The riskiness of home ownership

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bligh
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Re: The riskiness of home ownership

Post by bligh » Wed Oct 26, 2016 11:59 am

Another factor about house price risk is that house prices are local. You get rewarded with returns for taking on this risk. Compare Vancouver to Atlantic city. One homeowner made out like a bandit, the other was left holding the bag. A renter in Vancouver is cursing his luck, a renter in Atlantic city is looking to move to where the jobs are.

When you buy a house, you are essentially making a medium to long term bet mostly on the local economy. In some cases you are also making a bet on technology and industry. What do I mean by that? Well, the inner cities saw a long period of decline with the rise of the highway system and the suburban sprawl it enabled. As you can imagine, this was not good for inner city homeowners. To this day, house prices on a per sq ft basis in South Central LA, (which from a convenience perspective are ideal) are much lower than decent suburbs. Anyone from SoCal will tell you this.

Let's talk about one example in the news. How the rise of self driving tech will affect house prices in the next 10-30 years is anyone's guess. It could accelerate gentrification as millennials shift to dropping cars entirely in favor of ubering short distances. Or it could lead to a spike in house prices in the exurbs as people are now able to live further away from where they work because their self driving electric vehicles no longer impose as much of a burden and they get way more bang for the buck outside the city. Who knows?

That is just one example of social, economic and technological dynamics that are always at play. Sinking a significant percentage of your assets into something is always going to be a risk vs not doing so. It is by definition the opposite of diversification. You are focusing your bet on the local economy, while holding a job there, and while maintaining exposure to the nation and worldwide risks of changing times.

There is risk, and often that risk is rewarded handsomely.

KlangFool
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Re: The riskiness of home ownership

Post by KlangFool » Wed Oct 26, 2016 12:27 pm

freebeer wrote:
KlangFool wrote:...2 rules ...
1) The house's price has to be 1/2 to 1/3 of your net worth excluding the house.
...
KF, two questions about your rules:

1. Your rule 1 (quoted above) reads like it means NO MORE than 1/2 and NO LESS than 1/3 of net worth. But, I don't understand why it would be a rule not to buy a house worth less than that (y current house's price is about 15% of net worth excluding the house). Did you perhaps mean NO MORE than than a fuzzy threshold somewhere between 1/2 and 1/3 of net worth with no lower threshold?

2. Your rule 2 (PITI < rent) would seem to be somewhat income-dependent not net-worth dependent and also highly dependent on the loan type chosen. For example if PITI < rent for a 30 year mortgage but I want to pay it off faster and have the income to do so, but the 15-year mortgage is > rent, why is that necessarily added risk? Contrariwise if the only way to make rule 2 work was to get a sketchy adjustable-rate mortgage instead of a conventional 30-year mortgage, that might be a higher-risk proposition? And of course if you put 50% cash down or more you can have any PITI you want. Perhaps you meant not literally to not take more actual PITI than equivalent rent in a given situation but to compare PITI with conventional 30-year financing to renting SAME house and only buy if former is lower (even if the actual financing will be different)?
freebeer,

1) Your understanding is correct. That mean I could pay off the mortgage if I want to.

2) I use 20% down payment and 30 years mortgage as the benchmark. But, for the house that I bought even if I use 15 years mortgage, it was about the same. In my case, it was $2,300 (rent) versus $1,800 (buy).

KlangFool
Last edited by KlangFool on Wed Oct 26, 2016 12:44 pm, edited 1 time in total.

KlangFool
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Re: The riskiness of home ownership

Post by KlangFool » Wed Oct 26, 2016 12:29 pm

BW1985 wrote:
freebeer wrote:
KlangFool wrote:...2 rules ...
1) The house's price has to be 1/2 to 1/3 of your net worth excluding the house.
...
KF, two questions about your rules:

1. Your rule 1 (quoted above) reads like it means NO MORE than 1/2 and NO LESS than 1/3 of net worth. But, I don't understand why it would be a rule not to buy a house worth less than that (y current house's price is about 15% of net worth excluding the house). Did you perhaps mean NO MORE than than a fuzzy threshold somewhere between 1/2 and 1/3 of net worth with no lower threshold?

2. Your rule 2 (PITI < rent) would seem to be somewhat income-dependent not net-worth dependent and also highly dependent on the loan type chosen. For example if PITI < rent for a 30 year mortgage but I want to pay it off faster and have the income to do so, but the 15-year mortgage is > rent, why is that necessarily added risk? Contrariwise if the only way to make rule 2 work was to get a sketchy adjustable-rate mortgage instead of a conventional 30-year mortgage, that might be a higher-risk proposition? And of course if you put 50% cash down or more you can have any PITI you want. Perhaps you meant not literally to not take more actual PITI than equivalent rent in a given situation but to compare PITI with conventional 30-year financing to renting SAME house and only buy if former is lower (even if the actual financing will be different)?
I'm also curious about rule 2, does that assume a 30 year mortgage? For me a 30yr would have been cheaper than rent but I chose a 15yr for the lower rate but my PITI is more than rent.
BW1985,

I meant 30 years but for my actual house purchase, the PITI is about the same as rent with 15 years.

KlangFool
Last edited by KlangFool on Wed Oct 26, 2016 12:45 pm, edited 1 time in total.

KlangFool
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Re: The riskiness of home ownership

Post by KlangFool » Wed Oct 26, 2016 12:37 pm

juanovo wrote:KlangFool,

1) For the most part I agree with your conclusions to the extent that I agree with your assumptions. I also realized that this is premised on folks renting "less house" than they end up buying. I believe that this is generally true. I started to wonder why it is so true that folks rent less than they buy.

I believe now that folks generally rent a "house" and buy a "home". If folks rented "homes" and bought "homes" or rented "houses" and bought "houses" the situation would skew more (not necessarily completely) to ownership.

What's your take?

2) Retrospectively I probably should not have bought my house, but it was 2009 I got a good deal for the Bay Area. I have been able to rent out part of the house. I live in a rent controlled area but my unit is not subject to rent control. At the same time I wasn't maxing my 401k, renting or buying. Buying actually allowed me to increase my contributions due to the rental income I started to receive, but it was a huge amount of debt vs. my income. It has appreciated considerably--but honestly it was a HUGE risk, and I just got lucky.
juanovo,

<< I believe now that folks generally rent a "house" and buy a "home". If folks rented "homes" and bought "homes" or rented "houses" and bought "houses" the situation would skew more (not necessarily completely) to ownership. >>

Why should a person spend MORE on housing just because they are buying? In fact, a person should spend LESS if they are buying in order to be probably compensated for THE RISK.

