Up until today, IFTF has focused primarily on the purchasing of stocks and saving for emergencies. These are very important aspects to a successful future, but they aren’t the only ones. The common concept that IFTF tries to impart is ownership. Whether you own shares of Apple or US Savings Bonds, you are investing into something today with the idea of a payoff in the future. Another aspect to building wealth is ownership in housing.
In speaking to folks in many facets of real estate, from real estate agents, to insurers, to landlords, we’ve found that they all agree that the key to building wealth is a stable foundation. Many landlords who rent their homes to “good renters” agree that if their tenant could afford a home, they should not be paying rent. Let’s briefly go over the virtues of renting vs. ownership, and what IFTF believes are the benefits of ownership.
All Expenses Are Not Created Equal
There is a distinct difference between paying a dollar towards the ownership of a house vs. renting. Let’s say that a mortgage for a home, and rent on a home both cost $1,000 per month. As a renter, you make a monthly payment to your landlord of $1,000, who presumably takes care of the expenses involved in maintaining the home. When you own a home, the $1,000 operates differently. Of that $1K, depending on your market, let’s say $75 goes to property taxes, and another $75 goes to insurance. The remaining balance ($850) will go to paying the mortgage in two forms: principle, and interest.
Principal and Interest
Every mortgage that has a fixed interest rate, whether it’s for 5 years or for 30 years, will initially begin with monthly payments, split unevenly into principal and interest. At the beginning of a mortgage, the majority of the payment will go towards paying down the interest owed on the loan. Using the $1K example, $850 goes towards the principal and interest, and on the very first mortgage payment, the breakdown will be approximately $840 going towards interest and around $10 going towards the principal (the balance of the mortgage).
At this point you might be saying WTF! Only $10 will go towards paying off the principal?! That is correct. But before you call us crazy, ask yourself: how much of your own principal would you be paying off each month that you pay the landlord’s rent? Remember, wealth is built over time, not in a day.
What Are The Benefits Of Ownership?
Uncle Sam encourages home ownership by providing tax reductions to most homeowners who pay interest on a mortgage. In order to qualify, you must be income eligible, itemize your deductions, and pay mortgage interest. If you qualify, you are entitled to a reduction on your taxable income. What does this mean? Using the $1,000 example, if we assume that $850 goes to principal and interest, and around $10 goes to principal, Uncle Sam will allow (if you itemize) a claim or for you to retrieve a percentage of the interest paid, based on your tax bracket. So if you are in the 25% tax bracket, your true cost per month for owning that home is closer to $790 (in mortgage, insurance, and taxes), versus the $1,000 to rent from a landlord. This tax benefit is one of the ways a homeowner can build equity over time. There are no tax benefits for renters.
Each month, as you make a monthly payment on a home, you are reducing the balance on the amount owed on the house. Using our $1,000 example above: on the first mortgage payment, $10 goes to the principal and $840 goes to interest. On the final payment of a mortgage, $840 goes to the principal and $10 goes to the interest. Each monthly payment in a home increases your equity stake in the home. Equity is defined as the value in an asset. Paying down a home is a simple way to build up a future savings account without thinking about it. However, it should not be the only way).
Unfortunately, renting brings none of these luxuries. Using our example, as a renter, you pay $1000 per month for a year or two, and when the lease expires the landlord might increase the rent. This continues every couple of years. At the end of 5, 10, 30 years, the landlord has “paid off the mortgage,” the renter has built no equity, and if asked to leave, has nothing to bargain with and must start anew.
Ownership of a house is not without its disadvantages. Maintenance and repair are real expenses and the responsibility of the owner. In fact, at times, homeownership can feel downright painful. But when you look at the pros – i.e. building your own equity/tax benefits – ownership outweighs renting in a huge way. Everyone’s financial situation is different and ownership is not always immediately possible for some. With that said, IFTF recommends that if you can afford a home but are renting, think strongly about ownership. If you want a home but can’t afford one today, don’t give up. Talk to your friends who own homes, or do research on the internet and look for a real estate person whose specialty is working to help folks who currently can’t afford homes eventually get into one. These are agents who will work on improving your credit over time as well as the savings profile you may need to purchase a home. There are plenty of willing, experienced realtors who can help you get started. You just have to be willing to ask. At the end of the day, we all have to live somewhere. Why not consider ownership of the place?