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The cost of renting vs. buying a home comes up all the time. What is the better financial decision, though? With renting, the total cost is just the amount that you give your landlord that you never see again. So, for example, if your rent was $2,000 a month, multiply that by 12 months, and you have $24,000 a year that you just never see again.

The total cost of owning a home, however, includes a mortgage payment, which is comprised of interest and principal, as well as miscellaneous costs like maintenance per year. So, to make an Apples-to-Apples comparison, we need to figure out how much money will never get back again in both of the scenarios.

Cost Of Home Ownership

The main thing that we’re trying to solve for is the cost of home ownership, and we need to get it to a monthly basis. That way, we can compare it to our rent costs and figure out which one is the better option for us. Theoretically, if our monthly cost of home ownership is cheaper than renting a comparable home, then we should probably be buying instead of renting, and vice versa should apply.

Now, there are three components to home ownership and figuring out this whole monthly cost of calculations. That includes property taxes, maintenance costs, as well as the mortgage payment. The mortgage payment will be broken down into two different components, which we are going to discuss thoroughly in this article. However, all of these costs are associated with home ownership that a renter will not face.

Property Taxes

First, we need to talk about property taxes. Property taxes occur on any property that you own, and basically what it means is, by owning that property, you must owe the government or the state that you live in a certain percentage of the property’s value in taxes every single year.

In the United States, the average property tax rate is 1.11% across all residential real estate. So, we’re going to use that number in our example, and we’re also going to use the example of a five hundred-thousand-dollar home.

On a house that costs $500,000, you’re going to pay $5,500 in property taxes every single year. That’s 1.11%, and those are the costs that you’ll never see again.

Maintenance Cost

The next cost is the maintenance cost of your home. Experts suggest that you set aside one to two percent of your property’s value per year aside just for maintenance costs. Now, that could be a little bit more if your home is really old and you feel like it always needs fixing up. For simplicity’s sake, we’re going to use one percent in our calculations. So, our maintenance cost for a $500,000 home over the course of a year is going to be one percent of that, so $5,000 per year.

Alright, so up until this point, we figured out the property taxes and the maintenance costs that we’ll never get back for owning a home, and that amounts to about 2% to 2.11% per year of the property’s value.

Mortgage Payment

Next up, we actually need to figure out the cost of the mortgage payment. That actually just means what our money is actually costing us by putting it into this home. Assuming a 20% down payment, that means you’re going to finance or take out a loan on the remaining 80% of the home’s value.

Using simple numbers again, if our home value is $500,000, that means we are going to put a 20% down payment of $100,000 on the home and then finance the remainder, the $400,000, probably over the course of 30 years. That’s the most common type of mortgage.

So, there are two moving parts here. There’s first the cost of the down payment, as well as what the loan is costing us. That’s the cost of debt.

The Opportunity Cost

A common thing that you’ll hear people say is that there’s an opportunity cost to your money. So basically, when you put the $100,000 on a down payment, then that means you’re not putting that $100,000 into the stock market to help you make more money.

That’s actually a pretty valid concern. And first, we need to figure out what the opportunity cost of your down payment is, and this is the first part of the cost of capital equation.

S&P Data For The Past 30 Years

According to the data, the S&P 500 has returned for the past 30 years an average of 7.19% per year adjusted for inflation. Residential real estate, or the median home prices in the United States over the past 30 years, they’ve actually appreciated 1.97% after accounting for inflation.

So, I purposely used median home prices in this situation because if I had included commercial or rental properties, that would have skewed the real estate returns way higher. And since most people are renting a home and then comparing it to residential real estate, we should probably use the residential real estate median home pricing.

For simplicity’s sake, if stocks are returning about 7% per year on average and real estate is returning about 2% per year on average, that means the difference between these two is around 5%. So, stocks are outperforming real estate by 5% per year.

If you put $100,000 on a down payment, that’s $100,000 that could be earning 5% more per year had you invested it into the stock market. That’s the money that you could be earning if it weren’t invested into this home. So, we’ll actually plug in some real numbers here soon, but first, I just want to illustrate this concept. This is the first part of the cost of capital or the cost of the mortgage payment.

Global Real Estate Returns

Now, if you aren’t in the United States, you can actually just simply Google what global real estate returns are. Or perhaps your own country’s real estate returns are and compare them to the S&P 500 or any stock market index that you have.

What I found, though, is that stocks tend to outperform real estate depending on your country by around 3% to 5%.

