Suppose you're interested in buying a house, but you want to know if it makes financial sense.
Real estate agents and mortgage officers will almost always say yes because you get both tax breaks and equity buildup over time. With rent, all the money just goes down the drain.But the truth is, psychological benefits of home ownership aside, you don't always end up with much more money by owning than renting. Interest slurps up almost the entire amount of the payments you make for the first 10 years of a 30-year mortgage, and most people don't stay in a house longer than a decade.
For example, say you are now paying $700 a month in rent, plus utilities and renter's insurance. The landlord pays the taxes and fixup costs.
For about the same monthly cost - $626 for interest and principal on an $80,000 mortgage at 8.7 percent - and $74 a month in property taxes, you could buy a house.
Where will you be financially 10 years later?
- Ten years of rental payments at $700 a month costs you $84,000. Now that money is all gone with no lasting benefits.
- Ten years of mortgage payments at $626 a month will give you $8,844 in equity. The rest of the payments all went for interest, just like the rental payment, down the drain.
But several other factors also come into play.
When you bought the house, you probably had to spend at least $8,000 for the down payment and closing costs, so you're not much ahead after 10 years with $8,844 in equity.
On the other hand, you probably got some tax breaks with your 10 years of interest payments ($66,327) and a decade of property taxes ($8,880.) If you are in the 28 percent tax bracket and itemize your taxes, you could save about $2,000 a year in payments to the IRS because of the mortgage interest and property taxes.
You'll need that $2,000 a year in savings as a homeowner because houses are expensive to maintain, especially over 10 years - fixing the roof, painting the house, taking care of the gutters, replacing or repairing the furnace, hot water heater, oven, stove, washer, dryer, dishwasher, garbage disposal and much, much more.
Over time, depending on the economy, your house may rise in value and increase your equity. That happened dramatically in many parts of the United States during the 1970s and early '80s.
But as many homeowners have discovered in the late '80s and early '90s, your house may fall in value as well, sometimes below what you owe on the mortgage.
In this decade, strong efforts are being made to keep inflation low and housing prices are rising slowly or not at all in some places. The easiest way to increase your equity in this situation is with a 15-year mortgage.
Like the example above - an $80,000 mortgage with an 8.7 percent interest rate - the monthly payments on a 15-year term would be $797 a month instead of $626 over 30 years. Your equity buildup in 10 years would be a hefty $41,320, much better than the equity you have with a 30-year mortgage. But not everyone wants to make those higher monthly payments to get the benefit.
One final point: As long as you rent, you can never be sure the landlord won't raise the rent. You can always move, but you may not find another house or apartment that you like as well for the same price.
When you have a fixed-rate mortgage, the monthly payments stay the same over time. But property taxes don't; if your house rises in value, the taxes are likely to increase as well.