I am willing to pay $2,300 to rent a townhouse. But, I am only willing to pay $1,800 PITI to buy the similar townhouse. Most people THINK differently and they got themselves into trouble.

To me, my house is a consumption item aka expense. There is no difference between PITI and RENT. With my position, I do not care about the house price. I am always ahead in my housing expense because of imputed rent. I made money from buying my house all the time. I do not have to sell my house in order to make money.

KlangFool

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Wed Oct 26, 2016 1:05 pm

KlangFool wrote: Why should a person spend MORE on housing just because they are buying? In fact, a person should spend LESS if they are buying in order to be probably compensated for THE RISK.
I don't mean to condone it per se, but the usual answer is that you get a lot of that money back when you sell the house, whereas when renting you don't. If you compare buy vs. rent where PITI=rent, then you are expected to come out ahead with regard to net worth - in the long run - when you sell the house. Therefore one can generally "afford" to buy more than they can rent. This assumes a few things, like that you can actually afford the monthly PITI in the short term, and that your house price grows reasonably.

You can use the NYTimes Buy vs. Rent calculator to see all of this for yourself. Go here: http://www.nytimes.com/interactive/2014 ... .html?_r=0. Simply taking the default settings (how they are when you load it up), you'll see that the recurring costs of housing (PITI) are $163,398, which divided by 9 years (the default assumed length of ownership; you can change it) gives you a monthly PITI+reno costs of $1512 (if you exclude assumed reno costs and just look at PITI, it's $1294/month in the first year). The equivalent renting cost, i.e. the one that provides you with the net worth upon selling, is $884 (at the start; it's assumed that rent price increases through time). Hence you should be more willing to pay a high PITI than a high rent, from the perspective of long-term value.

Again, the exact numbers depend entirely on the assumptions that go into the calculation. Go ahead and play with them. E.g. Suppose that your home value actually doesn't increase (0% growth), but the stock market has a good 9 years of average 7% growth. Then for a PITI+reno cost of $1,460/month (again $1294 for just starting PITI), the equivalent rent price is $1,482 - i.e. you can actually afford to rent more! The reason here is that putting a lot of money in the house didn't work out well - it failed to grow in value, when all that money could have been put into the market and given you a big reward. So it all depends on what the future holds. None of us knows the future, so we simply have to see what ranges of outcomes are possible and choose what fits our risk-reward preferences. That was the purpose of my stochastic model.

In any case, I think most of us agree that one should probably never buy a house that requires them to stretch or be "house poor". Make sure you can continue to make those payments even when the going gets rough.

Admiral
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Re: The riskiness of home ownership

Post by Admiral » Wed Oct 26, 2016 1:47 pm

KlangFool wrote: Why should a person spend MORE on housing just because they are buying? In fact, a person should spend LESS if they are buying in order to be probably compensated for THE RISK.

KlangFool
This is a false equivalency. There is plenty of risk in renting: 1) rent goes up every year 2) you are forced to move out of the area because rents are too high, forcing you to change your lifestyle or get a new job, or send kids to a new school 3) You have a landlord who does not make reasonable improvements, impacting your quality of life and/or pocketbook. 4) The property is sold and you must move, and see above. Most people get to a point in their lives (usually when they have kids) that need housing and price stability, for one reason or another.

And, an I noted earlier, even if one assumes no market appreciation over time, a fixed mortgage becomes cheaper while rent becomes more expensive owing to inflation. Over 15-30 years this can be a significant delta.

soboggled
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Re: The riskiness of home ownership

Post by soboggled » Wed Oct 26, 2016 1:55 pm

The issue posed is RISK. NYT calculations assume everything goes well, e.g., there is no housing bubble, you can always meet the payments, your needs remain the same, you never have to sell quickly and there are no other major unforeseen events.

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Wed Oct 26, 2016 1:58 pm

soboggled wrote:The issue posed is RISK. NYT calculations assume everything goes well, e.g., there is no housing bubble, you can always meet the payments, your needs remain the same, you never have to sell quickly and there are no other major unforeseen events.
Default assumptions, yes. You can play with them. Put the house value growth rate to be negative, for example. Change the length of ownership to 4 years, as if you suddenly were forced to move. Increase the insurance rate if you live in a high insurance rate area. Change the investment return rate to negative if you want to see what happens if the market crashes. Obviously it doesn't include everything, but there are a lot of moving parts.

soboggled
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Re: The riskiness of home ownership

Post by soboggled » Wed Oct 26, 2016 2:04 pm

If you are in a non-recourse state the risk of owning is reduced a bit as you can walk away though you lose down payment and credit rating will take a hit (I know some have ethical problems with this, but remember it's probably priced into the mortgage rates you are paying.)

KlangFool
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Re: The riskiness of home ownership

Post by KlangFool » Wed Oct 26, 2016 2:05 pm

Admiral wrote:
KlangFool wrote: Why should a person spend MORE on housing just because they are buying? In fact, a person should spend LESS if they are buying in order to be probably compensated for THE RISK.

KlangFool
This is a false equivalency. There is plenty of risk in renting: 1) rent goes up every year 2) you are forced to move out of the area because rents are too high, forcing you to change your lifestyle or get a new job, or send kids to a new school 3) You have a landlord who does not make reasonable improvements, impacting your quality of life and/or pocketbook. 4) The property is sold and you must move, and see above. Most people get to a point in their lives (usually when they have kids) that need housing and price stability, for one reason or another.

And, an I noted earlier, even if one assumes no market appreciation over time, a fixed mortgage becomes cheaper while rent becomes more expensive owing to inflation. Over 15-30 years this can be a significant delta.
Admiral,

<< There is plenty of risk in renting: 1) rent goes up every year 2) you are forced to move out of the area because rents are too high, forcing you to change your lifestyle or get a new job, or send kids to a new school 3) You have a landlord who does not make reasonable improvements, impacting your quality of life and/or pocketbook. 4) The property is sold and you must move, and see above. Most people get to a point in their lives (usually when they have kids) that need housing and price stability, for one reason or another.>>

The basic assumption of your risk about renting is the person has job security. Given that many of us do not have that, those risks are not relevant to many of us. We are not lucky enough to be around any place long enough to have that problem.