Cost of Debt

The second part of the cost of capital equation is the cost that the interest payments are costing you, or AKA this is known as the cost of debt. Just for simple calculations today, we’re going to assume that it is $28,000 per year, we’ll just use the straight-up method of loan balance multiplied by the interest rate per year.

This is going to give us a really conservative buffer on figuring out what type of homes that we can afford and just what are the costs that we don’t get back.

Alright, so if you guys are still following here, then the cost of capital is then the opportunity cost of the down payment, which we figured out was 5% of $100,000, that’s $5,000 plus the $28,000 in interest payments per year. That’s a total of $33,000 in costs every year that we don’t get back (Cost of Capital = Downpayment + Financing).

Represented as a percentage, we would take $33,000 divided by the home’s value, and that equals 6.6%.[ ($5,000 + $28,000) / $500,000 = 6.6% ]

Summing it All

Alright, so now that we have all of those numbers, let’s add up everything that we’ve actually talked about already: the property taxes, the maintenance costs, and the cost of capital, and we will come up with a really simple rule.

Property Tax (1.1%) + Maint. Cost (1.00%) + Cost of Capital (6.60%) = 8.71%

It is, therefore, the property tax of 1.11% plus the one percent maintenance cost plus 6.6% cost of capital, and our total is 8.71%.

The 8.71% Rule

We can use this 8.71% then as a quick and dirty easy guideline to figure out what the cost of home ownership looks like on a monthly basis.

The rule here is to take the home price, multiply it by 8.71%, and divide it by 12. That’s the total cost of your home ownership on a monthly basis.

So, if you have a $400,000 home in your area, we would take that $400,000 number multiplied by 8.71%, and that actually gives you the annual cost of home ownership there, which is $34,840. Now, divide that by 12, and you get $2,903.

That’s how much it would be costing you on a monthly basis in terms of home ownership. So, if it’s cheaper to rent a $400,000 comparable home in your area for less than $2,903 per month, that heavily tips the scale in favor of renting.

Now, this rule is incredibly simple, and a lot of people will love it, but a lot of people will also throw some hate on it as well. Now, it does help you assess what your break-even point is on a monthly basis, but it does have a lot of flaws, and there are some important considerations we should talk about that don’t involve the math of buying a home as well.

Flaws of The 8.71% Rule

1. Humans Are Irrational

The first flaw that I see is that humans are often irrational and oftentimes impulsive. Like, there are times that I know that it’s not a great idea to buy a seven-dollar latte, but I go ahead and splurge on it anyways.

Just because there’s an opportunity cost consideration of your capital, it doesn’t mean that if you don’t make that down payment, the renter is going to take that hundred thousand dollars that they might have and invest it perfectly into the market and capitalize on their opportunity cost.

Basically, investing takes a lot of discipline, and you also have to play pretty perfectly. Who’s to say that the renter is not going to take that down payment and go ahead and just put it all on black, you get the idea. Humans are irrational and not always perfect, so there is that.

2. Cost of Capital Changes

And then also, I view a mortgage payment as almost a forced savings method because you are accruing equity while you pay your mortgage payment. That’s going to be a really good thing for a lot of Americans out there who are not very good at saving in general.

So, on that topic of building equity, in this article we talked about the cost of the interest as simply being the mortgage rate times your loan amount. In actuality, mortgages don’t work like that. Mortgages are on what’s called an amortization schedule.


That means at the beginning of the mortgage, you’re actually paying less in equity and more of the interest upfront. But as 30 years progresses of that mortgage term, what actually happens is that you start to pay less in interest and more in equity as the mortgage goes on.

So, basically, it’s at this point I’ve kind of realized that your cost of equity and your cost of debt is always changing because of the variation of the amortization schedule. If you pair that with the fact that, “Hey, there’s also 15-year mortgages out there, there are different types of variable-rate mortgages out there”, then we have a lot of variables that we’re not accounting for in our simple rule.

Plus, at the end of 30 years, the cost of interest is virtually gone. It’s almost all equity at that point. That’ll change the rule that we’re talking about in this article considerably. And as well, that is another benefit or upside to buying over renting, which is at the end of 30 years, you actually have a tangible asset that could have appreciated in value over time.

The renter, on the other hand, has been paying this monthly payment every single month, and it’s been going into their landlord’s pocket and bank account, and they’re never seeing the fruits of that money.

