Month: April 2019

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A few years back, I wrote a blog comparing the financials of renting versus buying your house. Back then renting came out ahead when you just looked at the dollars, which was a bit surprising. It seemed to buck conventional wisdom that buying is also the best option.

This seems especially important in light of some of the tax changes that impact your mortgage and property tax deductibility.

For this post, I want to look at the choice from a purely financial perspective.  And what better way to do that than break it down Dr Jack style?  Just to put a little meat on the analytical bone, let’s assume we have a home that we could buy for $400,000 or we could rent for $2000 (I did a quick search on Zillow in a few different markets and this seemed reasonable).

UP-FRONT COSTS:  When you rent, you have to give a deposit which is typically something like one month of rent, so that’s $2000.  Not a big deal in the grand scheme of things.  When you buy, your down payment is in the range of 20% (or maybe even higher since the 2008 financial crisis—the Fox family had to put 25% down on our house).  That would mean $80,000 if you’re buying.

At first glance that may not seem like a big deal because it’s still your money, it just happens to be “invested” (did you notice how I used quotes there?) in your home.  However, when your $80,000 is tied up in your house you can’t invest it (no quotes there) in the stock market.  Since the stock market historically returns about 6% that means you’re passing up $4800 per year on average.  Over an investing career that ends up being a TON of money.

Advantage: Bid advantage to RENTING

RISING INTEREST RATES: We’ve been living the last decade with historically low interest rates. A 30-year fixed loan was in the 3.5% range, and all was well. Since then interest rates have steadily crept up.

The math on interest rate increases is pretty powerful. A 1% increase would increase your monthly mortgage payment about $3200 per year or about $280 per month.

A couple months ago, interest rates rose to about 5%, but since then it has settled down to about 4%. Either way, interest rates are going up, and it seems that will probably be the long-term trend.

Advantage: RENTING

MONTHLY PAYMENT:  The most common knock I hear on renting is “every month you pay rent, you’re throwing that money away.”  I hate that comment, and part of this post is to show how little sense that makes.  Obviously when you are renting, your monthly payment is your rent, $2000 in this example.

When you buy, your monthly payment is your mortgage (here we aren’t going to include insurance and taxes, that will come later).  If you have a typical 30-year mortgage, let’s say at 4.5% interest, your payment is going to be about $1620 per month.  That’s quite a bit less than you’re paying in rent, so obviously that’s an advantage for buying, but then there’s another little bit of good news.  That $1620 you’re paying is mostly interest, but a small amount is going towards paying down your loan.  In a way that can be seen as you “saving” money.  In this example the amount going towards you’re loan would be about $200 per month.  So that’s pretty nice. Of course that “forced savings” has a low return compared to the stock market, so it’s not as good as it could be.

Of course, that means that about $1400 per month is going to interest.  So when people say that you’re throwing away your rent, can’t you say the same thing for the interest on your mortgage?  Either way, this is definitely an advantage to buying.

Advantage: BUYING

OTHER COSTS:  With renting, once you pay that rent check, you’re pretty much done.  With buying you have a lot of other expenses that nickel-and-dime you to death.  Property taxes have to be paid (let’s say 1% of the property value so that’s $333 per month).  If you live in a condo complex or an association you might have monthly dues that could range from pretty minor to a significant chunk of money (when the Foxes lived in a condo in downtown Chicago, our monthly association fees were $900 per month—ouch!!!).  Those can definitely add up, so that’s a nice advantage to renting.

Advantage: RENTING

TAX ADVANTAGES: This is where a huge change has happened recently. Before, all your mortgage interest and property taxes were tax deductible. Now there is a $10,000 limit on those deductions. In a lot of scenarios, your property taxes won’t be tax deductible. Because of the higher standard deduction, a lot of times it won’t make sense to deduct your mortgage interest either.

Before, the deduction for your mortgage interest and property taxes might be worth about $600 per month.  Now that is certainly less, maybe all the way down to nothing.

Advantage: WASH

INFLATION:  Once you buy your house your biggest cost, your mortgage, is going to stay put.  We’ve talked about inflation before, and the enormous impact that even a little inflation can have on expenses after many years, so this seems pretty awesome that you don’t need to worry about it for your biggest expense.

With rent “that’s where they get you”.  Rents almost always go up.  Often there are laws that put a cap on how much they can go up, 2% seems a number I’ve heard before, so that provides some relief, but even that 2% can be a big deal.  If today your rent is $2000, in 10 years it would be $2440, in 20 years it would be $2970, and in 50 years it would be $5390.  That sucks, especially when compared to buying where your mortgage payment will always stay the same.

