A large portion of the renting population out there face a few fears about owning a home. It will cost too much. If I don’t pay my mortgage, they’ll take my home. I don’t have the money for a down payment. The list goes on. This article is designed to show you that owning is cheaper than renting, long term.
Let’s consider a couple in their 20’s renting a 2 bedroom apartment in Scottsdale with an annual combined income of $40,000.00. For the sake of this article, we’ll leave out non-discretionary spending such as utilities, phone bills, car payments, etc., and we’ll focus solely on a comparison of rent vs. mortgage.
In some areas of Scottsdale, you can pickup a nice 2-bedroom apartment for $1000/month. That’s $12,000.00/year. This is the first step in determining how much house you can afford, because it all depends on how much cashflow you have. If, from month to month, you find that you are spending what you are making, then you’re breaking even.
A Renter Breaking Even
Rent is money paid to someone else who owns. Rent is a monthly expense that cannot be deducted from your income at tax time, and is considered a total loss.
When someone rents and breaks even on their income and expenses, they are losing ground in the marketplace. Inflation is slowly chipping away at their dollar over time. If their income level doesn’t meet or exceed the increase in cost of living through inflation, that person will eventually find him/herself in trouble.
An Owner Breaking Even
The principal portion of your monthly mortgage payment is like automatic savings. When you write that check every month, part of the money goes towards the interest, and part of it goes towards your home. If you eventually sell your home, you will recover the principal and you may even be able to draw on that principal to remodel your home or go on a vacation. The brilliant part of this financial situation is that all of the interest portion of your payment can be deducted from your income at the end of the year.
A Renter’s Income
In our example above, Joe and Judy Renter, making $40,000.00/year will find themselves in the 15% tax bracket. This means that at the end of the year, they will owe the IRS roughly $5197.50. This leaves them with $34802.50 for living expenses. From that we subtract $12,000.00 for rent. Joe and Judy now have $22,802.50 for all other living expenses.
An Owner’s Income
Bob and Lisa Owner chose a different route. They decided to purchase a home. Joe and Judy are spending $1000.00/month on rent, so we’ll figure out the price of a home that would require $1000.00/month mortgage payment to keep the cash flow on even keel.
Not everyone will have the same credit score, and as a result, not everyone’s payment will be the same on a single home. Today’s interest rate is roughly 6% on a 30 Year fixed mortgage, which is what we’ll use as a model.
With $20,000.00 down, Bob and Lisa were able to afford a home priced at $187,000.00. Their loan, at 6%, was $167,000.00. Their monthly payment is $1000.00.
So what’s different about these two situations? Joe and Judy, Bop and Lisa all make $40,000/year and spend $12,000.00/year on their housing. How can that be any different?
Here’s Why Bob and Lisa Spend Less
Over the course of their first year of mortgage payments, Bob and Lisa paid out $9956 in interest, and $2044.00 in principal payments. They also fall in the 15% tax bracket. The difference is that we get to subtract the interest they paid from their taxable income. Rather than showing that they made $40,000.00, they get to deduct the $9956.00 in interest. Their total taxable income is only $30,044.00. After applying the 15% tax bracket to their income, they owe the IRS $3704.10. Not only did they save nearly $1500.00 on their taxes, they also “deposited” $2044.00 in equity in their home. With long term average home values increasing at a rate of 7%, they have essentially invested their $2044.00 at 7% and will recover it.
Conclusion
Bob and Lisa spent the same amount of money during the year that Joe and Judy spent, but at the end of it all, Bob and Lisa have increased their wealth by $3544.00. With the tax savings, they can invest. With a mortgage, they have automatic savings in their home’s equity. The only difference between the two couples is that one couple decided to spend less so they could afford the downpayment.
Renters are typically caught in a pattern of spending, thinking they’ll never get out. In the future, it’s possible that Joe and Judy may end up renting Bob and Lisa’s house, which means Joe and Judy will be putting $3500/year into Bob and Lisa’s pockets while Bob and Lisa move on to their next home investment, continuing to build wealth.
If this article inspires you to quit renting, we’re ready to help you get out of the spending pattern! Let us know what your situation is today by filling out the form below:
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