3. Assumes Conditions Remains The Same

The third flaw that I see often with this rule is that it always assumes that the conditions are the exact same. Inflation could go crazy one year, which it actually has been, or perhaps your mortgage rate could double, or perhaps the opportunity cost of your equity is a lot different. That’s definitely something to consider.

4. Tax Benefit of Deduction Mortgage Interest

Lastly, we didn’t even discuss the tax benefits of deducting mortgage interest. So if you are in the United States, you can deduct mortgage interest against your income. Now, the standard deduction in the United States is $13,000 to $14,000 per year on an individual basis.

So that means if you don’t have more than that in terms of mortgage interest to write off, then it’s not really worth it. However, if you do have more than fourteen thousand dollars, let’s say, in mortgage interest that you can deduct, then it actually lowers your overall cost of home ownership on a monthly basis.

You’d actually have to run these numbers on your own because there are so many variables that come with mortgage interest as well as the deduction, including your tax bracket, your mortgage amount, and as well as your interest rate.

Pros of Owning

There are also some pros to owning a home that does not involve math calculations at all.

1. Predictable Fixed Payments

The first is that you have predictable fixed payments, especially with a fixed mortgage. Since your payment never actually changes too much, what you can actually do is budget for your mortgage payment accurately, whereas if you are renting, your landlords could jack up the price at any given moment.

2. Control Over Home

Another pro is that you have way more control when you own your own home. So, basically, if you make modifications or updates to your property, you don’t have to run it by a landlord.

3. Added Security

You also have added security because the landlord isn’t going to just evict you or kick you out because they sold their property to another owner.

4. Inflation Advantage

The other nice thing about owning a mortgage is that inflation actually helps you out. Now, I know that this sounds a little bit counter-intuitive, but basically what it means is that you owe fewer dollars in terms of value over time.

I’ll give you a pretty extreme example here that doesn’t really exist, but let’s pretend for a moment that there was a 50-year fixed mortgage and that you bought your house. I know that there’s not a 50-year mortgage out there, that doesn’t exist, and the 40-year mortgage is just a myth as well, but just entertain me for the sake of this example.

So, 50 years ago, you get a 50-year fixed-rate mortgage, and your mortgage payment is $300 per month. Well, back then, $300 a month is like $2,000 a month today. However, because of this fixed mortgage payment that you have, you’re still paying $300 a month for the entire life of the loan.

And these days, I don’t know about you guys, but $300 doesn’t seem like all that much. That actually happens with a normal 30-year mortgage, just on a smaller, lesser scale.

5. Capital Appreciation

And the last and biggest pro of owning a home is that you could see a ton of capital appreciation when it comes to your home value. Take for example a home that sold for $599,000 back in 1995 and recently just sold in January this year for $3.23 million.

That clearly outperformed the median home price appreciation in the United States by a factor of at least three, three times more. Homeownership just isn’t about the cost and the investments, though obviously sometimes it’s just downright fulfilling to own your own home.

There’s also peace of mind knowing that you have a home to retire in and live the rest of your life in, especially while you have the capacity to do so right now versus later on in life.

Pros of Renting

Now, I do want to point out there are some pros to renting, which I want to talk about.

1. Flexibility

The first is flexibility. You’re not going to be tied down to a home in 30 years. So, for some reason, if you live in a city right now and you want to leave next year or even next month, if you just want to break your lease early, you can do that.

2. No Taxes, Maintenance, or Down Payment

The next one is, you don’t owe taxes or maintenance or any type of costs like that when you’re renting. You simply rent the place, perhaps you have some renters insurance, and that’s it. Life is just a lot more simple in that regard.

3. Good Amenities

Lastly, you can also get access to some really great amenities by renting. Some big buildings, especially in big cities, they’ll have a doorman, so that’s going to be nice for security. They’ll have gyms, they’ll have pools. They’re going to have different places for barbecuing and holding events and stuff like that. And you’re just not going to get that when you own a home.

My Takeaway

The biggest takeaway that I have for you guys today is that you need to run your own numbers when it comes to renting versus buying a home, especially if you’re trying to figure it out for your own location. However, with the 8.71 rule today, I think that you should be pretty financially equipped to figure out the situation on your own.

With mortgage rates being so high in the United States as of right now, it really looks like renting is going to be much more appealing than owning a home, especially in the short interim period. However, if you’re planning on staying in a place for more than five to eight years and you’re actually buying a home, I think that actually has the greatest potential for the most amount of upside in terms of an investment.

I hope that you found this article helpful, let me know what your thoughts are in the comments about the renting versus buying situation. Peace and Happy Hustling!

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