Liz Davidson, Contributor Forbes.com
As a financial education company, we often see financial crises coming because employees contact us when they have financial problems or concerns they need help resolving. With the recent mortgage crisis, we began to see a major spike in calls on debt in the year leading up to the meltdown. Debt calls in 2006 increased to an all time high—representing close to half of our total calls at the time. Even worse, many callers were frantic. They weren’t looking to simply reduce their debt load; they were struggling to make ends meet. They weren’t asking about putting together a plan to pay off high interest rate debts; they were beginning to consider drastic options like foreclosure and bankruptcy.
It was rather like seeing a car crash in slow motion. You know it’s coming and you can tell the driver to slam on the brakes or swerve out of the way, but it’s too late to do much more.
Move up, Move down.
Today, there’s another mortgage crisis in the works—that is, NOT having one—choosing to rent when you can afford to buy; choosing to forgo building equity in a home as a major source of retirement security—something that may be more necessary now than ever before with a soft stock market and low interest rates. This emerging crisis is not yet at the car crash stage– more at the reckless driving without a seat belt stage. There is time for Americans to resolve this one, but they must change their perspective on home ownership before it’s too late.
Why own a home when you can rent? We are hearing this question much more these days as people choose to “sit out” of the real estate market or disregard homeownership altogether after seeing many of their friends and family end up in short sales or foreclosures. Renting is the low-risk option for these callers. It’s the only way to ensure that nightmare will never happen to them.
The problem is that it will; it’s just a different nightmare. Consider this: A homeowner with a $1,500 monthly payment would still be writing the same check fifteen years later while prices everywhere increase around them. In August 2011 the Consumer Price Index included a .4% increase in rents, the biggest increase since 2008, which represents an annualized increase of 4.8%. If rents didn’t even increase that much but simply kept up with inflation at a 3.2% annual increase, a $1,500 rent payment would cost that renter nearly $900,000 over the next 30 years. The same $1,500 payment made to their mortgage would be only $540,000 (because the payments don’t increase with inflation) and of course would end with a final payment. There might even be some real equity in the property, even with a dismal 1% growth rate over 30 years, a $300,000 property would appreciate well over $100,000 giving the homeowner an additional nest egg for retirement.
The renter, by contrast has no equity in their home, so in addition to almost $900,000 in rent in the above example, the renter would also be giving up $400,000 in retirement assets (and that’s at a growth rate of just 1%– far lower than even the lowest growth rate over a 30 year time period). At a time when retirement is becoming much more challenging, an extra $400,000 (or likely more) can make a major difference, not to mention the impact of NOT having to pay a mortgage. How much less would you have to save for retirement if you didn’t pay the mortgage?
And this doesn’t even include the tax benefits. The US government essentially subsidizes your house payment by allowing a mortgage interest and property tax deduction on Schedule A of the 1040. Any points you pay when you get the loan can also be deducted. Then an amazing thing happens: the IRS allows a tax exclusion on the sale of a primary residence. Owners who live in their property two out of the past five years, who have equity and sell their primary residence, receive a maximum capital gain exclusion of $250,000 (if married $500,000.) Where else can you get a tax break on an investment and then receive the proceeds tax free? I can’t think of another investment like it.
So, deciding that “renting” is safer and there’s no need to take the risk of buying a home or even waiting in an effort to time what is an unpredictable real estate market, buying only when prices have been up for a while, can be very costly. It doesn’t bring with it the emotional trauma of a foreclosure or short sale. But it is a slow drain on your finances, that over time, could compromise your ability to retire or at the very least, to retire the way you want, when you want.
All that said, I’m by no means advocating homeownership for everyone. For many, renting is the right option, at least for now. If you can’t afford to own a home, you shouldn’t even consider buying—one of the key lessons learned from the mortgage crisis. Your mortgage should be under 25-30% of your income not including bonuses or promotions and you should have an emergency fund of 3-6 months expenses in savings before you purchase a home. Also, if you don’t qualify for a reasonable interest rate on a mortgage due to credit problems, if your income is unstable, or if you crave mobility, renting is the better choice. Renting is cheaper than buying in the short term and has other advantages. Repairs: as a renter, when you turn on the shower and freezing cold water spurts out in your face, you simply make a phone call to the landlord and they have to install a new water heater instead of you footing the bill. Mobility: If you have a job opportunity or promotion in another state, you simply give notice and move. You don’t have to go through the arduous process of selling (or not being able to sell) your home. You are free from the obligations of homeownership. Property taxes: As a homeowner, even when your mortgage is paid off you still have to pay property taxes and insurance, and those costs will continue to rise.
Just remember that freedom has its price and, in this case, it is a steep one. It costs much more in the long run to rent, which is why homeownership can be the ultimate retirement strategy. When people are making decisions on whether to buy a house or not, many aren’t factoring in thirty years from now when the home is paid off. They are wondering if the market is at the lowest point possible, if interest rates will drop even lower or if the property will appreciate. This vital element of homeownership has a long incubation period. We always hear that an employee’s peak earning years come after age 50, when you combine high earnings with the elimination of an expense that takes up a third of most people’s take home pay, people have a real chance to meet their financial goals. Homeownership is the ultimate retirement plan.
Home ownership isn’t for everyone, but for many, it is the best choice. The smartest choice, of course, is making the right decision for the right reasons based on your own circumstances. Homeownership basics apply just the same as they always have: buy only the home you can afford, lock in a fixed rate loan with the lowest interest rate possible, and refinance only to get a lower rate and only for the same loan amount and same term. What got many people in trouble during the financial crisis was going to the extreme and buying a house they could barely afford with a variable rate loan payment. When the payments reset with higher interest rates, many couldn’t make the payment. They never should have been in the house in the first place.
If Americans don’t recover soon from their pessimism around homeownership, we predict another fallout from the financial crisis will surface many years from now when a nation of renters tries to retire. They won’t have equity in their homes. Their paychecks will be stretched to the limit, not leaving room for saving and investing for retirement and other financial goals such as college funding. Instead of their expenses reducing through retirement, they will look straight down the barrel of increased rent payments for the rest of their lives. Homeownership makes a significant difference in the long run so it is concerning to see so many walking away from the American Dream. We don’t want to see it become the American Nightmare.