the only way it really can be answered. I keep using a $300,000 home and $270,000 loan as my default assumptions here. I'm going to pull a few more assumptions out of my hat, but I'm going to do my best to make them reasonable assumptions. 6.25 first trust deed, 10% second for any loan amount over 80 percent of value. Five percent annual property appreciation (perhaps a tad low in the long term), 1.2% yearly property tax (marginally above the basic assessment for most California properties), yearly tax increases of two percent (Prop 13's legal maximum in California), non-deductible homeowner's expenses of $200 per month, 4 percent inflation, $1500 in non-housing deductions on Schedule A of your federal taxes, marginal tax rate of twenty-eight percent, and a return net of taxes on any alternative investment with the same money of ten percent. I also assume you're married (That makes a difference on how much your default deduction is).
Since state and local income taxes are different everywhere, I'm going to neglect those. They would functionally move the equation in favor of home ownership, but the effects are relatively minor in most cases. Furthermore, because investments are only worth your net proceeds after you actually sell them, I'm going to deduct seven percent of the theoretical market price of your home investment in any given year before I compare the net benefit of buying a home to renting and investing any money you didn't spend on buying. This is questionable to be sure, as most people will just spend at least a certain percentage, but I'm in the mood to be generous. You'll see why in a moment.
I'm also going to assume here, very unrealistically, that you never refinance, but that's actually a middle of the road assumption, as far as net benefit goes. The actual spreadsheet works a couple of other assumptions, and refinancing every five years and making a minimum payment usually comes out better, while refinancing every five years and keeping a thirty year payoff goal usually comes out worse.
Here are the net results:
Year 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30 | Value $300,000.00 $315,000.00 $330,750.00 $347,287.50 $364,651.88 $382,884.47 $402,028.69 $422,130.13 $443,236.63 $465,398.46 $488,668.39 $513,101.81 $538,756.90 $565,694.74 $593,979.48 $623,678.45 $654,862.38 $687,605.50 $721,985.77 $758,085.06 $795,989.31 $835,788.78 $877,578.22 $921,457.13 $967,529.98 $1,015,906.48 $1,066,701.81 $1,120,036.90 $1,176,038.74 $1,234,840.68 | Monthly Rent $1,900.00 $1,976.00 $2,055.04 $2,137.24 $2,222.73 $2,311.64 $2,404.11 $2,500.27 $2,600.28 $2,704.29 $2,812.46 $2,924.96 $3,041.96 $3,163.64 $3,290.19 $3,421.79 $3,558.66 $3,701.01 $3,849.05 $4,003.01 $4,163.13 $4,329.66 $4,502.85 $4,682.96 $4,870.28 $5,065.09 $5,267.69 $5,478.40 $5,697.54 $5,925.44 | Equity 30,000.00 47,979.07 66,906.50 86,833.25 107,813.09 129,902.79 153,162.25 177,654.70 203,446.90 230,609.35 259,216.47 289,346.90 321,083.67 354,514.53 389,732.17 426,834.57 465,925.28 507,113.76 550,515.76 596,253.68 644,456.99 695,262.65 748,815.58 805,269.15 864,785.74 927,537.24 993,705.71 1,063,483.99 1,137,076.39 1,214,699.45 | Net Benefit -21,000.00 -7,516.04 7,147.46 23,091.84 40,427.33 59,273.84 79,761.82 102,033.27 126,242.72 152,558.43 181,163.62 212,257.85 246,058.50 282,802.46 322,747.86 366,176.10 413,393.96 464,735.97 520,801.42 582,152.57 649,284.52 722,739.36 803,110.70 891,048.67 987,265.32 1,092,540.71 1,207,729.42 1,333,767.79 1,471,681.92 1,622,596.32 |
Yes, after 30 years you are $552,000 better off from having bought a $300,000 home, as opposed to continuing to rent for that whole period. Not to mention that you own it free and clear for the cost of maintenance plus property taxes, as opposed to paying over $4600 per month rent.