You are a very lucky person.

I had faced annual and quarterly laid off from my employers over the last 10+ years. I was unemployed for more than a year multiple times. Many of my peers in the 40s and 50s had been long-term unemployed and under-employed. Been forced to move across the country in order to find employment is a normal occurrence among my peers.

KlangFool
Last edited by KlangFool on Wed Oct 26, 2016 2:12 pm, edited 1 time in total.

Admiral
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Re: The riskiness of home ownership

Post by Admiral » Wed Oct 26, 2016 2:11 pm

KlangFool wrote:
The basic assumption of your risk about renting is the person has job security. Given that many of us do not have that, those risks are not relevant to many of us. We are not lucky enough to be around any place long enough to have that problem.

You are a very lucky person.

KlangFool
I won't argue that. However--and to your point, I suppose--we are able to pay our mortgage on one income, even though we currently have two. This is the result not of luck but of prudence in home buying. To some extent, the housing market cannot be predicted. But, to some extent, it can. I would posit that only a fool would buy beachfront property anywhere from Florida to, say, Maine.

Nate79
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Re: The riskiness of home ownership

Post by Nate79 » Wed Oct 26, 2016 2:28 pm

This is a very interesting thread and topic. A few thoughts I've had when reading about these topics.

1. Does the analysis consider the life expectancy of the person when they first own or rent and lifetime cost of housing? In other words a 15y or 30y mortgage taken early in life sets one up to have very cheap housing late in life. So when I did the analysis in my own case I compare rent vs buy over 60y, not just the 30y loan period.
2. Does the opportunity cost of rent vs buy compare to similar investment (maybe something like TIPS bond)? Comparing to 100% stock return is disingenuous.

rbaldini
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Re: The riskiness of home ownership

Post by rbaldini » Wed Oct 26, 2016 2:31 pm

Nate79 wrote:This is a very interesting thread and topic. A few thoughts I've had when reading about these topics.

1. Does the analysis consider the life expectancy of the person when they first own or rent and lifetime cost of housing? In other words a 15y or 30y mortgage taken early in life sets one up to have very cheap housing late in life. So when I did the analysis in my own case I compare rent vs buy over 60y, not just the 30y loan period.
2. Does the opportunity cost of rent vs buy compare to similar investment (maybe something like TIPS bond)? Comparing to 100% stock return is disingenuous.
1. The NYTimes page and the model I did assumes a certain mortgage length AND a length of time you will live there. The default "living-there" time for NYTimes is 9 years (not sure where that number is from - perhaps it's an average?). If you believe you're actually going to stay at your property for 60 years (I almost certainly will not!), then you can choose that number in the NYTimes page if you wish.
2. The NYTimes asks you to provide an "investment return rate". You can see it at whatever you want. The default is 4%, I believe - closer to historical value for bonds than stocks. But you can put it negative to run the scenario that a crash happens, etc.

juanovo
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Re: The riskiness of home ownership

Post by juanovo » Wed Oct 26, 2016 3:05 pm


juanovo,

<< I believe now that folks generally rent a "house" and buy a "home". If folks rented "homes" and bought "homes" or rented "houses" and bought "houses" the situation would skew more (not necessarily completely) to ownership. >>

Why should a person spend MORE on housing just because they are buying? In fact, a person should spend LESS if they are buying in order to be probably compensated for THE RISK.
KlangFool,

I agree with your conclusion but not your premise. I believe that if there were not cultural biases against renting and for home ownership then people would spend MORE on rental properties than they do now because they would view the renting as a long term rather than something to get through.

I believe that people spend LESS on rentals because they view renting as a short term experience to sacrifice and get through in order to achieve their goal of owning a home. i believe this is a simple case of delayed gratification. If the majority of renters truly considered the rental as a long term option the calculus would change as I believe they would raise their standard of acceptable housing. An equivalent example is that I am willing to accept lower pay or a less desirable job for a short period of time if I saw it as a means to get to work for the company I am interested in or until the economy turns back up. If I viewed the job as a percent or long term proposition I would likely not accept the job.

To be clear I am not saying I agree with the bias toward home ownership--I don't. But I also don't believe that people accept a non-equivalent and lower cost rental with the same expectations of living there long term like they do when they buy a house. Should they rent or buy based on the prospect of long term living and therefore have a more equivalent location rental? Yes , but I don't believe they do.

liberty53
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Re: The riskiness of home ownership

Post by liberty53 » Wed Oct 26, 2016 3:39 pm

rbaldini wrote:
You can use the NYTimes Buy vs. Rent calculator to see all of this for yourself. Go here: http://www.nytimes.com/interactive/2014 ... .html?_r=0. Simply taking the default settings (how they are when you load it up), you'll see that the recurring costs of housing (PITI) are $163,398, which divided by 9 years (the default assumed length of ownership; you can change it) gives you a monthly PITI+reno costs of $1512 (if you exclude assumed reno costs and just look at PITI, it's $1294/month in the first year). The equivalent renting cost, i.e. the one that provides you with the net worth upon selling, is $884 (at the start; it's assumed that rent price increases through time). Hence you should be more willing to pay a high PITI than a high rent, from the perspective of long-term value.

Again, the exact numbers depend entirely on the assumptions that go into the calculation. Go ahead and play with them. E.g. Suppose that your home value actually doesn't increase (0% growth), but the stock market has a good 9 years of average 7% growth. Then for a PITI+reno cost of $1,460/month (again $1294 for just starting PITI), the equivalent rent price is $1,482 - i.e. you can actually afford to rent more! The reason here is that putting a lot of money in the house didn't work out well - it failed to grow in value, when all that money could have been put into the market and given you a big reward. So it all depends on what the future holds. None of us knows the future, so we simply have to see what ranges of outcomes are possible and choose what fits our risk-reward preferences. That was the purpose of my stochastic model.

In any case, I think most of us agree that one should probably never buy a house that requires them to stretch or be "house poor". Make sure you can continue to make those payments even when the going gets rough.
A few years ago I wanted to model early retirement. I was sitting on a very expensive house in a HCOL area, with associated high taxes and maintenance costs for the house. The NYTimes calculator was the best tool to compare downsizing and the rent vs buy decision. I decided to reverse engineer the calculator in excel so I could compare multiple scenarios simultaneously. I found the calculator to be very thorough. There wasn't anything missing that I could see as far as variables. To me, these rent vs buy arguments only need to be resolved by pointing to the online calculator.

