Buy or Rent? One Family, One City and a Five-Year Worked Example

Every slogan in personal finance is half true, and that is precisely what makes it dangerous. A flat lie gets caught. A half-truth gets repeated at dinner parties for forty years. "Rent is throwing money away" is the champion of the genre: it is correct about one line of the ledger and silent about the five others.

So let us do what slogans are designed to prevent. Let us count. This post takes one hypothetical family in one hypothetical city, puts them through the same decade in two different housing arrangements, and shows when owning pulls ahead. Then it asks what the numbers cannot measure, because a home is not only an asset. Everything is general information. The figures are invented and rounded, real markets vary enormously, and nothing here is advice about your own decision, which depends on facts a blog post cannot know.

Definitions and the claim

Owning means buying a home with a mortgage and paying all of its costs. Renting means paying a landlord a monthly amount and investing whatever you save relative to the cost of owning. Break-even is the year in which, if the family sold the home, the owner's net position equals the renter's.

My claim has three parts. One: for a family that stays long enough, owning is often the better financial bet. Two: for a family that moves within a few years, it is a costly one. Three: the slogan is wrong in the direction its fans do not expect, because a mortgage payment contains plenty of money that is every bit as gone as rent.

The assumptions

A worked example is only as honest as its assumptions, so here they all are.

• The home: $350,000.
• Down payment: 10 percent, or $35,000, leaving a loan of $315,000.
• Mortgage: a 30-year fixed loan at 6.5 percent. The monthly payment of principal and interest is $1,991.01.
• Property taxes: 1.1 percent of the home's value each year, so $3,850 in year one.
• Homeowner's insurance: $1,800 in year one, rising 3 percent a year.
• Maintenance: 1 percent of the home's value each year, $3,500 in year one.
• Closing costs on purchase: 3 percent of the price, $10,500.
• Cost of selling: 6 percent of the sale price, taken when the home is sold.
• Home appreciation: 3 percent a year.
• Comparable rent: $2,100 a month in year one, rising 3 percent a year.
• Investment return for the renter: 5 percent a year, compounded monthly.

The renter starts with the same cash the buyer spends at closing: the $35,000 down payment plus the $10,500 closing costs, which is $45,500, invested at once. Each month, the renter also invests the difference between the owner's total monthly cost and the rent. In year one, the owner's monthly outlay is $1,991.01 plus $320.83 in taxes, $150.00 in insurance and $291.67 in maintenance, which is $2,753.51. Subtract the $2,100 rent and the renter invests about $653.51 that month.

What the model ignores, and I will say it plainly: the mortgage-interest deduction and other tax effects, which depend on whether the family itemizes; private mortgage insurance, which a 10 percent down payment often triggers and which would make owning costlier; taxes on the renter's investment gains; and any rent control or surprise increase. Leaving out mortgage insurance flatters owning. Leaving out the deduction flatters renting. I mention both so that you can see I have not tilted the board on purpose.

The five-year result, line by line

After 60 months, the family that owns has paid down part of the loan, owns a house worth more than it paid and has spent a good deal on things that never come back. Let me name them. In the first year alone, the owner pays $3,850 in property tax, $1,800 in insurance and $3,500 in maintenance, which is $9,150 that builds no equity whatever. Add the interest on the loan, the bulk of the early payments, and the closing costs, and a large piece of the "equity-building" mortgage payment is exactly as gone as a rent check.

That is the heart of the correction. Rent is a price paid for housing. A mortgage payment, plus taxes, insurance and upkeep, is also a price paid for housing, with one component, the principal, that you get back. In the first year of this loan, most of the $1,991.01 monthly payment is interest. The renter is not throwing money away. The renter is paying a price, and so is the owner, and the question is which price is lower over a given period once you count what each can do with the rest of his money.

Here are the results, year by year, if the family were to sell at the end of that year.

All figures are rounded to the dollar. The "owner's net" is the sale price times 0.94, minus the loan balance. At the end of year 5, for instance: $405,746 times 0.94 is $381,401, minus $294,875 gives $86,526, which the table carries as $86,527 because of rounding in the underlying calculation.

The break-even year is year 7. Through the end of year 6, the renter is ahead. Somewhere in the seventh year the lines cross, and by year 10 the owner leads by about $26,000.

Look at year 3, which is when many families move for a job or a growing household. The owner who sells then is behind by $20,862, because the 6 percent selling cost alone is $22,947 (6 percent of $382,454), and the closing costs on purchase are already sunk. The owner who stays for ten years is ahead. The same house, the same family, the same city: a three-year stay is a loss, and a ten-year stay is a gain. That is the whole argument in two lines of a table.

The steelman: the principle of forced saving

Before drawing a conclusion, I want to give the pro-ownership side its best argument, and it is stronger than the table suggests.

The case runs like this. The model assumes the renter actually invests the difference between the owner's cost and the rent, every month, for a decade, at a steady return. Real people do not. The renter who finds $653 a month of spare cash will often find a use for it. A mortgage is a forced savings plan: every payment, whatever the family's mood, retires a bit of principal. A family that would not otherwise have saved a dime ends up with a house.

That is a strong point, and it is consistent with what we know about habits. The mortgage turns a decision, repeated monthly, into a commitment that happens once. A household that cannot rely on its own discipline may be far better off owning than the model suggests, because the model grants the renter a discipline the renter might not have. I would add that a paid-off home is also a hedge against retirement costs, since it removes the largest monthly bill.

I accept this. It does not overturn the table, but it changes who the table is for. The table is for a disciplined renter. For an undisciplined one, the comparison is between owning and not saving at all, and owning wins that contest.

