Renting Vs. Buying

This is a story of two Denver residents Barbara and Kathy.  Both moved to Colorado in 2013 and started careers as teachers.  In 2014 Kathy decides to become a first time home buyer and she got preapproved for a loan and bought a house.  Hypethetically, we will say she paid $300,000 and put $0 down.  Since Kathy is a veteran serving in the US Army she was approved for a VA loan and did not need to put anything down for a down payment.  Barbara, continued to rent her 1 bed 1 bath.  Her rent in 2013 was $1000.00 and had gone up 10 % each year so she was paying just over $1200.00/month in 2016.

Kathy’s monthly Mortgage payment including PMI and property taxes was approximately $1200.00 per month and is living in a much larger space than Barbara.  Now let’s take the $1200/month for Barbara’s rent and the $1200/month for Kathy’s mortgage and break down what benefits Kathy receives as a home owner in taxes and equity from 2014 through 2016.

 

_________________________________Kathy                                                               Barbara

3 year Total Paid                             $43,200.00                                                       $39,600.00

Total Tax & Interest Paid                $25,200.00                                                       $0.0

Total Principal Paid                         $18,000.00                                                       $0.0

 

Kathy’s Principal

Okay, what is Principal?  The principal is the amount of money borrowed from the bank.  Kathy borrowed $300,000.00 so the principal is $300,000.00.  Kathy, has paid $18,000.00 toward the principal so she has a remaining balance of $282,000.00 left to pay.  This is paying equity into the home.  Think of it as a savings account, as you pay the principal you are putting dollars into an account.  If Kathy sold her house for $300,000.00 she would only owe the lender $282,000.00 and therefore would have made $18,000.00.  Granted she would have closing costs and realtor fees.

 

Kathy’s Mortgage Interest Deduction

What is a mortgage interest deduction?  The government wants to encourage us to by homes and how they do this is by allowing us to deduct our Mortgage interest payment from our taxes.  The total Kathy paid in Mortgage Interest (MI) is $25,200.00.  Let’s make our math easy by saying Kathy pays 25% tax rate.  When you take 25% of the MI over the 3 years this means Kathy will get a $6,300.00 ($25,200.00*0.25=$6,300.00) check from the federal government.   So when you see those H&R Block commercials about getting your billions back, homeowners are the ones benefiting from this particular deduction.

 

Kathy’s Home Equity

Over the last three years houses have appreciated 22.6% nationally. This comes down to economics (supply and demand).  Now this benefits Kathy and her net worth owning a home and all it means for Barbara is that she will likely be looking at paying higher rent year after year.  Let’s take the national average appreciation of 22.6% and apply it to Kathy’s current home value.  When we calculate this appreciation to the original purchase price of $300,000.00 we have a new value of $367,800.00.  This means if Kathy decided to sell her home today she would now have $67,800.00 cash just from this appreciation.

 

 

Net Worth

Now let’s talk about Barbara and Kathy’s net worth after they have both spent approximately $40,000.00 to live over the 3 year period.  Kathy, paid $18,000.00 toward the principal of the loan.  She also received a $6300.00 check from her MI deduction.  All along her home had appreciated 22.6% or $67,800.00.  Kathy’s total Net Worth Gain over 3 years as a home owner $92,100.00.   Barbara, meanwhile was unable to benefit from any tax or equity gains and is only thinking of how much her rent will rise over the next few years.

 

______________________________Kathy                                              Barbara

3 year Total paid                      -$43,200.00                                     -$39,600.00

Total Tax Rebate                       $6,300.00                                        $0.0

Total Principal Paid                   $18,000.00                                      $0.0

Appreciation Equity                  $67,800.00                                       $0.0

Total Net Gain/Loss                 $48,900.00                                      -$39,600.00

 

Difference in Net Worth over 3 years                  Kathy +                 $88,500.00

 

Renting Vs. Buying

This is a unique scenario puting the buyer way ahead of the renter as far as Total Net Worth.  The Denver housing industry has been red hot over these few years and the homeowner is benefiting from it.  Now if this scenario was from 2006-2008 the buyer would have surely lost.  Home prices crashed and homeowners were underwater with their mortgages oweing more than what the home was worth.  Buying a home can certainly go either way and we caution you to make an informed decision.  Now if Kathy bought in 2007 just before the crash and kept the house until today her home would surely be worth more today.  Home prices are fluid and ever changing because of this we advocate buying and holding for the long turm.  Owning a home has a number of great benefits; more space for the same price as renting, MI tax deductions, paying off principal and building net worth.  If you are curious about buying and learning more about how owning a home can add to your bottom line please give us a call 720.204.8793.