Advantage: Big advantage to BUYING

SELF-DETERMINATION:  A neighbor was renting a few houses down from us.  The family loved the house, loved the neighborhood, loved the neighbors (of course they did).  But one day the landlord called her and said she wasn’t renewing the lease because she (the landlord) was moving into the house.  That family that was renting was FORCED to move even though they didn’t want to.  That sucks.

When you rent, you’re definitely at the whim of your landlord.  If you buy, you are in control of your own destiny, baby.  Get drunk off that power.

Advantage: BUYING

UPKEEP:  One of the super-nice things about renting is that you don’t need to worry about when things break down.  If there is a problem with the toilet, call the landlord.  Water damage from the really bad storm, call the landlord.  Fridge on the fritz, whatever—call the landlord.   In general this is an awesome advantage.  This is even better if you’re not a very handy person.

If you own a home, whenever anything goes wrong you need to fix it yourself (hence my “handy” comment) or worse you have to pay someone to fix it for you.  There’s no perfect estimate, but a generally accepted rule is you should plan on spending 1% of the home’s value on maintenance.  In our example that would be about $4000 per year.

Advantage:  RENTING

NICENESS:  As an owner, if you want to make your place nicer you absolutely can.  If you want a pool, build it; hardwood floors, install them; custom closets, wallpaper, nice landscaping, and on and on.  As a renter there’s a reluctance to do it because in some sense you’re paying to make someone else’s property nicer.  If you rent there for years and years, maybe that’s not a huge deal, but that “self-determination” issue rears its ugly head.

I don’t have statistics on this, but I bet that most renters would love to make their place nicer, but just don’t because there is some deep attitude that you don’t do that when you rent.  I totally get it and understand it, but it sucks that this keeps you from making your place as nice as it would otherwise be.

Advantage: BUYING

WORST-CASE SCENARIO:  I’m not talking about your hot-water heater going bad or having to replace the roof (those we captured in “Upkeep”).  Here I’m talking about real worst case scenarios like a natural disaster (in California earthquakes aren’t covered by most homeowners insurance policies; you can get earthquake insurance which is really expensive, so most don’t get it), or the neighborhood really turns bad, or termites or black mold infestations happen inside the walls.  Let your imagination run with this for a second and you can really think of some nasty stuff.

As a renter, you can pick up and leave the nightmare behind.  Just go somewhere else and start paying someone else rent, and problem solved.  Not so if you own the home.  Your single largest investment is at risk.  Sucks to be you.

By its nature, the worst-case scenario isn’t very likely, but still it could happen.  This is one of the things that keeps me up at night as a homeowner.

Advantage: RENTING

ASSET ALLOCATION:  A mortgage is a “forced savings” program in a way.  Every month you’re making a mortgage payment and part of that goes towards your equity that you can use as you get older (reverse mortgages, cash-out refinances) or pass on to your heirs.  After 30 years your house will probably be paid off and you’ll have a tidy little sum of cash to supplement your portfolio.  Also, because home values tend to be much steadier than stocks, in a way this investment might seem like a bond.

We saw how crazy important asset allocation is, so if you have a lot of home equity, that might make you feel more comfortable to put a bigger portion of your portfolio into stocks which historically have a higher return.  This is a bit of a tricky one, but there’s definitely some level of advantage there.

Advantage: WASH

REALTOR COSTS:  There will come a time when you are ready to leave your current home and move somewhere else.  If you’re renting this is easy (but not super-easy).  Usually, you’ll wait for your lease to expire and then head on down the road.  If you need to move right away and your lease isn’t up for a while, that can create a bit of a challenge of breaking you’re lease.  That could be as easy as paying a penalty of a month’s rent, or your landlord could play hardball and hold you to your lease until the end.  So this can be a pain, but more in the “moderate” zone.

When you own a home and have to sell it, that is a monumental undertaking.  Getting a home ready for sale, listing it, showing it, and ultimately closing the sale can take months from beginning to end.  Also, it’s not cheap.  While realtor fees vary, they average about 6% of the home’s value.  In our little example that would be $24,000.  That is a lot of money.  If you’ve been in the house for 30 years, that will amortize to less than $1000 per year, but if you’ve only been living there a few years that could be thousands of dollars per year that you need to tack on the to “Buy” expense column.