This is a fascinating study in leverage. If, on the other hand, taxes start out at 2 percent and rise by 4 percent per year, the peak year in absolute terms is year 22, at $101,964 net benefit. On the other hand, I'm running rent increases at exactly the general rate of inflation and they almost always go up faster. Back to the first hand, resetting variables in the last set of suppositions to default and changing the appreciation rate to approximately like the long term average - 7 percent - while making a net return of 8.5 percent on investments bumps the net benefits of buying that home to $1,630,195.38. Five and a half times the original purchase price!
One more scenario: Restore to default values. Say you lose $30,000 of value, or ten percent of purchase price, in the first year. It does take longer to be ahead of the game - more than 6 years - and the net benefit after 30 years (as opposed to investing the money at an assumed return of 10%) is "only" $437,223.05. For the mathematically challenged, this is still nearly one and a half times the original value of the property! Yes, the money will be worth less in thirty years. We all know about inflation. Would you turn me down if I offered to give you $437,000 in thirty years time?
I've been playing with this spreadsheet for quite a while now. Under the basic assumptions I've listed above, it's kind of hard to be ahead of the game by buying a house instead of investing in the stock market after less than two years under any kind of reasonably average assumptions. On the other hand, it's very difficult not to be ahead after five to seven, and way ahead after ten.
After thirty years, most sets of even vaguely reasonable assumptions have you so far ahead by buying the home that if you didn't watch over my shoulder as I built the spreadsheet, a reasonable person would be skeptical. Heck, I knew which calculation the numbers favored, but I really never stopped to think how strongly they worked in favor of home ownership. It is difficult to come up with a reasonable set of assumptions and starting numbers where you aren't ahead by significantly more than the original purchase price of the home. Yes, we're all aware of the issues with inflation, and the ratio illustrated here, with a 4 percent rate of inflation, is a little more than three to one (which remembering the rule of 115, seems reasonable, so the first approximation check validates this). So what this means is that by purchasing a $300,000 house that you're going to live in for the rest of your life now, you're adding more than $100,000 in today's dollars to your net worth in thirty years if you just invested the difference between rent and the costs of owning. Actually, it's usually more. That safe, conservative, middle of the road $552,000 net result after thirty years from the first example converts to more than $177,000 in today's money! No flipping, no games, no wild schemes, no re-zoning jackpots and no wealthy benefactors to come along and pay you twice what it's worth. In fact, in this scenario you never talk to another real estate or loan person as long as you live, and you've still effectively "gifted" yourself with almost sixty percent of the property's purchase price immediately upon taking possession.
This should persuade most folks that they should want to buy a home, and that you don't want anyone else to. After all, the more poor schmoes there are, the better this will work for the rest of us. Actually, that last crack about poor schmoes isn't true, because the law of supply and demand is always in effect. But is shows how good for the overall economic health of the nation encouraging home ownership is.
Caveat Emptor
Original here
Categories
Buying and SellingThe Book on Mortgages Everyone Should Have
What Consumers Need To Know About Mortgages
The Book on Buying Real Estate Everyone Should Have
What Consumers Need To Know About Buying Real Estate
Buy My Science Fiction and Fantasy Novels!