What changes the answer

The break-even year is not a law of nature. Run the same model with different assumptions and it moves a long way.

• Appreciation. At the base case of 3 percent a year, break-even is in year 7. If the home appreciated 5 percent a year, the break-even would come in year 3. If it appreciated 1 percent a year, the owner would still be about $37,700 behind after twelve years. If it did not appreciate at all, the owner would still be about $73,300 behind after twelve years.
• The renter's return. If the renter's investments earned 7 percent instead of 5, the break-even would slip to year 11, since the renter's portfolio would grow faster.
• How long you stay. This is the most important variable, and it is the one the family controls. The first years are expensive because transaction costs are front-loaded and interest dominates the early payments.
• Rent versus price. In some cities rent is a small fraction of what it costs to own an equivalent home, and in others it is large. Where renting is much cheaper, the break-even year moves far out. Where it is only slightly cheaper, the break-even comes sooner.

I would be misleading you if I presented 3 percent appreciation as a safe assumption. Home prices have fallen in many places and periods, and an owner with a large loan and a falling market can end up owing more than the home is worth. The leverage that makes ownership attractive in a rising market is exactly what makes it punishing in a falling one. A family that can only afford the purchase with the thinnest possible margin should say so to itself plainly.

A rule of thumb you can test yourself

The table suggests a simple discipline, and it is one you can apply to your own market with a calculator and an afternoon. Call it the holding-period test.

1. Add up the round-trip cost. Closing costs on the purchase plus the cost of selling. In the example, that is $10,500 plus roughly 6 percent of the sale price, which together exceed $30,000 on a $350,000 house. This is the entry fee, and it has to be earned back before ownership can come out ahead.
2. Add up the running costs that never return. Interest, property tax, insurance and maintenance. Put aside the principal, because that part you keep.
3. Compare with the rent you would pay for an equivalent home, and ask what the difference would earn if invested. Be honest about whether it would be invested.
4. Ask how long you will really stay. Not how long you hope to stay: how long you can say with confidence, given your job, your family and your plans. People overestimate this number. A good habit is to cut your first guess by a year or two.
5. Compare that number with the break-even year. If the break-even is year 7 and your honest estimate is 4, the numbers say to rent, or to buy only with open eyes about the price of leaving early.

None of that is a verdict on anyone's life. It is a way of replacing a slogan with a count, and counting is the whole point of this post. If you also want a sense of how families get into trouble, the same arithmetic explains why a purchase made at the very limit of a family's income is dangerous: a market that falls, a job that moves or a repair that arrives can turn a gain into a loss before the break-even year ever comes.

Who each choice suits

Owning tends to suit a family that expects to stay in the same area for seven years or more; has a stable income and a reserve beyond the down payment; is willing to pay for repairs without drama; and values control of the property, the freedom to change it and the certainty of a payment that does not rise with the market.

Renting tends to suit a family that expects to move within a few years; whose job is uncertain or whose career may require relocation; that has not built an emergency fund yet; or that is in a market where owning costs far more than renting. For this family, the sensible question is not whether to rent but how to make sure the savings actually happen. A family that rents and invests the difference is doing something perfectly respectable, and the slogan about throwing money away should not shame it.

The reserve matters. A homeowner without savings is one burst pipe from the credit card. That is the argument of Why the Emergency Fund Comes Before Every Other Money Goal You Have, and it applies doubly to a house, where the repairs are yours alone. The myths that cost first-time buyers real money are tested in Seven Myths About Owning a Home That Cost First-Time Buyers Real Money, and a family choosing a payment should read it alongside this post.

What the numbers cannot count

A conservative is entitled to say that a home is not a spreadsheet row, and I will. A house is a place to raise children who will remember the height marks on a door frame. It is a place where the neighbours learn your name and you learn theirs, as argued in Know Your Neighbors' Names, the Small Habit That Holds a Republic Together. It is a stake in a community and a reason to care about the school board, the zoning hearing and the property tax rate. People who own their homes show up to meetings, and officials know it.

There is a founding-era reason for this. The Fifth Amendment puts property beside life and liberty in its due process clause: no person shall be "deprived of life, liberty, or property, without due process of law," nor shall "private property be taken for public use, without just compensation." The right to hold a home against the state is not a footnote to the American idea. It is part of the structure. The settlers who claimed land under the Homestead Act of 1862 knew what it meant to own the ground under one's feet, a history told in The Homestead Act of 1862 and the American Habit of Earning Your Own Ground.

But I want to be careful with this point. The non-financial goods of ownership are real, and they are not free. They have a price in the table above: for a family that moves in three years, the price is about $20,000. A person who wants roots badly enough to pay for them has not made a mistake. A person who buys because a slogan told him renting was wasteful, and then moves in two years, has.

The case in brief

1. "Rent is throwing money away" is half true: a mortgage payment, with its interest, taxes, insurance and maintenance, also contains large costs that never come back.
2. In the labeled example, a $350,000 home with 10 percent down at 6.5 percent, set against comparable rent invested at 5 percent, the break-even year is 7.
3. A family that sells in year 3 is about $20,862 behind; one that stays ten years is about $26,215 ahead, because selling and closing costs are front-loaded.
4. The answer moves with appreciation, the renter's return and the local price-to-rent gap, and a mortgage's forced-savings effect favors owning for those who would not otherwise save.
5. The non-financial goods of ownership, roots, stability and a stake in the community, are real and have a price you can now see.

What you can do: before you buy or renew a lease, write down how many years you are certain to stay, and compare it with the break-even year for your own market and your own numbers.