Advantage: Big advantage to RENTING

PRICE APPRECIATION:  We saved the best for last, kind of.  When you own your home, you get to take advantage of any price increases that your home experiences.  Of course, if your home goes down in value, you suffer those loses too.  However, like stocks, homes have historically increased in value over time, with notable exceptions like when home values crashed in 2008.

That’s great news, right?  No question.  However, it’s not as good as most people think.  You hear all sorts of crazy stories about people making a killing off their house, but those tend to be anecdotes rather than the rule.  The numbers are hard to come by but I think the most definitive and well-respected data, the Case-Shiller index (developed by my BFF Robert Schiller) shows that prices for existing homes have only increased 0.5% over the past 40 years after you account for inflation.

THAT’S CRAZY.  That goes against everything we hear.  How can that be?  Well his index controls for things like home sizes getting bigger, houses getting nicer features, etc.  So it really tries to do an apple-to-apples comparison of what you can expect will happen to your home.  So home prices do tend upward, but just not at anywhere near the pace that we’ve come to believe.

Advantage: BUYING

Buy	Rent
Investment return on down payment	$400
Interest/rent	$1,333	$2,000
Property taxes	$333
Tax advantage	$0
Maintenance	$333
Realtor fees (5 years)	$400
TOTAL	$2,800	$2,000

If you put it all together Buying “loses” with a score of 5-6-2.  Furthermore the math shows that Renting comes out ahead on a monthly expense basis, and it has become an even bigger advantage with the new tax laws.  Yet, Buying wins on a lot of those intangibles. Ahhhh, this is why the decision is so complex.  Hopefully you saw my point that buying isn’t the unambiguously better option.

If you look at the numbers, it really breaks down to two major factors—realtor costs and price appreciation.  The longer you’re in your home, the more years you can spread that 6% realty fee over.  So if you’re planning on moving after a few years, that becomes a major disadvantage to buying.  Your home appreciating in the icing on the cake that can really make the whole difference.  However, the Case-Schiller index showed that prices don’t rise nearly as fast as everyone seems to think (hence, I didn’t even include it in the expense comparison).

It’s a tough call, but the dollars are real. Renting costs about $800 less than Buying in our example; that 40%!!!

The Fox family owns our home, and it has turned out to be the best investment we’ve ever made.  We bought in 2010 when the housing market in Southern California had been thoroughly thrashed by the 2008 crisis.  In the past 5 years our home has rebounded, more than doubling in value.  We would have missed all that had we rented, but if I’m honest with myself, it was just really lucky timing.  Sometimes it’s better to be lucky that good.

Do you rent or do you own?  What do you think?

In the United States, Social Security is an important part of most peoples’ retirements, actually probably too important in many instances.  Social Security is a fairly simple program that was designed to be pretty idiot-proof.  You don’t really need to make many decisions for it, which contrasts sharply with all the decisions you need to make on your other investments (like tax strategies, asset allocation, picking investments, etc.).

With Social Security, you just work and the government takes its 12.4% (6.2% from you and 6.2% from your employer) of your compensation.  In fact, you don’t really have a choice in the matter and the government does it automatically.  Then when you get old, the government gives you a monthly pension.  Not real complicated on your end.

However, there is one really important decision you need to make regarding Social Security: when you start taking it.  Basically, you have three options: 1) Early retirement-when you turn 62; 2) Regular retirement-when you turn 67 for most of us; 3) Late retirement-when you turn 70.  And as you would expect, if you start taking Social Security later, you get a larger monthly check from the government.

This is obviously an important choice to make, and it’s one that gets a lot of press coverage with all sorts of people opining on what to do (I guess with this post, I am adding my opines to those ranks).  Generally speaking, the advice slants towards taking it later.  Yet, I wonder if that’s really good advice.  Using my handy-dandy computer, let’s go to the numbers to see what they tell us.

I checked my Social Security statement and I’ll be able to pick from one of the three choices:

Age to start taking Social Security	Monthly check
Early retirement—age 62	$1800
Full retirement—age 67	$2600
Delayed retirement—age 70	$3200

As you would expect, the answer to this riddle is a morbid one.  When do you expect to die?  The longer you live, the more it makes sense to delay taking Social Security so you can get the bigger check.  That’s not a tremendous insight, but when you do the math, you start to see some interesting things going on.  I fully appreciate that Social Security is very nuanced and complex, so I am just covering the simple basics here.

