4 ms·

Well, the 'myth' has merit. Let's apply common sense. You buy a smallish house in a suburb and pay $1000/month for you mortgage. $900 of that goes directly t

Well, the 'myth' has merit. Let's apply common sense. You buy a smallish house in a suburb and pay $1000/month for you mortgage. $900 of that goes directly to equity. At the end of the year, if you home retains its value, you have over $10,000 in equity. If you pay the same amount for rent, you have nothing to show for it. And oftentimes rent for an equivalent house is actually more than the mortgage + tax payments. So, which is better $10,000 or $0? The volatility of the last few years has complicated this a bit (people going underwater, for example), and I don't think people should see a home as a vehicle for getting rich, but it is generally a nice value store. Plus, there are HUGE advantages for people invested in the area to own their property. It is more stable for them (they can't be kicked out), they are more likely to invest in the value of their area (volunteerism, making sure local politicians take care of the parks, reporting crime, that kind of thing). Edit: Let me point out that yes, these numbers are made up and don't accurately reflect reality. I did not use a mortgage calculator or anything (I thought that would be obvious) but the underlying idea that I was trying to convey holds....if you are spending x dollars and are able to store any portion of that in something that holds some value it is better than spending x dollars and not storing any of that value. So, even if only $10 of every $1000 spent on the mortgage goes into equity, it is better than $0 if you rent.