Of course, everyone would still argue about the intangible aspects of buying vs renting.


The result for me is that we sold in 2014, I got rid of tons of accumulated possessions, moved to a nice modern apartment close by, and gave up raking leaves, painting, and other repairs. The market has been very nice to me with the home equity that was unlocked by selling the house. I did move to another apartment when the rent went up, but got a better apartment, lower rent, and went through another round of reducing possessions. I am now retired :D

I think your stochastic model would be very useful.

soboggled
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Re: The riskiness of home ownership

Post by soboggled » Wed Oct 26, 2016 4:02 pm

And some people would be absolutely miserable in an apartment. In housing intangibles matter a lot. (I would like one if I could find one large enough - unfortunately not available where I am. Perhaps more amenable when we are quite young or quite old.)
Last edited by soboggled on Wed Oct 26, 2016 4:04 pm, edited 1 time in total.

SQRT
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Re: The riskiness of home ownership

Post by SQRT » Wed Oct 26, 2016 4:04 pm

Boy, emotions run high on real estate. For me ownership is control. I like control but realize it costs quite a bit. Owning homes (we have 4) is a lifestyle decision with costs (a lot) and benefits (also a lot). I didn't buy these places with a view to make money, but rather to enjoy them. I didn't buy them until I could afford to pay cash and my investment portfolio has increased more over the years than real estate has, even in Toronto (not sure about Vancouver). Real estate is a place to live and enjoy life. No more no less. Buy a house that suits you, you can afford, and pay the mortgage off as appropriate. Or rent and save the difference. Up to you.

TomCat96
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Re: The riskiness of home ownership

Post by TomCat96 » Wed Oct 26, 2016 6:36 pm

SQRT wrote:Boy, emotions run high on real estate. For me ownership is control. I like control but realize it costs quite a bit. Owning homes (we have 4) is a lifestyle decision with costs (a lot) and benefits (also a lot). I didn't buy these places with a view to make money, but rather to enjoy them. I didn't buy them until I could afford to pay cash and my investment portfolio has increased more over the years than real estate has, even in Toronto (not sure about Vancouver). Real estate is a place to live and enjoy life. No more no less. Buy a house that suits you, you can afford, and pay the mortgage off as appropriate. Or rent and save the difference. Up to you.

Emotions run high on many things. The best way to remain neutral about this is to ask yourself where is the line, objectively?

At what point is it better to rent, and at what point is it better to buy? Don't answer that subjectively. Actually find the exact dollar value.
The math required does not exceed algebra 2.

In my models, even renting out an entire house for the cost of the mortgage was inferior to putting the money into stocks.
But how can that be? With rent 100% of your costs are being wasted, while with a mortgage, at least some portion is going into equity.

But what about that giant 20% downpayment? In the rent scenario you invest it. In the housing scenario, you put it into the house. If you didn't have the 20% downpayment, you would just keep renting because you don't have a housing option. (I didn't consider all interest loans)

There's also the additional fees with homeownership:
1. Property taxes - deductability of property taxes.
2. HOA fees
3. Maintenance fees.
4. Reduction of any rental income by your marginal tax rate.

Do the property taxes, HOA fees, and maintenance exceed the gains in equity?

From my calculations, the dollar amount at which it's better to buy instead of rent is surprisingly high. Even if you could find a mortgage for the same amount as renting, the opportunity costs forgone from the downpayment and the additional costs of homeownership make it so that you are still mathematically still better off renting.

Of course buying a home is emotional decision. Man cannot live on math alone. But I think after running some numbers people will realize home ownership is more consumption than investment. There's nothing wrong with consumption. I don't view buying clothes to stay warm as
"investment" even as the benefits clearly outweigh the costs. But finding the exact number helps take the emotions out of it. At the outset it says one side will be right some of the time, and the other will correct the other part of the time, and the point is to figure out when each is correct.

KlangFool
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Re: The riskiness of home ownership

Post by KlangFool » Wed Oct 26, 2016 7:14 pm

Folks,

There are essential 2 ways to look at the house that you buy and live in.

A) It is the same as an expensive car. Aka, it is an expense. I do not care about the value of my house. It is a consumption item. I only look at imputed rent.

B) It is an investment. People that count on their house to make money fo them. For some people, it is their only asset.

People that think like (A) will spend a small percentage of their income and net worth on the house. The reverse is true for (B). Most people are somewhere between (A) and (B).

KlangFool

Dottie57
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Re: The riskiness of home ownership

Post by Dottie57 » Wed Oct 26, 2016 8:09 pm

KlangFool wrote:Folks,

There are essential 2 ways to look at the house that you buy and live in.

A) It is the same as an expensive car. Aka, it is an expense. I do not care about the value of my house. It is a consumption item. I only look at imputed rent.

B) It is an investment. People that count on their house to make money fo them. For some people, it is their only asset.

People that think like (A) will spend a small percentage of their income and net worth on the house. The reverse is true for (B). Most people are somewhere between (A) and (B).

KlangFool
There is a third option.

I think of my home as a pleasure and a retreat from a busy and sometimes harsh world. A place to meet with friends and socialize.

I did not think of it as an investment guaranteed to grow or as a consumable. Emotional - yes. But everything does not need to be reduced to $.

KlangFool
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Re: The riskiness of home ownership

Post by KlangFool » Wed Oct 26, 2016 8:20 pm

Dottie57 wrote:
KlangFool wrote:Folks,

There are essential 2 ways to look at the house that you buy and live in.

A) It is the same as an expensive car. Aka, it is an expense. I do not care about the value of my house. It is a consumption item. I only look at imputed rent.

B) It is an investment. People that count on their house to make money fo them. For some people, it is their only asset.

People that think like (A) will spend a small percentage of their income and net worth on the house. The reverse is true for (B). Most people are somewhere between (A) and (B).

KlangFool
There is a third option.

I think of my home as a pleasure and a retreat from a busy and sometimes harsh world. A place to meet with friends and socialize.

I did not think of it as an investment guaranteed to grow or as a consumable. Emotional - yes. But everything does not need to be reduced to $.
Dottie57,

You do not care whether the house worth some money. By definition, it is (A).

