You’re throwing money away!

I am for the first time seriously considering making a bid on a home. Coincidentally, two seemingly intelligent women chattering next to me at lunch today agreed that when renting “you are throwing money away”, whereas buying a house means you will (somehow) get that money back. It’s bizarre that most people don’t understand the true cost of owning a home.

A good place to start is to run your current housing situation through the excellent Buy vs. Rent calculator from the NYTimes. The table below the chart outlines all the expenses for buying. Except for principle payments, everything else in that list is the equivalent of rent, i.e. you’re throwing it away. The calculator already adjusts for the interest and property tax deductions from your taxes. You also “throw away” the closing costs, selling costs, and the lost investment income from your down payment. And don’t forget the ludicrously high condo/co-op fees. Your profit comes entirely from home appreciation, which is historically 2-3% on a 5X leveraged investment. As the recent global financial meltdown should have taught everyone, housing can also be a risky investment.

Outside most urban areas, housing is usually a good deal relative to renting. A rule of thumb is a house should be cheaper than equivalent rent times 240. In urban areas both housing and rent are insanely expensive. The housing meltdown may have finally caused some homes to dip below equivalent rentals. Many of the homes I’ve looked at in my neighborhood near Manhattan have suffered a 10-20% loss. Due to leverage, that is a 50-100% loss of their down payment. That is in addition to all those monthly costs already mentioned above. All these people threw their money away on overpriced homes.

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One comment

  1. Mike Hall

    Agreed. I have noticed the trend: Irrationality has an exponential relationship to price.

    Consider the following:
    1. Buyers go to the grocery and debate between organic vs. pesticide laden grapes.
    2. The same buyers go to the car dealer, pay >10% more for the “new” tag, and make decisions based on color and leather interiors (and don’t forget the new car smell).
    3. The same buyers go out on the housing market and do 10 minute walk-through with an agent (whom they seem convinced is on their side) and make completely emotional based decisions on the largest purchase (or accumulation of debt) of their lives.

    Of course, there are many fields of interest regarding just this topic: http://en.wikipedia.org/wiki/Predictably_Irrational

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