pnut 13y ago
Have you ever actually had a mortgage? The majority of your mortgage payment goes directly to interest, NOT equity. Equity contributions only ramp towards the very end of the term. Up front, you are paying mostly interest.
- seandhi 13y ago
  And if you live in a state with high property taxes, like Texas, then your taxes will likely dwarf any principal that you pay at the beginning of your loan.
  - marincounty 13y ago
    It seems like so many people fail to realize how much property taxes can add up too?
- craigyk 13y ago
  On the plus side, just by paying a couple hundred bucks extra a month you can double to triple the amount going into equity at the beginning. Bonus is they send you a check every couple of months as they recalculate how much interest you've headed off at the pass.
adanto6840 13y ago
Although I agree that there are some cases where it [buying] has merit, I can't help but point out what I consider to be a flaw in your math that likely exacerbates the problem. This is especially true IMO for those that are likely far less informed than the HN crowd. Due to how amortization works, it's very unrealistic to assume that with a $1k/mo mortgage payment, that $900 of that is going to equity. In fact, in most cases (standard down payment, 15 or 30 year mortgage, etc.), it'd be closer to the opposite of what you outline, especially at the beginning of the loan term. You can pull up a calculator to see for yourself but typically in the first few years of a new mortgage you'll be paying closer to $900 of that $1k towards INTEREST with the remaining going to principle / money that you may see later assuming home value is indeed retained. That said, I hate paying rent -- but I've also been "burned" a bit on home purchases a couple of times, too! ;-) EDIT - As someone above mentioned, you also have to keep in mind things such as PMI, property taxes & special levies, upkeep, etc...
- aliston 13y ago
  This is part of the problem with the American housing industry. How did it become "normal" to borrow 4/5ths of the value of a home? It didn't used to be that way. If you look at average loan-to-value ratios over the last 40 years, they've consistently gone up. Same with the home value to income ratio. Home prices have appreciated much more quickly that they should have based on fundamentals of the economy, propped up by government incentives, cheap money sloshing around, and an oversized mortgage industry. Ultimately, what we really need is to go back to a system where people can actually afford the homes they live in. The vast majority of Americans, whether they "own" or "rent," are still renters with no real chance of ever actually owning their home outright. If that perception changed, prices would come down, and we'd eventually get back to a system where you could buy a home for 2X your annual income. The problem with a return to a sane system is that it would bury existing homeowners, and we aren't willing to accept the pain in the short run. We need to artificially inflate housing prices in order to allow people to sell their homes, keep the economy functioning etc. So, in short, we're stuck. http://www.doctorhousingbubble.com/wp-content/uploads/2013/02/HouseholdPercentEquityQ32012.jpg http://www.doctorhousingbubble.com/wp-content/uploads/2013/0...
- 13y ago
clarky07 13y ago
I'd love to know where you get your mortgages. 900 of 1000 most certainly does not go to equity unless you are in the last few years. At first it's more like the reverse, and that's not counting pmi (we are talking about low income borrowers, unlikely they put 20% down), house insurance, maintenance, or taxes. Owning a home can be a good thing, but it isn't just easy money and wealth.
jseliger 13y ago
Let's apply common sense. Part of the reason "common sense" doesn't apply to this situation is that a huge number of factors (and costs, and risks) do apply. Maintenance and taxes are going to cost far more than $100 / month. For example: * these numbers don't include a down payment on the mortgage * they don't include transaction costs in either buying or selling * they don't take into account interest on the mortgage versus how much the same money would appreciate if invested in an index fund instead of a house—in other words, the time-value of money. * they don't take into account (and can't) how valuable moving might be; in finances, options are usually valuable because of their flexibility. * they don't include homeowners insurance. In short, "common sense" is anything but. That's why it's dangerous to do simple, back-of-the-envelope calculations about a major decision in the lives of most people.
- foobarqux 13y ago
  Also interest rate risk for ARMs.
- clavalle 13y ago
  I was pulling numbers out of the air for simplicity. But essentially, even if you only bank $10 in equity, $10 is better than $0 you'd bank if you paid rent.
  - glenra 13y ago
    > I was pulling numbers out of the air for simplicity. But essentially, even if you only bank $10 in equity, $10 is better than $0 you'd bank if you paid rent. Heck, then I'll do the same. Let's just pull some new numbers out of the air such that the rent is $20 cheaper than the mortgage payment. Now as a renter you can bank $20 in savings, which is better than the $10 you'd bank in equity if you had a mortgage. Problem solved!
    - clavalle 13y ago
      Ok. But in my area rent is often more than mortgage + taxes. I know it is different in other places but that's why it is a simplifying assumption.
jordanb 13y ago
Your math only works if you're near the end of your mortgage life. At the beginning, nearly every penny of your mortgage payment goes to interest, which is front-loaded. For most Americans, who move around fairly often, they will never come close to paying off a mortgage and the only equity they will ever own will be what they bought with their down payment plus whatever they get on the margin if the value of the house goes up. If you, say, live in a house for five years and then move, then you basically rented the house from the bank for five years. Except that unlike a renter you also assumed the (upside and downside) risk of home value change, and assumed the cost of taxes, maintenance, etc. Plus you tied up a large sum of money in a down payment. This may be worth it if you want to bet that home prices will go up in the next five years. It also may be worth it because mortgage interest, unlike regular rent, is deductible from your taxes, which is perhaps the most obscenely regressive thing in the tax code.
- clavalle 13y ago
  Even if 99% goes to interest, $10 is still better than $0.
  - wreegab 13y ago
    10$ is the cash asset. The big picture demands that you look at all the assets/liabilities/revenues/expenses. It's far from being that straightforward if you take into account net equity over time, risks, cash flow, depreciation, what-ifs, etc.
  - wpietri 13y ago
    As long as you ignore the many thousands of dollars you paid in transaction costs to get the place. And potentially the many thousands you pay in opportunity cost if the house keeps you from moving when you otherwise would.
    - refurb 13y ago
      And don't forget the opportunity cost of having the money for your down payment locked into an asset and not earning returns in other investments.
wreegab 13y ago
Correct me if I am wrong, but I tried to used numbers which fit your scenario, and roughly got this: Mortgage: 100,000$ Term: 25 yrs Rate: 1% Principal payment for the 12th month: 59.38$ Interest payment for the 12th month: 993.84$ Cumulative interest after 12 months: 11,998.64$ Cumulative principal after 12 months: 675.02$ All this with an incredible 1% rate.
- clavalle 13y ago
  The pedantry in this thread is really disheartening. I thought it would be obvious that I was using made up numbers for the sake of simplicity but that the underlying idea is the same. Storing any amount of money for the amount spent is better than banking none of that money.
  - mikestew 13y ago
    It's not pedantry when your simplification is off by at least an order of magnitude. Believe it or not, an error that large could make a difference in the calculation. And because you "simply" forgot to include maintenance and property taxes, you end up being just plain wrong. In reality, a house is a money pit in the first years of the mortgage. Whereas in your simplified example it looks to be a good deal because it's assumed one is gaining $10K in equity every year.
  - Dylan16807 13y ago
    You're the one making the unfounded assumption that mortgage and rent are the same price. Imagine if rent was 10% cheaper: you would bank much more money, in a much more liquid form, than having a mortgage. Honestly I downvoted your earlier comment specifically because of your edit saying that it doesn't matter if equity is 900/1000 or 10/1000. It matters a hell of a lot. Only a fool* would avoid putting 900/1000 into equity, with an effective 'rent' price of 100 if they move out after a few years. But there are real decisions to be made if just about none goes to equity. *assuming they expect to live in one place for a while
    - clavalle 13y ago
clavalle 13y ago
So, I did some more detailed calculations on a $500,000 home with closing costs included. I left out property taxes because I assumed anybody renting would recoup property taxes through increased rent. So, assuming rent + taxes == mortgage + taxes on a $500,000 property with $100,000 down payment where the value of the property stays the same over the life of the mortgage: $500,000 30yrs at 4.25% 20% down $100,000 $1967.76 monthly payment $22,644 closing costs By year four you are in the black compared to renting by $6132 You'd need an investment on your $100,000 that returns 1.49% compounded annually to make up the difference if you rented and invested the $100K that would have been spent on the down payment. By year five you are in the black by 14,122 You'd need 2.645% By year six you are in the black by 22459 You'd need 3.382% 7 31157 3.881% 8 40233 4.234% 9 49701 4.5% 10 4.683% 30 5.222% Here is the amortization chart: http://www.myamortizationchart.com/30-year/400000-dollars/4_25-percent/ http://www.myamortizationchart.com/30-year/400000-dollars/4_... Here is the closing costs calculator I used: http://michaelbluejay.com/house/closingcosts.html http://michaelbluejay.com/house/closingcosts.html In short, you have a pretty good shot at breaking even between renting and buying if you invest the down payment. If you have less than a 20% down payment (3% I think is what you need for a FHA loan) then you reach covering the closing costs faster with accumulated principal payments but your monthly payment can be significantly more (up to 20% more a month). IOW a huge amount depends on what you can rent the same house for. If rent == mortgage + tax these calculations hold. If rent is less than it is almost always going to be better to rent. If rent is more you are looking at a better situation buying if you are staying more than a few years. Also, interest rates would play a huge part.