KlangFool

SQRT
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Re: The riskiness of home ownership

Post by SQRT » Wed Oct 26, 2016 11:34 pm

TomCat96 wrote:
SQRT wrote:Boy, emotions run high on real estate. For me ownership is control. I like control but realize it costs quite a bit. Owning homes (we have 4) is a lifestyle decision with costs (a lot) and benefits (also a lot). I didn't buy these places with a view to make money, but rather to enjoy them. I didn't buy them until I could afford to pay cash and my investment portfolio has increased more over the years than real estate has, even in Toronto (not sure about Vancouver). Real estate is a place to live and enjoy life. No more no less. Buy a house that suits you, you can afford, and pay the mortgage off as appropriate. Or rent and save the difference. Up to you.

Emotions run high on many things. The best way to remain neutral about this is to ask yourself where is the line, objectively?

At what point is it better to rent, and at what point is it better to buy? Don't answer that subjectively. Actually find the exact dollar value.
The math required does not exceed algebra 2.
Too many subjective considerations. Like I said I want control and am willing to pay for it. How do you model that? I know exactly how much each of my houses cost. It would be very difficult to justify on a straight economic basis. But I don't care. I can obviously afford if and like the lifestyle. For me these are lifestyle choices not investment decisions. Probably not representative. But does illustrate some of the challenges inherent in modelling home ownership.

freebeer
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Re: The riskiness of home ownership

Post by freebeer » Thu Oct 27, 2016 12:13 am

KlangFool wrote:
BW1985 wrote:
freebeer wrote:
KlangFool wrote:...2 rules ...
1) The house's price has to be 1/2 to 1/3 of your net worth excluding the house.
...
KF, two questions about your rules:

1. Your rule 1 (quoted above) reads like it means NO MORE than 1/2 and NO LESS than 1/3 of net worth. But, I don't understand why it would be a rule not to buy a house worth less than that (y current house's price is about 15% of net worth excluding the house). Did you perhaps mean NO MORE than than a fuzzy threshold somewhere between 1/2 and 1/3 of net worth with no lower threshold?

2. Your rule 2 (PITI < rent) would seem to be somewhat income-dependent not net-worth dependent and also highly dependent on the loan type chosen. For example if PITI < rent for a 30 year mortgage but I want to pay it off faster and have the income to do so, but the 15-year mortgage is > rent, why is that necessarily added risk? Contrariwise if the only way to make rule 2 work was to get a sketchy adjustable-rate mortgage instead of a conventional 30-year mortgage, that might be a higher-risk proposition? And of course if you put 50% cash down or more you can have any PITI you want. Perhaps you meant not literally to not take more actual PITI than equivalent rent in a given situation but to compare PITI with conventional 30-year financing to renting SAME house and only buy if former is lower (even if the actual financing will be different)?
I'm also curious about rule 2, does that assume a 30 year mortgage? For me a 30yr would have been cheaper than rent but I chose a 15yr for the lower rate but my PITI is more than rent.
BW1985,

I meant 30 years but for my actual house purchase, the PITI is about the same as rent with 15 years.

KlangFool

OK then I like your two rules so you are wrong (someone likes them!). I even think I have followed them all my life through 6 home purchases! OTOH had I stretched to buy a nice house in Palo Alto when in early working years... I might have a MUCH higher net worth now... :confused

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Re: The riskiness of home ownership

Post by Caduceus » Thu Oct 27, 2016 4:12 am

I think folks are conflating two different questions. How much home to buy is not the same question as whether to rent or buy that given home.

You will almost always come out ahead, financially speaking, by buying a smaller house to live in and investing the surplus. (If real estate is such a good investment, you can live in a small house and use your excess cash to buy investment property in the same area. That much should be obvious. You will earn more as a landlord collecting rents than consuming the entirety of the imputed rents by living in the house.)

Once you've decided on the type of house to buy, deciding how to finance it - whether to buy it or rent it - can be modeled. There are costs to both decisions. When you rent, the cost is the monthly rent. When you buy, the cost is the amortized interest that does not go to building equity as well as the accumulated property taxes and maintenance.

There are probably no good rules of thumb, given how local real estate is, but to the extent there are rules, I think these are it: Choose the smallest house you can be happy in, then decide rationally whether to finance it through a mortgage or rent based on a realistic modeling of all the variables.

People generally don't go too far wrong in their decision whether to buy or rent, since financial markets are relatively efficient in the medium term at sorting out the interest costs; where people go wrong is buying too much house in the first place, then deluding themselves into thinking it's a great "investment." There's nothing wrong with wanting a big house; just don't kid yourself about what it represents.

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Re: The riskiness of home ownership

Post by Engineer250 » Thu Oct 27, 2016 9:14 am

EnjoyIt wrote:I really don't understand why the arguing. If we go with the fact that MOST home consumers do the following:

1) Buy a larger home than they rent
2) Churn houses once every ~7 years
3) On average home prices only keep up with inflation or slightly above it.
Disagree with your assumptions.

1) Downgraded by about 300 sq ft when I went from renting to buying. I agree with what others have said, some people rent small places because they see it as "temporary". But just as often I've seen people rent larger places because it's cheaper than buying, so they can afford to rent a "nicer" place.

2) I think this is what it was during the downturn, but is higher now (13 years or so).

3) In my county home prices went up by 4% last year, rents by 6%. BLS says CPI for a large city in my region was 2.4% from last September to this September. So while the government uses certain measures for inflation and increases social security or federal interest rates accordingly, real life inflation might be much higher. Do I expect that to continue year over year every year? Absolutely not. But home ownership is as good an inflation hedge as half the things people invest in for such purposes.

I bought a house for much the same reason airlines buy fuel contracts. It's nice to lock in the price of something. It's possible the airlines might make a mistake, they may end up paying more for fuel than it's going for on the market because the price of oil unexpectedly dropped, but I'd bet most airlines would buy a 30 year fuel contract today if they could. It's helpful to have fixed and expected costs. Secondarily, inflation is always going to be a thing, to some extent. Even in today's "low inflation" environment.
Where the tides of fortune take us, no man can know.

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Re: The riskiness of home ownership

Post by KlangFool » Thu Oct 27, 2016 9:26 am

Engineer250 wrote:
EnjoyIt wrote:I really don't understand why the arguing. If we go with the fact that MOST home consumers do the following:

1) Buy a larger home than they rent
2) Churn houses once every ~7 years
3) On average home prices only keep up with inflation or slightly above it.
Disagree with your assumptions.

