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| The Basics | Why its smarter to buy than rent
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The tax benefits help somewhat, but its the long-term gain in value thats crucial to building real wealth.
By Liz Pulliam Weston
Yup, the clich is true: Buying a home is one of the smartest financial decisions most people will ever make.
Dont take my word for it. Take the Federal Reserves. Its Survey of Consumer Finances has consistently found a huge gap between the wealth piled up by homeowners and that accumulated by renters.
| Average net worth of homeowners vs. renters | | Annual income | Owners | Renters | | $80,000 and up | $451,200 | $87,400 | | $50,000 to $79,999 | $194,610 | $25,000 | | $30,000 to $49,999 | $126,500 | $10,600 | | $16,000 to $29,999 | $112,600 | $4,240 | | Under $16,000 | $73,000 | $500 |
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Source: VIP Forum, Federal Reserve Board
Home ownership builds wealth in two ways: through the forced savings of paying down a mortgage, and through appreciation -- the rise in the homes value over time.
The earlier you get in the game, the quicker you can get that appreciation working for you. The longer you wait well, the consequences can be stiff.
Youll always be poor
If you rent, youll always be poor, declares real-estate cheerleader and bestselling author David Bach, author of Smart Women Finish Rich and the upcoming The Automatic Millionaire Homeowner. The longer you rent, the less likely you are to buy. You fall further and further behind.
Bach may be indulging in a bit of hyperbole, but he has a point. Those who wait for the current housing boom to crash may be waiting a long time. Prices even in the most overheated markets could plateau or just rise more slowly in the future, maybe even returning to the 6% average annual gain the National Association of Realtors says is the norm nationally.
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Still, even Bach acknowledges buying a home isnt always the best choice. Sometimes youre smarter to hold off and rent, postponing the day when you graduate to the ranks of homeowner.
But how do you decide if youre being prudent or chicken?
Dont expect most Buy vs. Rent calculators you find on the Internet to be much help. Outlays for maintenance, repairs, insurance and utilities almost invariably will be greater for a homeowner than a renter, yet many calculators fail to consider the full impact of these expenses. And some expect you to predict events -- like future appreciation or how much your down payment would earn if invested in stocks instead -- that you cant possibly know.
Its a crapshoot
When I bought my first house, for example, Southern California was experiencing its worst-ever real-estate slump. The property, purchased with two friends, lost about 10% of its value in my initial years of ownership, then recovered to post a 20% price gain.
Not bad, huh? Except after considering all my outlays for maintenance, repairs and insurance, and factoring in the tax benefits, I determined that I had barely broken even when compared with the rent I would have paid during those six years.
Had I invested my down payment in an index fund that matched the Standard & Poors 500 instead, I could have tripled my money in the same period.
The case has been almost exactly reversed with our current house: The stock market has basically been treading water for the past five years. But our home in the insanely hot Southern California market has more than doubled in value.
Theres no way I could have predicted the performance of either market -- stock or real estate -- in advance.
Tax benefits help, but not for long
Besides asking for the impossible, many Buy vs. Rent calculations -- and most discussions of home ownership benefits in general -- exaggerate the potential tax benefit.
Heres a dose of reality:
At least half of the nations homeowners get no tax break. Some own their homes outright, but many dont pay enough mortgage interest and/or property tax to be able to itemize.
If you do get a tax break, its probably less than you think. What matters isn't the total amount you pay in interest but whether all your deductions added together exceed the standard deduction amount.
The standard deduction in 2005, for instance, gives married couples who file a joint tax return $10,000 in "free" deductions, even for those who don't pay a penny in mortgage interest. If youre a homeowner with mortgage interest and other deductions totaling $11,000 last year, the only advantage you would have over a renter who paid zero interest is an extra $1,000 in deductions. If you're in the 25% tax bracket, the $11,000 you spent garnered you a tax break worth just $250 -- so your write-off is worth about 2% of what you paid.
Even if you get a decent deduction now, that tax benefit will tend to shrink over time. Most mortgages are front-loaded so that you pay less interest, and more principal, with each passing year. At the same time, the standard deduction keeps getting adjusted upward, squeezing your tax break from both directions.
4 keys to profitable home ownership
Youre most likely to win by owning, rather than renting, if the following are true:
You plan to stay put at least three years and preferably more. In most markets, it can take three to six years for a home to appreciate enough to offset the costs of selling and moving. (Bach thinks anyone who knows he or she wont be moving in the next year should roll the dice and buy; Im a little more cautious, particularly in overheated markets where you may need to stay put even longer than five years to ride out a real downturn.)
Youre psychologically prepared. Home ownership means dealing with whatever comes up -- from noisy neighbors to clogged plumbing. You cant just call the landlord for help or pack up and move as easily as when you were renting.
You have some extra savings. Home buyers who spend every dime they have buying a house inevitably are blindsided by repairs, maintenance and all the other costs of owning a home. Then they go into debt trying to keep up their current lifestyle. Smart home buyers make sure they have an amount in savings at least equal to two mortgage payments after the deal closes, and preferably much more.
You manage your money pretty well. That forced savings aspect I discussed above works only if you can keep your hands out of the cookie jar. Otherwise, its too easy to drain away your wealth with home equity loans and lines of credit. If youre the kind of person who lives on credit cards and doesnt know where the money goes, youd be smart to clean up your financial act long before you go hunting for a house.
Liz Pulliam Weston's column appears every Monday and Thursday, exclusively on MSN Money. She also answers reader questions in the Your Money message board.
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