## 11.22.2009

### To Save or Borrow for a Home?

Let's say two families would each like to buy a nice house for \$250,000. Both families have about \$2000 that they can put towards housing each month. Family A, the Anderson's, decide they would like to save up for their house and pay for it in cash. They rent an apartment for \$750 per month and save the rest in a regular old savings account. (They are afraid of high risk investment, you see.) Family B, the Bailey's, can't wait that long to move into their house and everyone has told them that buying a house is an investment. They decide to take out a mortgage. They get a decent 7% interest rate on a 30-fixed-rate mortgage. The monthly payment is \$1663.26 plus (the national average) property taxes of about 300 each month. So they are paying \$1963.26 on their house each month and have \$36.74 left over to put in their savings. They bank at the same place as the Anderson's so they all have the same annual interest rate (compounded monthly) of .58 percent. The Anderson's move into their nice little apartment and the Bailey's move into their nice big house and life goes on as usual.

Fast forward 16 years assuming status quo on the property taxes, rent, income, etc. Who is doing better? Who made the better decision?

Here's a little chart to keep things straight:

Do you think you know the answer? You might be surprised.

16 years later...

Savings:
The Anderson's have saved up \$252,796.52, quite enough to purchase the house they dreamed of with cash, with enough change to buy some new drapes and maybe a sofa. The Bailey's have a whopping \$7430.20 in savings. They decide to blow it on a used car for their teenage son. (Or not, you decide.)

(You might say, "hey dummy, that means after the Anderson's buy their \$250K house, the Bailey's have more." Well... let's do some more math, shall we? Stay with me, you'll love this.)

Housing:
Both families own a home originally valued at \$250,000. To be fair, the Anderson's house might be a little smaller because of inflation. The difference is, the Anderson's own their home free and clear. From now on, they can pay their little \$300 a month on property tax and continue to save the remaining \$1700 of their budget or spend it on whatever they wish.

Meanwhile, the Bailey's still have a loan balance of \$231,728.88. Even if the Bailey's won the lottery and were able to pay off the balance immediately, they have already shelled out 16 years worth of payments, putting their total at \$608,674.80.

I don't care how much their house has appreciated in value over the past 16 years, they'll never be able to sell if for that figure! They have paid \$101,483.33 in interest. In comparison, the Anderson's have spent \$144,000 in rent. (Before you say, "The Anderson's have nothing to show for their rent," please keep reading.)

Let me recap. Both families are living in a house now, since the Anderson's have just moved in and just about depleted their savings. Both families have put \$2000 a month into housing (whether into a mortgage, rent, or savings account) for the past 16 years. But one family completely owns their home, and the other still owes 93% of the original purchase price.

Another 14 years later...

Savings:
For the next 14 years, the Bailey's will continue to shell out \$1963.26 on their house each month and have \$36.74 left over to put in their savings. The Anderson's have the option of saving \$1700 each month for the next 14 years at the same low interest rate.

If they both continued to save the remainder of their \$2000 housing budget, the Anderson's will have \$300,473.86 (assuming they didn't spend the \$2796.52 left over from their home purchase) at the end of 30 years and the Bailey's will have \$14,486.76 (assuming they never spent their savings at all).

Housing:
At the end of 30 years, the Anderson's and Bailey's will both own their home free and clear. The Anderson's will have paid \$250,000 for their home (or \$300,400 if you add in property taxes) and the Bailey's will have paid \$598,773.60 (or \$706,773.60 with property taxes). Someone would have to rent a \$750 apartment for 78 and a half years to match what the Bailey's have spent over 30 years on their house.

Let me recap yet again.... Anderson's: House + \$300K vs. Bailey's: House + \$14K

Even if the Bailey's were some how able to increase their monthly payment by \$500 and completely pay off their mortgage during those first those 16 years while the Anderson's were penny pinching, they still would have paid \$167,033.13 in interest. Can a house appreciate that much in 16 years without any renovations or additions or changes to the home? I doubt it.

The Moral of the Story Is....

Despite common assumption, it is better to rent and save than to borrow. (Obviously, you need to save more than you spend on rent for it to be timely.)

I did not know this 2 years ago when we bought our house. Now that we are trying to move to a new town, if we are able to sell and move, rather than take out another mortgage for another house, we plan on renting and saving up for our second home. After seeing these figures, I just can't justify doing it any other way. Maybe getting to live in a house right now is worth paying double for some people, but I'd rather put my quarter of a million dollars towards something else. If for some reason, we cannot move, I plan on doing everything I can to send in extra payments and decrease the amount of interest we pay on this house.

And by all means, internet, please, if you can give me a reason - and show me the math - of why it's better to take out a mortgage than to live in an apartment while you save for a house, do it.

Disclaimer: I based all my figures on average prices of rent and homes in my city. All calculations were done on Bankrate.com. I am not a financial advisor, I'm just a woman who knows how to use a calculator.

1. I agree, and when we move we will likely to the same thing. I've even considered selling our house now and renting for the remainder of our time in Joplin.

2. In general I completely agree. There's no arguing with the math there. However, as with most things in life, there are a lot of "it depends" with the question of whether to rent or borrow. I think there's a reason that major financial advisors like Dave Ramsey assume that everyone is going to have a mortgage. Part of that is illustrated in your post: the Anderson's are living in a (probably no more than 2 bedroom) apartment for 16 years. By the time people are looking for a place to live, your average couple is going to want a family before 16 years goes by. I personally intend to have 3 or 4 kids by the time my husband and I have been married for that long! A family of 5 or 6 is likely going to need an apartment that costs more than \$750 a month in rent. I'm not saying that your scenario is impossible, it just isn't likely going to be the route most people are realistically going to want to take.

There are just times when the most logical thing (financially speaking) isn't truly the best choice. For example, if I had stayed at my job for another 4 or 5 years we could have completely paid off our mortgage. We built our house just 3 years ago... how awesome would it have been to pay it off in less than 10 years! But the reality was that we wanted to start our family... and I wanted to be a stay at home mom. I did not want to wait until I was 30 to have kids. Sure, it would have made things a whole lot easier in terms of money, but I would have hated every bit of those years just working for the house.

So I guess I can't show you any math about why you might not choose to rent & save over having a mortgage, but there may be reasons outside of the math. My husband and I rented for 2 years while we paid off all of our debt and saved up for a downpayment on a house. I worked another 3 years to pay down the mortgage to a manageable single-income payment. And now I'm happily in a home that we intend to stay in forever, God-willing. Regardless of the math, I don't think I'd have it any other way.

3. 16 years later, that 250,000 house will now cost them close to 600,000 due to inflation. I'm just sayin!

4. You expect the value of a home to more than double over 16 years? Homes in this area, bought about 12 years ago, and sold a little over 2 years ago before the big crash, still only gained about 1.5 times and that was during the big home surge. Counting on your house to more than double is a big gamble. Besides, my savings scenario was based on putting all the cash in the lowest annual rate checking account. Most families saving for a home would choose higher yeilding savings plans accounting for average inflation. I also did not account for an increase in wages and therefore monthly savings. Therefore it would take much less time than 16 years to save - I just went the extreme route to make a simple point.

5. how does this scenario work in Ca?