1) Downgraded by about 300 sq ft when I went from renting to buying. I agree with what others have said, some people rent small places because they see it as "temporary". But just as often I've seen people rent larger places because it's cheaper than buying, so they can afford to rent a "nicer" place.

2) I think this is what it was during the downturn, but is higher now (13 years or so).

3) In my county home prices went up by 4% last year, rents by 6%. BLS says CPI for a large city in my region was 2.4% from last September to this September. So while the government uses certain measures for inflation and increases social security or federal interest rates accordingly, real life inflation might be much higher. Do I expect that to continue year over year every year? Absolutely not. But home ownership is as good an inflation hedge as half the things people invest in for such purposes.

I bought a house for much the same reason airlines buy fuel contracts. It's nice to lock in the price of something. It's possible the airlines might make a mistake, they may end up paying more for fuel than it's going for on the market because the price of oil unexpectedly dropped, but I'd bet most airlines would buy a 30 year fuel contract today if they could. It's helpful to have fixed and expected costs. Secondarily, inflation is always going to be a thing, to some extent. Even in today's "low inflation" environment.
Engineer250,

The question is do you pay more in PITI versus rent?

Yes or no.

If yes, you had increased your housing expense. You may justify your reasoning by claiming that you had hedged your housing expense. But, you still choose to pay more when you buy versus rent.

No. Why do you need to argue / claim that the house price / rent had gone up? You do not have to. You had cut your housing expense by buying even if the house price / rent stayed the same.

<<Secondarily, inflation is always going to be a thing, to some extent.>>

Which may or may not be relevant to your housing expense.

<<In my county home prices went up by 4% last year, rents by 6%. >>

In my area, the house price went up even more. But, it is still below 2004/2005 level. Meanwhile, the rent stays at the 2012 level.

It is very simple.

Some people choose to pay more when they buy. They justified their reasoning by claiming that the house price will go up and so on.

Meanwhile, some people choose to pay less when they buy. They justified their reasoning by claiming that they should be compensated for taking on the additional risk of house ownership.

You made your money when you buy. If you do not know whether you are making money when you buy, it is probably a lousy deal. Do not buy.

KlangFool

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Re: The riskiness of home ownership

Post by Admiral » Thu Oct 27, 2016 10:09 am

We're going round and round here, trying to make a general rule for something that is very dependent on specific markets, on timing, on price, and so on. If I bought my house in 2006 and then tried to sell in 2009, I got killed. If I bought in 2009 and sold this year, I made a bundle. It's just impossible to predict if it's a good "investment" or not. Over 30 years, we can assume it will keep up with inflation (as Shiller has found, I believe.)

Not every choice in life is about money. There are emotional concerns. I happen to like fixing up my house, it gives me pleasure working on something I own and improving it for my own (and my family's benefit). Would I do carpentry and paining on a rental (assuming I was allowed to)? I wouldn't. Perhaps others would.

I like my street. My neighbors. We're a community. Houses turn over rarely. When they do, and some corp swings in and makes apartments, we don't like it. It gets noisy. Renters don't keep the street clean, etc. They don't feel like part of the community. Why? Because they have a year lease, they know they'll be gone.

If you could rent your clothing for less money than purchasing it, would you? I wouldn't.

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Re: The riskiness of home ownership

Post by rbaldini » Thu Oct 27, 2016 11:19 am

Yes, lots of strong feelings here. Not sure why.

I personally don't see a house as strictly as an "investment" or an "expense". How about seeing it like this:

"A house is a thing that you buy (for a lot of $), so that you can live in it and/or possibly rent out. Its value will probably rise over time, but may not (and probably not as fast as stock market). It involves a large down payment, taxes, insurance, maintenance. Any capital gains or losses upon sale are not taxed up to a large value, though you'll probably have to pay a sale commission. The financial outcomes of buying a home can be calculated under various scenarios, if desired, and this can help you make the right decision. As always, the 'right' decision depends on your individual financial situation."

No need for some monolithic rules about the "correct" way to handle this stuff.

learning_head
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Re: The riskiness of home ownership

Post by learning_head » Thu Oct 27, 2016 1:22 pm

KlangFool wrote:The mortgage payment (PITI) has to be CHEAPER than renting
TomCat96 wrote:Even if you could find a mortgage for the same amount as renting...
Caduceus wrote: ... then decide rationally whether to finance it through a mortgage or rent ...
SouthernCPA wrote:In my area, I save about $400 a month with my mortgage than what the house next door to me rents for.
etc...

As often happens in this type of threads, mortgage is compared to rent which IMO is comparing apples to oranges.

Mortgage is just a loan payoff for an asset / equity you [will] own, just as if you were buying a stock on margin except on much better terms. You could have $0 in mortgage or a lot more depending on how you choose or are able to finance that equity purchase.

Rent ($X / year) is something you pay and never get back for ability to live in a certain place. It should be compared to items of house ownership that you also never get back ($Y / year), including: property taxes, home insurance (over and above your renters insurance, if any), potential extra bills vs rent (like snow plowing and lanscaping), fixups / house maintenance (in general I heard estimates of 1-3% of home value per year; my experience is around 2%).

So as far as finances go, you should be comparing $X in yearly rent vs $Y in expenses I just mentioned, plus essentially an investment asset, which is potentially financed via mortgage.

If $Y > $X, I doubt it's generally advantageous to also speculate on a house asset along the way (unless you a pro for example). If $X > $Y, you still might be taking on too much concentrated risk with a house asset. The more savings you get from $X-$Y, the easier it becomes to justify the house asset IMO and the more risk you can take w.r.t. this asset.

Disclaimer: above is just about how to view financial aspect of renting vs owning. There are other emotional and intangible parts of this question, for sure. A number of good ones were also mentioned in various responses, and those can definitely affect the final decision, but again, what I said above is only related to how I view financial aspect of it.
Last edited by learning_head on Thu Oct 27, 2016 4:25 pm, edited 1 time in total.

roflwaffle
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Re: The riskiness of home ownership

Post by roflwaffle » Thu Oct 27, 2016 4:17 pm

rbaldini wrote:Y'all,

I'll likely be buying a house some time in the next year, in the Boulder, CO area. I've been thinking more about the financial aspects of home ownership. It recently struck me that buying a house on a loan is relatively risky decision, in the sense that the range of outcomes is greater than renting + investing that money in the market - i.e. you can make a lot, but you can also lose a lot. I think there are two main reasons for this:
(1) Since you can buy a house with only 20% down, you can leverage to potentially realize very large returns or losses. For example, with only $100,000 you can buy a $500,000 house, and therefore realize the returns or losses of whatever happens to that house (minus interest on loan, commission to realtor, etc.).
(2) The lack of a capital gains tax on your residential property (well, on the first $500k for a married couple) swings both ways: you don't pay taxes if you win, but you can't write it off if you lose... right?