Dan Melson Amazon Author Page
Dan Melson Author Page Books2Read
Links to free samples here
The Man From Empire
Man From Empire Books2Read link
A Guardian From Earth
Guardian From Earth Books2Read link
Empire and Earth
Empire and Earth Books2Read link
Working The Trenches
Working the Trenches Books2Read link
Rediscovery 4 novel set
Rediscovery 4 novel set Books2Read link
Preparing The Ground
Preparing the Ground Books2Read link
Building the People
Building the People Books2Read link
Setting The Board
Setting The Board Books2Read link
Moving The Pieces
Moving The Pieces Books2Read link
The Invention of Motherhood
Invention of Motherhood Books2Read link
The Price of Power
Price of Power Books2Read link
The End Of Childhood
The End of Childhood Books2Read link
Measure Of Adulthood
Measure Of Adulthood Books2Read link
The Fountains of Aescalon
The Fountains of Aescalon Books2Read link
The Monad Trap
The Monad Trap Books2Read link
The Gates To Faerie
The Gates To Faerie Books2Read link
Gifts Of The Mother
Gifts Of The Mother Books2Read link
C'mon! I need to pay for this website! If you want to buy or sell Real Estate in San Diego County, or get a loan anywhere in California, contact me! I cover San Diego County in person and all of California via internet, phone, fax, and overnight mail. If you want a loan or need a real estate agent
Professional Contact Information
Questions regarding this website:
dm (at) searchlight crusade (dot) net
(Eliminate the spaces and change parentheticals to the symbols, of course)
Essay Requests
If you don't see an answer to your question, please consider asking me via email. I'll bet money you're not the only one who wants to know!
Requests for reprint rights, same email: dm (at) searchlight crusade (dot) net!
Add this site to Technorati Favorites
Subscribe to Searchlight Crusade
My Links
-
Heavy Lifters
- Instapundit
- Hot Air
- Wizbang
- Victor Davis Hanson
- Q and O L Places I get to as often as I can
- Soldier's Angels
- The Anchoress
- Argghhh!
- Armies of Liberation R
- Asymmetrical Information
- Belmont Club
- Tim Blair
- Eject! Eject! Eject!
- Jihad Watch
- Michelle Malkin
- Neo-neocon
- Powerline
- Protein Wisdom
- Real Clear Politics
- Mark Steyn
- Strategy Page
- Vodkapundit
- Volokh Conspiracy Personal Finance, Economics and Business Sites
- Bloodhound Blog
- Financial Rounds
- Free Money Financea> Other sites I've linked and visit
- Ace of Spades
- Ann Althouse
- The Anti Idiotarian Rottweiler
- Atlas Shrugs
- Professor Bainbridge
- Baldilocks
- Beldar
- Blackfive
- Classical Values
- Coyote Blog
- Daily Pundit
- Drudge Report
- IMAO
- The Jawa Report
- Just One Minute
- Libertarian Leanings
- Liberty Papers
- Normblog
- Patterico's Pontifications
- Right Wing Nut House
- Samizdata
- SCOTUS Blog
- Stop the ACLU
- Unalienable Right Consumer and Research Sites
- Better Business Bureau
- Consumer Reports
- NASD Home
- California Department of Real Estate
- California Licensee Lookup
- California Department of Insurance
- National Association of Insurance Commissioners (NAIC)
- Do Not Call Homepage
- IRS Charities Search
- Internet Fraud Complaint Center
- SEC Home Page
- Stop Mortgage Fraud
- Report Mortgage Fraud Debunking Many so-called Real Estate Gurus
- John T. Reed Worthwhile Web Comics
- Sluggy Freelance
- Day by Day It is site policy to list the main page of every site I reference. Sometimes the real world intervenes and I haven't gotten to it yet, or one falls through the cracks on a long post with multiple references. It is also site policy to list the main page of every site that lists this one on their equivalent roll, as well as the main page of all sites that are members of any of the same groups this site is a member of. Please send me an email with a link to the main page of your site if I've overlooked you (dm at the domain name). For the clue-challenged, note that it is a requirement for your link to appear on every page of your site, just like mine does, and I will not link to spam sites.
Logical failures (straw man, ad hominem, red herring, etcetera) will be pointed out - and I hope you'll point out any such errors I make as well. If there's something you don't understand, ask.
Nonetheless, the idea of comments should be constructive. Aim them at the issue, not the individual. Consider it a challenge to make your criticism constructive. Try to be respectful. Those who make a habit of trollish behavior will be banned.
Leave a comment