pnut 13y ago

Have you ever actually had a mortgage? The majority of your mortgage payment goes directly to interest, NOT equity. Equity contributions only ramp towards the very end of the term. Up front, you are paying mostly interest.

seandhi 13y ago
And if you live in a state with high property taxes, like Texas, then your taxes will likely dwarf any principal that you pay at the beginning of your loan.
- marincounty 13y ago
  It seems like so many people fail to realize how much property taxes can add up too?
craigyk 13y ago
On the plus side, just by paying a couple hundred bucks extra a month you can double to triple the amount going into equity at the beginning. Bonus is they send you a check every couple of months as they recalculate how much interest you've headed off at the pass.

adanto6840 13y ago

Although I agree that there are some cases where it [buying] has merit, I can't help but point out what I consider to be a flaw in your math that likely exacerbates the problem. This is especially true IMO for those that are likely far less informed than the HN crowd. Due to how amortization works, it's very unrealistic to assume that with a $1k/mo mortgage payment, that $900 of that is going to equity. In fact, in most cases (standard down payment, 15 or 30 year mortgage, etc.), it'd be closer to the opposite of what you outline, especially at the beginning of the loan term. You can pull up a calculator to see for yourself but typically in the first few years of a new mortgage you'll be paying closer to $900 of that $1k towards INTEREST with the remaining going to principle / money that you may see later assuming home value is indeed retained. That said, I hate paying rent -- but I've also been "burned" a bit on home purchases a couple of times, too! ;-) EDIT - As someone above mentioned, you also have to keep in mind things such as PMI, property taxes & special levies, upkeep, etc...