To investigate this, I made a stochastic simulation of the costs of renting vs. buying. I modeled it off of the NYTimes website (http://www.nytimes.com/interactive/2014 ... lator.html), except that rather than having the user input the market and house returns, I simulated 1000's of possible future time series based on some historical data for both stock returns and Boulder house prices. Long story short, it is indeed the case that the range of costs is usually greater for home ownership than for renting: you can make a lot or lose a lot. On average, buying is the better decision for the price range of houses I'm looking at, but the potential downside is a bit daunting. Reinforces my inclination to buy something cheap.

I don't have any particular questions here - just wondering if y'all have any input, or think that I'm going about this the wrong way. Would be happy to talk about the model a bit more.
Can you share your model on this forum or another site?

The only thing I can think of adding is loosely coupled dependent variables and maybe some other opportunity costs. For instance, if home values drop, maintenance costs and taxes will drop. Rents will also drop, but taking advantage of that may require another move, which is an opportunity cost most people don't think about. A homeowner can maintain their own residence at some other opportunity cost. Etc... Like most things, real estate is local.

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Re: The riskiness of home ownership

Post by rbaldini » Thu Oct 27, 2016 4:22 pm

roflwaffle wrote: Can you share your model on this forum or another site?

The only thing I can think of adding is loosely coupled dependent variables and maybe some other opportunity costs. For instance, if home values drop, maintenance costs and taxes will drop. Rents will also drop, but taking advantage of that may require another move, which is an opportunity cost most people don't think about. A homeowner can maintain their own residence at some other opportunity cost. Etc... Like most things, real estate is local.
To really share it would take some work. I could eventually host it as an app... but no plans to do that yet.

I do some of this loose coupling. Pretty sure I built it so that tax and maintenance costs are recalculated each year as home value randomly changes through time, because e.g. property tax is proportional to home value. I haven't stochastically modeled rent (would need past data to fit that model) - just assumed a fix compounding rate of rent increase that is set by the user. Haven't built "moving costs" into it... all important things to consider.

BW1985
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Re: The riskiness of home ownership

Post by BW1985 » Thu Oct 27, 2016 4:32 pm

learning_head wrote:
KlangFool wrote:The mortgage payment (PITI) has to be CHEAPER than renting
TomCat96 wrote:Even if you could find a mortgage for the same amount as renting...
Caduceus wrote: ... then decide rationally whether to finance it through a mortgage or rent ...
SouthernCPA wrote:In my area, I save about $400 a month with my mortgage than what the house next door to me rents for.
etc...

As often happens in this type of threads, mortgage is compared to rent which IMO is comparing apples to oranges.

Mortgage is just a loan payoff for an asset / equity you [will] own, just as if you were buying a stock on margin except on much better terms. You could have $0 in mortgage or a lot more depending on how you choose or are able to finance that equity purchase.

Rent ($X / year) is something you pay and never get back for ability to live in a certain place. It should be compared to items of house ownership that you also never get back ($Y / year), including: property taxes, home insurance (over and above your renters insurance, if any), potential extra bills vs rent (like snow plowing and lanscaping), fixups / house maintenance (in general I heard estimates of 1-3% of home value per year; my experience is around 2%).

So as far as finances go, you should be comparing $X in yearly rent vs $Y in expenses I just mentioned, plus essentially an investment asset, which is potentially financed via mortgage.

If $Y > $X, I doubt it's generally advantageous to also speculate on a house asset along the way (unless you a pro for example). If $X > $Y, you still might be taking on too much concentrated risk with a house asset. The more savings you get from $X-$Y, the easier it becomes to justify the house asset IMO and the more risk you can take w.r.t. this asset.

Disclaimer: above is just about how to view financial aspect of renting vs owning. There are other emotional and intangible parts of this question, for sure. A number of good ones were also mentioned in various responses, and those can definitely affect the final decision, but again, what I said above is only related to how I view financial aspect of it.
Are you including the interest on the mortgage as an expense? If not, shouldn't it be? With rent you do not have this expense.
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Re: The riskiness of home ownership

Post by roflwaffle » Thu Oct 27, 2016 4:38 pm

I'm interested in whatever you have so far. I was just thinking about my local comment and I'm thinking that economic rents related to scarce land/resources and an abundance of capital could explain some of the near-bubble prices on the coasts. Large investors have the capital and time to write off depreciation on some of their investments instead of selling, which helps raise both home prices and rents than if there were more smaller investors.

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Re: The riskiness of home ownership

Post by rbaldini » Thu Oct 27, 2016 4:40 pm

roflwaffle wrote:I'm interested in whatever you have so far. I was just thinking about my local comment and I'm thinking that economic rents related to scarce land/resources and an abundance of capital could explain some of the near-bubble prices on the coasts. Large investors have the capital and time to write off depreciation on some of their investments instead of selling, which helps raise both home prices and rents than if there were more smaller investors.
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Re: The riskiness of home ownership

Post by Caduceus » Thu Oct 27, 2016 7:01 pm

learning_head wrote:
Rent ($X / year) is something you pay and never get back for ability to live in a certain place. It should be compared to items of house ownership that you also never get back ($Y / year), including: property taxes, home insurance (over and above your renters insurance, if any), potential extra bills vs rent (like snow plowing and lanscaping), fixups / house maintenance (in general I heard estimates of 1-3% of home value per year; my experience is around 2%).
You missed the most important part - you don't get back interest payments either. When you finance a house using a mortgage, you pay rent to the bank (basically, you're renting the money). When you live as a tenant, you pay rent to the landlord (you're renting the house). Either way, you pay rent.

Also, people usually build up very little equity during the early years of home ownership based on the amortization schedule. The initial percentage of your monthly mortgage payments that go toward interest is high in the early stage, and decreases as you go along. So if you just stay in a home for 5 years, the hurdle rate is high.

