October 18th, 2011 8:30 PM by Taydus Taydus, AHWD, CNE, CRS, GRI
Today, there’s another mortgage crisis in the works—that is, NOT havingone—choosing to rent when you can afford to buy; choosing to forgo buildingequity in a home as a major source of retirement security—something that may be more necessary now than ever before with a soft stock market and low interest rates. This emerging crisis is not yet at the car crash stage– more at the reckless driving without a seat belt stage. There is time forAmericans to resolve this one, but they must change their perspective on home ownership before it’s too late.
Why own a home when you can rent? We are hearing this question muchmore these days as people choose to “sit out” of the real estate market or disregard homeownership altogether after seeing many of their friends and family end up in short sales or foreclosures. Renting is the low-risk option for these callers. It’s the only way to ensure that nightmare will never happen tothem.
The problem is that it will; it’s just a different nightmare. Consider this: A homeowner with a $1,500 monthly payment would still be writing the same check fifteen years later while prices everywhere increase around them. In August 2011 the Consumer Price Index included a .4% increase in rents, the biggest increase since 2008, which represents an annualized increase of 4.8%. If rents didn’t even increase that much but simply kept up with inflation at a 3.2% annual increase, a $1,500 rent payment would cost that renter nearly $900,000 over the next 30 years. The same $1,500 payment made to their mortgage would be only $540,000 (because the payments don’t increase with inflation) and of course would end with a final payment. There might even be some real equity in the property, even with a dismal 1% growth rate over 30 years, a $300,000 property would appreciate well over $100,000 giving the homeowner an additional nest egg for retirement.
The renter, by contrast has no equity in their home, so in addition toalmost $900,000 in rent in the above example, the renter would also be giving up $400,000 in retirement assets (and that’s at a growth rate of just 1%– far lower than even the lowest growth rate over a 30 year time period). At a time when retirement is becoming much more challenging, an extra $400,000 (or likely more) can make a major difference, not to mention the impact of NOT having to pay a mortgage. How much less would you have to save for retirement if you didn’t pay the mortgage?
And this doesn’t even include the tax benefits. The US government essentially subsidizes your house payment by allowing a mortgage interest and property tax deduction on Schedule A of the 1040. Any points you pay when you get the loan can also be deducted. Then an amazing thing happens: the IRS allows a tax exclusion on the sale of a primary residence. Owners who live in their property two out of the past five years, who have equity and sell their primary residence, receive a maximum capital gain exclusion of $250,000 (if married $500,000.) Where else can you get a tax break on an investment and then receive the proceeds tax free? I can’t think of another investment like it.
So, deciding that “renting” is safer and there’s no need to take the riskof buying a home or even waiting in an effort to time what is an unpredictable real estate market, buying only when prices have been up for a while, can be very costly. It doesn’t bring with it the emotional trauma of a foreclosure or short sale. But it is a slow drain on your finances, that over time, could compromise your ability to retire or at the very least, to retire the way you want, when you want.
All that said, I’m by no means advocating homeownership for everyone. For many, renting is the right option, at least for now. If you can’t afford to own a home, you shouldn’t even consider buying—one of the key lessonslearned from the mortgage crisis. Your mortgage should be under 25-30% ofyour income not including bonuses or promotions and you should have anemergency fund of 3-6 months expenses in savings before you purchase ahome. Also, if you don’t qualify for a reasonable interest rate on a mortgage due to credit problems, if your income is unstable, or if you crave mobility, renting is the better choice. Renting is cheaper than buying in the short term and has other advantages. Repairs: as a renter, when you turn on the shower and freezing cold water spurts out in your face, you simply make a phone call to the landlord and they have to install a new water heaterinstead of you footing the bill. Mobility: If you have a job opportunityor promotion in another state, you simply give notice and move. You don’thave to go through the arduous process of selling (or not being able to sell)your home. You are free from the obligations of homeownership. Property taxes: As a homeowner, even when your mortgage is paid off youstill have to pay property taxes and insurance, and those costs will continueto rise.
Just remember that freedom has its price and, in this case, it is a steepone. It costs much more in the long run to rent, which is why homeownership can be the ultimate retirement strategy. When people are making decisions on whether to buy a house or not, many aren’t factoring in thirty years from now when the home is paid off. They are wondering if the market is at thelowest point possible, if interest rates will drop even lower or if the property will appreciate. This vital element of homeownership has a long incubation period. We always hear that an employee’s peak earning years come after age 50, when you combine high earnings with the elimination of anexpense that takes up a third of most people’s take home pay, people have areal chance to meet their financial goals. Homeownership is the ultimateretirement plan.
Home ownership isn’t for everyone, but for many, it is the best choice. Thesmartest choice, of course, is making the right decision for the right reasonsbased on your own circumstances. Homeownership basics apply just the same as they always have: buy only the home you can afford, lock in a fixedrate loan with the lowest interest rate possible, and refinance only to get alower rate and only for the same loan amount and same term. What got many people in trouble during the financial crisis was going to the extreme and buying a house they could barely afford with a variable rate loanpayment. When the payments reset with higher interest rates, manycouldn’t make the payment. They never should have been in the house inthe first place.
If Americans don’t recover soon from their pessimism around homeownership, we predict another fallout from the financial crisis will surface many years from now when a nation of renters tries to retire. They won’t have equity in their homes. Their paychecks will be stretched to the limit, not leaving room for saving and investing for retirement and other financial goals such as college funding. Instead of their expenses reducing through retirement, they will look straight down the barrel of increased rent payments for the rest of their lives. Homeownership makes a significant difference in the long run so it is concerning to see so many walking away from the American Dream. We don’t want to see it become the American Nightmare.
Written by: Liz Davidson is CEO of Financial Finesse, the leading provider of unbiased financial education for employers nationwide, delivered by on-staff Certified Financial Planner™ professionals. For additional financial tips and insights, follow Financial Finesse on Twitter and become a fan on Facebook.