21 January 2008 2 Comments Print This Post  Email This Post

There is a lot of talk about whether or not you should pay off your mortgage or invest. This topic has been beaten to death throughout the blogosphere and the answer remains the same, it depends. The basic idea is that if you invest rather than pay down your mortgage, you can earn a higher return than the mortgage rate. So if you’re paying 6% interest on your mortgage, which is less after tax benefits, and earn 10% in the stock market, you’re coming out with big profits over the long term. Therefore, many say that you should never pay off your mortgage. However, in some cases you shouldn’t even buy a house at all. In a lot of overvalued metropolitan areas, by renting then investing the money saved, you will ultimately become a lot wealthier over time.

Calculate Rent Vs. Buy Correctly

A lot of rent vs. buy calculators on the internet are really misleading. I have yet to find a truly good one. Take for instance the Ginnie Mae calculator. In just about every case, you’ll see that buying is better over 30 years. This is because the calculator takes into account appreciation but leaves out selling costs, maintenance, extra utilities and insurance over those 30 years of homeownership. It also assumes the homes will keep appreciating at the same rate forever. A significant thing that this calculator and many others leave out is what you can do with the money you save every month by renting.

Investment growth is neglected by almost every rent vs. buy calculator. I guess they figure you’ll just blow the money you save on Louis Vuitton purses. The great benefit about renting is that in a lot of cases, it’s cheaper than owning on a per month or per year basis. This frees up cash to invest in whatever asset class you wish. Sure, if you own a home you’ll build equity but thats like putting your eggs in one basket and investing in one asset class. If you rent you have more free cash to jump on investment opportunities in any asset class such as stocks, real estate, businesses, fine art, whatever. Renting has great psychological benefits as well. Your monthly obligations are low compared to buying, and therefore if an emergency came up you wouldn’t have to worry much about losing your home.

The old school mentality is that you need to own a home to get rich and that renting is a waste of money. My dad thinks like that, but that mentality is likely not true anymore for a lot of areas in the US. In case you’re wondering if you can get rich by renting, a popular proponent of renting and investing is the Millionaire Mommy Next Door. Her name says it all.

The Answer Still Is: It Depends

The reason why I won’t say its definitely better to rent is because every real estate market is different. Real estate is local and conditions differ. For instance, here in the San Francisco Bay Area, I advised my relatives to save their money, keep renting and start investing. They know I’m not lying because I’m a licensed real estate agent and there must be good reason I’m turning down a $15,000 commission. They are renting at $1600 a month and in that area, comparable 2 bedroom homes are in the $750,000 price point. It’s definitely smarter to rent in their case.

On the flip side, in some areas of the US you have relatively high rents and low home values. I wrote a while ago that I’ve decided to leave San Francisco to build wealth. I’m moving to Sugar land, TX which is a nice suburb of Houston. There, a $150,000 home would rent for $1500 a month, which is exactly why I’m going to buy. Builders are also slashing prices to move inventory so I’d likely be able to get a $170K home for $150K. If I rent there, I’d likely be “throwing away my money.”

As you can see, things can be very different depending on your location. Every market is different and every person’s finances, risk tolerance and preference is different. No article or rent vs. buy calculator can tell you exactly what to do, it’s up to you to do your rent versus buy calculations with the factors that matter. Just remember to calculate it correctly and use all the numbers, not just some. Housing is likely the largest expense we’ll ever incur through our lives, so make sure you make the right move when you start.

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