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burt
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Re: The riskiness of home ownership

Post by burt » Fri Oct 28, 2016 6:05 am

MossySF wrote:
The median American stays in their home for 5.9 years. 6% commissions + all the other stuff needed to buy a house -- I think the proper response is ouch. Seems like "they" need high investment returns to keep up with the churn. This is where the risk is. The average American has a much higher risk of losing money when they have to move to where the employment is.
You nailed it. Home ownership is darn risky if your job is not stable. And wouldn't you know it, when the economy burps, jobs go away, and...home values go down. Kind of like the perfect storm. It really stings when you are making mortgage payments on the old home (because it won't sell) while at the same time paying rent at the new location. 8 years after the 2008-2009 crash, I am amazed at the number of people who are still unintentional landlords.

burt

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Re: The riskiness of home ownership

Post by KlangFool » Fri Oct 28, 2016 8:06 am

burt wrote:
MossySF wrote:
The median American stays in their home for 5.9 years. 6% commissions + all the other stuff needed to buy a house -- I think the proper response is ouch. Seems like "they" need high investment returns to keep up with the churn. This is where the risk is. The average American has a much higher risk of losing money when they have to move to where the employment is.
You nailed it. Home ownership is darn risky if your job is not stable. And wouldn't you know it, when the economy burps, jobs go away, and...home values go down. Kind of like the perfect storm. It really stings when you are making mortgage payments on the old home (because it won't sell) while at the same time paying rent at the new location. 8 years after the 2008-2009 crash, I am amazed at the number of people who are still unintentional landlords.

burt
burt,

That is a good thing. It is a good source of low-cost rental.

KlangFool

learning_head
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Re: The riskiness of home ownership

Post by learning_head » Fri Oct 28, 2016 2:22 pm

BW1985 wrote:Are you including the interest on the mortgage as an expense? If not, shouldn't it be? With rent you do not have this expense.
Caduceus wrote:You missed the most important part - you don't get back interest payments either. When you finance a house using a mortgage, you pay rent to the bank (basically, you're renting the money). When you live as a tenant, you pay rent to the landlord (you're renting the house). Either way, you pay rent.

Also, people usually build up very little equity during the early years of home ownership based on the amortization schedule. The initial percentage of your monthly mortgage payments that go toward interest is high in the early stage, and decreases as you go along. So if you just stay in a home for 5 years, the hurdle rate is high.
Good question...

I did not exactly miss it: those interest payments are part of the loan for your equity position, if you choose or must get one. The way I viewed this in my post is that there are 2 parts to the decision:
(a) $X vs $Y for rent vs money-down-the-drain on house
(b) asset purchase: it could be a good or bad purchase depending on price, terms of mortgage (the interest that you guys brought up), fees negotiated for sale and purchase (e.g. commissions, title insurance, etc)

While I mentioned (b), I concentrated on (a) more which is why it seems like I forgot about those interest payments.

Either (a) or (b) can be good or bad and the mortgage interest applies to part (b). Overall decision is based on combination of (a) and (b). E.g. rent could be much cheaper than house expenses in (a) but overall decision could still be to buy if you get a really great deal on a house you can flip in few years (not something I would recommend except for pros).

I do not think mortgage interest should be added to $Y in part (a):

- Say you have the money to pay cash and you decide for your financial plan it's more advantageous to take a low-interest mortgage to essentially leverage your other investments, protect against inflation, etc. Then this has nothing to do with rent vs spend-on-house part of the decision, or $X vs $Y in my post. Rather, ability to take a great tax-advantaged mortgage deal is a plus for the (b) part.

- If instead your FICO score is terrible and you *must* get an arguably expensive mortgage that you would not have wanted otherwise, I can see how one can think of it as another expense down the drain (which it is!), but I just think of it as one the minuses on the asset side of the decision that will affect overall decision in similar way as if it were in part (a).
Last edited by learning_head on Fri Oct 28, 2016 2:40 pm, edited 1 time in total.

BW1985
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Re: The riskiness of home ownership

Post by BW1985 » Fri Oct 28, 2016 2:37 pm

learning_head wrote:
BW1985 wrote:Are you including the interest on the mortgage as an expense? If not, shouldn't it be? With rent you do not have this expense.
Caduceus wrote:You missed the most important part - you don't get back interest payments either. When you finance a house using a mortgage, you pay rent to the bank (basically, you're renting the money). When you live as a tenant, you pay rent to the landlord (you're renting the house). Either way, you pay rent.

Also, people usually build up very little equity during the early years of home ownership based on the amortization schedule. The initial percentage of your monthly mortgage payments that go toward interest is high in the early stage, and decreases as you go along. So if you just stay in a home for 5 years, the hurdle rate is high.
I did not exactly miss it: those (tax-advantageous) interest payments are part of the loan for your equity position, if you choose or must get one.

I am not sure this should be added as part of $Y necessarily: say you have the money to pay cash and you decide for your financial plan it's more advantageous to take a low-interest mortgage to essentially leverage your other investments, protect against inflation, etc. Then I am not sure this has anything to do with rent vs spend-on-house part of the decision, or $X vs $Y in my post.

In instead your FICO score is terrible and you *must* get an arguably expensive mortgage that you would not have wanted otherwise, I can see how indeed this interest should be part of the $Y expenses indeed.
In that situation I agree, but most people are not in that situation. (money to pay off mortgage sitting in investments). You don't have to have a terrible FICO score to pay interest on a mortgage, every mortgage has interest and it should be included in $Y as it is an expense to own.
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Re: The riskiness of home ownership

Post by learning_head » Fri Oct 28, 2016 2:48 pm

BW1985 wrote:In that situation I agree, but most people are not in that situation. (money to pay off mortgage sitting in investments). You don't have to have a terrible FICO score to pay interest on a mortgage, every mortgage has interest and it should be included in $Y as it is an expense to own.
Thanks BW1985. I thought some more about this and updated my response with how I think of it. As I mentioned there, I still think it should be grouped together with the asset related part, but I get where you are coming from. However, simply adding averaged-out interest to expenses in $Y is not quite "fair", because then on the other (asset) side of your decision, you then essentially allow to spread payments for your asset purchase over many years for "free". It's similar to averaging out other costs of purchasing the asset (commissions and other closing costs), and moving them all to part (a). In my mind, that starts to blur the distinction between (a) and (b) and makes it more confusing. But again, I understand how you could view it the other way too.

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