aliston 13y ago
This is part of the problem with the American housing industry. How did it become "normal" to borrow 4/5ths of the value of a home? It didn't used to be that way. If you look at average loan-to-value ratios over the last 40 years, they've consistently gone up. Same with the home value to income ratio. Home prices have appreciated much more quickly that they should have based on fundamentals of the economy, propped up by government incentives, cheap money sloshing around, and an oversized mortgage industry. Ultimately, what we really need is to go back to a system where people can actually afford the homes they live in. The vast majority of Americans, whether they "own" or "rent," are still renters with no real chance of ever actually owning their home outright. If that perception changed, prices would come down, and we'd eventually get back to a system where you could buy a home for 2X your annual income. The problem with a return to a sane system is that it would bury existing homeowners, and we aren't willing to accept the pain in the short run. We need to artificially inflate housing prices in order to allow people to sell their homes, keep the economy functioning etc. So, in short, we're stuck. http://www.doctorhousingbubble.com/wp-content/uploads/2013/02/HouseholdPercentEquityQ32012.jpg http://www.doctorhousingbubble.com/wp-content/uploads/2013/0...
13y ago

clarky07 13y ago

I'd love to know where you get your mortgages. 900 of 1000 most certainly does not go to equity unless you are in the last few years. At first it's more like the reverse, and that's not counting pmi (we are talking about low income borrowers, unlikely they put 20% down), house insurance, maintenance, or taxes. Owning a home can be a good thing, but it isn't just easy money and wealth.

jseliger 13y ago

Let's apply common sense. Part of the reason "common sense" doesn't apply to this situation is that a huge number of factors (and costs, and risks) do apply. Maintenance and taxes are going to cost far more than $100 / month. For example: * these numbers don't include a down payment on the mortgage * they don't include transaction costs in either buying or selling * they don't take into account interest on the mortgage versus how much the same money would appreciate if invested in an index fund instead of a house—in other words, the time-value of money. * they don't take into account (and can't) how valuable moving might be; in finances, options are usually valuable because of their flexibility. * they don't include homeowners insurance. In short, "common sense" is anything but. That's why it's dangerous to do simple, back-of-the-envelope calculations about a major decision in the lives of most people.

foobarqux 13y ago
Also interest rate risk for ARMs.
clavalle 13y ago
I was pulling numbers out of the air for simplicity. But essentially, even if you only bank $10 in equity, $10 is better than $0 you'd bank if you paid rent.
- glenra 13y ago
  > I was pulling numbers out of the air for simplicity. But essentially, even if you only bank $10 in equity, $10 is better than $0 you'd bank if you paid rent. Heck, then I'll do the same. Let's just pull some new numbers out of the air such that the rent is $20 cheaper than the mortgage payment. Now as a renter you can bank $20 in savings, which is better than the $10 you'd bank in equity if you had a mortgage. Problem solved!
  - clavalle 13y ago
    Ok. But in my area rent is often more than mortgage + taxes. I know it is different in other places but that's why it is a simplifying assumption.

jordanb 13y ago

Your math only works if you're near the end of your mortgage life. At the beginning, nearly every penny of your mortgage payment goes to interest, which is front-loaded. For most Americans, who move around fairly often, they will never come close to paying off a mortgage and the only equity they will ever own will be what they bought with their down payment plus whatever they get on the margin if the value of the house goes up. If you, say, live in a house for five years and then move, then you basically rented the house from the bank for five years. Except that unlike a renter you also assumed the (upside and downside) risk of home value change, and assumed the cost of taxes, maintenance, etc. Plus you tied up a large sum of money in a down payment. This may be worth it if you want to bet that home prices will go up in the next five years. It also may be worth it because mortgage interest, unlike regular rent, is deductible from your taxes, which is perhaps the most obscenely regressive thing in the tax code.