In my analysis to be able to compare the different scenarios, I assumed that I saved all the Social Security checks and was able to invest them at 4%, about the historic rate for a bond.  If you do that the table above expands to this:

Age to start taking Social Security	Monthly check	Highest value
Early retirement—age 62	$1800	Die before age 79
Full retirement—age 67	$2600	Die between age 80 and 84
Delayed retirement—age 70	$3200	Die after age 85

That’s pretty profound actually.  The average life expectancy in the United States is 76 for men and 81 for women.  Doesn’t that mean that most of us should be taking Social Security with the early option?  That contradicts most of the advice out there on this topic.  That, ladies and gentlemen, is why Stocky is here for you.  This is where it starts to get fun, and we can apply a little game theory (awesome!!!).

When to start Social Security?

Actually, once you reach age 62, the life expectancy of those still alive (and able to make the decision on Social Security) is 82 for men and 85 for women.  This makes sense because you’ve survived to 62 so by definition you didn’t die before then (awesome insight, Stocky), and those early deaths pull down that initial life expectancy model.

Since women are better than men as a general rule (Foxy Lady took over typing for just a second there), let’s look at this decision as a 62 year-old-woman.  She needs to make a decision on when to take Social Security.  She knows her life expectancy at this point is 85, which means there’s about a 50% chance she makes it to 85.  So the worst choice for a 62 year-old is to take the early retirement option.  She’s probably going to live long enough that either full retirement or delayed retirement is the better option.

At 62 she does the smart thing, and decides to wait.  Her next decision comes at age 67, assuming she lives that long (there’s about a 5% chance she’ll die during those five years).  But a similar thing happens—when she was 62 her life expectancy was 85 (right on the border of picking between full retirement and delayed retirement), but now that she’s 67 her life expectancy jumps up a year to 86.  So if she makes it to 67 then she’s better off taking the delayed retirement (of course, there’s about a 4% chance she’ll die before she makes it to 70).

That’s a little bit weird though, isn’t it?  It kind of feels like you’re that horse with a carrot dangling over his head, keeping him walking forward.  It’s a bit of a conundrum.  At any given time, you’re better off delaying starting your Social Security, so the math tells you to keep waiting and waiting.  But if the dice come up snake eyes and you die, then you miss out on everything (not strictly true, but true enough for our analysis).

And keep in mind that since Foxy Lady hijacked Stocky’s computer, we’ve done this analysis for women.  The math tells you that it’s just about a wash between taking Social Security at 67 or 70.  Since women live on average 3 years longer, for men you would think it means that the advantage leans towards taking it early.

What does it really matter?

So the analysis tells us that we’re better off waiting if you’re a woman and it’s really close if you’re a man.  And of course the longer we wait, the further we come out ahead by taking delayed retirement instead of early or full retirement.  But how big of numbers are we talking?

Remember, the cut off for when full retirement becomes better is at about 80 years old.  The cut off for when delayed retirement becomes better is about 85 years old.

Future value of Social Security payments
Age	Early retirement (62)	Full retirement (67)	Delayed retirement (70)
85	$1,031,256	$1,119,603	$1,125,233
90	$1,450,231	$1,644,630	$1,716,663
100	$2,647,751	$3,158,200	$3,431,844

Those are meaningful differences.  If you make it to 100 years old, delayed retirement comes out about $800,000 higher than early retirement.  However, those are in future dollars, 38 years into the future if you’re 62 today and faced with this decision.  That $800,000 when you’re 100 would be worth about $370,000 today.  Of course that’s if you make it to 100, which isn’t really likely (about a 3% chance).

If you make it to 90 years old (you have less than a 30% chance) then the difference is about $260,000 in future dollars which is about $150,000 today.

Wrapping up, I’m really torn on this.  There’s a little bit of a prisoner’s dilemma type thing working that keeps making you want to push back when you start collecting.  And then when you look at the upside of delaying retirement, the numbers are pretty big (whenever you’re talking about hundreds of thousands of dollars, that’s real money), but the chances of us making it to that super-golden age are pretty small.

I suppose it’s best to wait, but I’m giving that a pretty “luke-warm” endorsement.  It certainly isn’t the “slam dunk” that so many pundits make it out to be.

Actually, I think the way the Social Security administration sets it up, the options are all pretty similar.  We all have this personal belief that we’ll live longer than average (but not everyone can live longer than average, expect if you’re from Lake Wobegon, MN).  And that makes us think we’re better off waiting, but it probably is all pretty equal.