Doing the Math on Home Ownership

In 2007, Sarah and I made the decision to become homeowners. We had fixed our finances to the point where we were ready with a down payment on a modest home. We were also under the belief that home ownership was the sure-fire way to build equity.

When we bought our home, we discovered that home ownership has a lot of hidden expenses beyond just the mortgage and that, if you’re not accounting for them, home ownership can be a big mistake. In fact, there are many situations where continuing to rent makes more sense even when you have the resources to buy a home.

Let’s walk through the pieces of the puzzle.

First of all, you’re going to want to make the choice that results in the smallest amount of your monthly income vanishing into the abyss. There are a lot of expenses for home ownership that are required to maintain and adequately protect your home and most of those bills do nothing more than maintain the home you already have.

In other words, you have to add up the total of the bills you’re paying each year in relation to your home and subtract from that the equity you build to see how much your housing is actually costing you. That number then needs to be compared to the cost of a year’s rent and rental insurance. Whichever number is lower is the option you should go with.

The expenses are numerous.

First, you have your mortgage payment. During the first half of your mortgage, the majority of your monthly payment will go to interest, while less than half will actually build equity in your home. The first few years, in particular, are mostly given over to interest. If you make a $1,000 mortgage payment and $900 is interest, you’re only building $100 equity in your home.

Next, you have homeowners insurance. This is an expense you need to have to protect against the unknown, but most of the time, it’s money that vanishes into the ether. You can reduce the cost of homeowners insurance with careful shopping, but it’s still an expense. If you’re looking at insurance, it’s probably worthwhile to check out Money360’s section on home insurance.

You’re also going to have to face property taxes. Renters are almost always shielded from this. Property taxes can vary widely, but unless you live in a very low cost area, it’s going to be in the thousands of dollars annually.

On top of that, you have maintenance and upkeep. A good rule of thumb here is that your home will cost 1% of your property value to maintain each year. Thus, if you have a $200,000 home, you’ll find yourself dumping $2,000 into property maintenance annually.

You’re also going to face increased energy costs, major appliance costs, homeowner association fees, and new utility fees (like garbage removal and sewer costs) that you might not have been paying before.

So, in the face of all of this, why would anyone own a home? There are a few good reasons for that, too.

First, any increase in property value due to the housing market is all yours. If your home value goes up 20% over five years, that’s money in your pocket. It’s really hard to perfectly assess this, but you can usually get an idea by tracking the prices that houses in your area are selling for.

Second, once the home is paid for, it’s far cheaper than renting a similarly-sized living space. Your mortgage payment is gone and the value of your property is likely increasing. Your only expenses are the insurance, taxes, and upkeep.

Finally, a home you own is yours to modify. You can’t just rip out the cabinets in your rental unit if you don’t like the kitchen arrangement. You generally can’t make those kinds of choices in a rental.

There’s also another concern: if you rent and aren’t building investments with the money you’re saving, then you’re not taking advantage of the situation. Some people simply find it easier to build equity by facing their bills with home ownership. From an investing standpoint, this isn’t the best choice, but it is a factor with how many peope make money decisions.

If I were making the decision all over again, I would make up a balance sheet. I’d try to estimate all of the costs for each option along with the equity gained in each option, add up the expenses, subtract the earnings, and then see what option comes out on top. If they’re close, I’d lean toward home ownership. If they’re not close, I’d lean toward renting. (If you’re in a situation where home ownership comes out way on top…. well, I’m flabbergasted, because that would be pretty unusual.)

Home ownership is not a home run. It certainly wasn’t for us. However, for many people in many situations, it can be a very good choice. You just need to make sure that it balances out for you.

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