clavalle 13y ago
Even if 99% goes to interest, $10 is still better than $0.
- wreegab 13y ago
  10$ is the cash asset. The big picture demands that you look at all the assets/liabilities/revenues/expenses. It's far from being that straightforward if you take into account net equity over time, risks, cash flow, depreciation, what-ifs, etc.
- wpietri 13y ago
  As long as you ignore the many thousands of dollars you paid in transaction costs to get the place. And potentially the many thousands you pay in opportunity cost if the house keeps you from moving when you otherwise would.
  - refurb 13y ago
    And don't forget the opportunity cost of having the money for your down payment locked into an asset and not earning returns in other investments.

wreegab 13y ago

Correct me if I am wrong, but I tried to used numbers which fit your scenario, and roughly got this: Mortgage: 100,000$ Term: 25 yrs Rate: 1% Principal payment for the 12th month: 59.38$ Interest payment for the 12th month: 993.84$ Cumulative interest after 12 months: 11,998.64$ Cumulative principal after 12 months: 675.02$ All this with an incredible 1% rate.

clavalle 13y ago
The pedantry in this thread is really disheartening. I thought it would be obvious that I was using made up numbers for the sake of simplicity but that the underlying idea is the same. Storing any amount of money for the amount spent is better than banking none of that money.
- mikestew 13y ago
  It's not pedantry when your simplification is off by at least an order of magnitude. Believe it or not, an error that large could make a difference in the calculation. And because you "simply" forgot to include maintenance and property taxes, you end up being just plain wrong. In reality, a house is a money pit in the first years of the mortgage. Whereas in your simplified example it looks to be a good deal because it's assumed one is gaining $10K in equity every year.
- Dylan16807 13y ago
  You're the one making the unfounded assumption that mortgage and rent are the same price. Imagine if rent was 10% cheaper: you would bank much more money, in a much more liquid form, than having a mortgage. Honestly I downvoted your earlier comment specifically because of your edit saying that it doesn't matter if equity is 900/1000 or 10/1000. It matters a hell of a lot. Only a fool* would avoid putting 900/1000 into equity, with an effective 'rent' price of 100 if they move out after a few years. But there are real decisions to be made if just about none goes to equity. *assuming they expect to live in one place for a while
  - clavalle 13y ago

clavalle 13y ago

So, I did some more detailed calculations on a $500,000 home with closing costs included. I left out property taxes because I assumed anybody renting would recoup property taxes through increased rent. So, assuming rent + taxes == mortgage + taxes on a $500,000 property with $100,000 down payment where the value of the property stays the same over the life of the mortgage: $500,000 30yrs at 4.25% 20% down $100,000 $1967.76 monthly payment $22,644 closing costs By year four you are in the black compared to renting by $6132 You'd need an investment on your $100,000 that returns 1.49% compounded annually to make up the difference if you rented and invested the $100K that would have been spent on the down payment. By year five you are in the black by 14,122 You'd need 2.645% By year six you are in the black by 22459 You'd need 3.382% 7 31157 3.881% 8 40233 4.234% 9 49701 4.5% 10 4.683% 30 5.222% Here is the amortization chart: http://www.myamortizationchart.com/30-year/400000-dollars/4_25-percent/ http://www.myamortizationchart.com/30-year/400000-dollars/4_... Here is the closing costs calculator I used: http://michaelbluejay.com/house/closingcosts.html http://michaelbluejay.com/house/closingcosts.html In short, you have a pretty good shot at breaking even between renting and buying if you invest the down payment. If you have less than a 20% down payment (3% I think is what you need for a FHA loan) then you reach covering the closing costs faster with accumulated principal payments but your monthly payment can be significantly more (up to 20% more a month). IOW a huge amount depends on what you can rent the same house for. If rent == mortgage + tax these calculations hold. If rent is less than it is almost always going to be better to rent. If rent is more you are looking at a better situation buying if you are staying more than a few years. Also, interest rates would play a huge part.