Renting vs. Buying a Home: The 8.71% Rule

Summary

This video explores the financial implications of renting versus buying a home, inspired by Ben Felix's analysis. It breaks down the costs of home ownership, including property taxes, maintenance, and the cost of capital, emphasizing how these compare to rent. With current mortgage rates much higher than before, the presenter illustrates how to calculate a monthly ownership cost using the 8.71% rule. While acknowledging the pros and cons of each option, the video encourages viewers to run their own numbers, especially considering their unique circumstances and future plans.

Takeaways

• 🏠 Renting vs. Buying: The ongoing debate revolves around which option is the better financial decision, considering the costs associated with each.
• 💰 Total Cost of Renting: Renting means the total cost is the rent paid to the landlord, which typically does not lead to any return on investment.
• 📊 Homeownership Costs: Homeownership includes mortgage payments (interest and principal), property taxes, and maintenance costs, which must be accounted for.
• 🔍 Apples to Apples Comparison: To compare renting and buying effectively, homeowners need to calculate the monthly costs of homeownership.
• 📉 Opportunity Cost: When making a down payment, there's an opportunity cost as that money could have earned returns in the stock market instead of being tied up in real estate.
• 📈 Historical Returns: Over the last 30 years, the S&P 500 has averaged a 7.19% return, while U.S. residential real estate has appreciated only 1.97% after inflation.
• 🧮 Calculating Cost of Capital: The cost of capital includes both the opportunity cost of the down payment and the annual interest payments on the mortgage.
• 📅 Simple Rule for Costs: A quick guideline for homeownership costs is to multiply the home price by 8.71% and divide by 12 to find the monthly expense.
• 🔧 Benefits of Homeownership: Homeownership can serve as forced savings through equity buildup, predictability in payments, and potential capital appreciation over time.
• 🏘️ Flexibility in Renting: Renting offers flexibility, lower responsibilities regarding taxes and maintenance, and access to amenities not typically available in owned homes.

Q & A

What are the main financial components to consider when comparing renting and buying a home?

The main components include property taxes, maintenance costs, and mortgage payments. Each of these contributes to the total cost of homeownership.

How does the concept of opportunity cost relate to making a down payment on a home?

Opportunity cost refers to the potential gains one misses out on by investing the down payment in a home instead of putting it into the stock market, which historically has higher returns.

What is the average property tax rate in the United States, and how does it apply to homeownership?

The average property tax rate in the U.S. is 1.11%. Homeowners pay this percentage of their property's value annually, which is a cost they will not recover.

How much should homeowners set aside for maintenance costs each year?

Experts recommend setting aside 1% to 2% of the property's value per year for maintenance costs. In this example, 1% is used, amounting to $5,000 annually for a $500,000 home.

What is the total annual cost of homeownership calculated in the video for a $500,000 home?

The total annual cost of homeownership for a $500,000 home is calculated as property taxes ($5,500), maintenance costs ($5,000), and cost of capital ($33,000), totaling $43,500.

What is the 8.71% rule mentioned in the video?

The 8.71% rule is a guideline to estimate the total cost of homeownership on a monthly basis by multiplying the home's price by 8.71% and then dividing by 12.

How can homeowners calculate their break-even monthly payment when considering buying a home?

Homeowners can use a calculator provided in the video to input variables such as home price, property taxes, and maintenance costs to determine their break-even monthly payment.

What are some limitations of the 8.71% rule?

The 8.71% rule does not account for variations in interest rates, the changing costs of debt over time, and the potential tax benefits of mortgage interest deductions.

What are the advantages of owning a home compared to renting?

Advantages include predictable fixed payments, the ability to build equity, more control over the property, and potential for capital appreciation.

What flexibility does renting offer compared to buying a home?

Renting offers flexibility by allowing tenants to move easily without the long-term commitment of a mortgage, and they are not responsible for property taxes or maintenance costs.