Own or rent in retirement? Let’s run the numbers

Neal Frankle

Neal Frankle

If you own your own home are you reconsidering the wisdom of that move? Pride of ownership is worth a lot – I agree with that 100 percent. But what about the cost of ownership? It’s something that many people underestimate – especially as they build equity in their property.

Should you own a home or rent? Let’s look at the financial pros and cons. Then you can make up your own mind.

The Benefits of Owning Your Home

When you own your home you have the best landlord possible – you. Nobody can throw out of the house or jack up the rent. And when the house is paid off, you can use the money you used to send to the bank to have a fuller life with less stress. That sounds pretty good to me.

When you own your property you have the opportunity to invest in it and create the kind of home you really want to live in. Renters canít do that. And in many cases the improvements you make add value which can be recaptured when you sell.

Itís true that when you buy property it usually means a larger equity commitment and higher monthly payments. But this acts as a forced savings for many people and that can be a very good thing. Remember that the payments you make consist of principal and interest. The interest is a true cost but the principal payments reduce your debt and builds equity you cash in on when you sell.

On top of that, home ownership carries with it tax benefits which sometimes make it even cheaper than renting.

With all these benefits, why would anyone ever want to rent? Let’s take a look.

The Benefits of Renting

As I mentioned above, renting is often far less expensive. And when you consider all the cost of ownership the price differential is significant. Itís easy to calculate mortgage, taxes and insurance expense. But repairs and maintenance costs are difficult to estimate.

According to personal finance columnist Liz Weston, homeowners should figure on spending 1 percent of their home value each year on repairs and maintenance. So if you rent rather than own a $400,000 property, you save that estimated $4,000 just for starters.

When you rent, you also gain a lot of freedom. If you don’t like where you live it is very easy to get up and go. When you own property, it’s a lot more involved.

Renting saves time too. All the little repairs and upkeep are someone else’s headache and time eater, not yours. No more running to the hardware store or crawling under the sink to fix those pesky drips. These just aren’t your problems anymore.

An Example

Let’s put this all together and compare owning versus renting. Let’s say that you can buy a property for $400,000 by putting down $100,000 and taking out a $300,000 mortgage at 3.5 percent.
home-ownership-chart1The adjacent chart below summarizes your total cost of ownership. Your annual mortgage payments are $27,000 but you get a tax benefit of approximately $8,100 back assuming you are in the 30 percent  bracket. I’ve calculated repairs and insurance using national averages and this brings your annual cost of ownership up to almost $32,000 annually. If you instead rented for $24,000 a year, your annual savings would be $8,000. This includes the lost return you could possibly earn on that $100,000 that you used as a down payment assuming you could earn 4 percent on average. Keep in mind, this $8,000 savings is only the first year’s savings. As you pay off the loan, the cost of holding on to the house grows. Let me show you why I say this.

Assume you pay off the loan the day you retire. If the house appreciates at 3%, it will be worth almost $1,000,000 when that 30 year loan is paid off. If you stay in your home the taxes, insurance and maintenance costs grow but since the mortgage is paid off, you won’t get a tax deduction. And remember, you are sitting on that equity of $1,000,000. If you sell the house and rent, you would be able to invest that money. At 4%, that $1,000,000 could bring you $40,000 a year. So by holding on to the house, you give up that $40,000 and it’s really a cost of ownership. All together, in the year you retire, it’s going to cost you about $70,000 a year to hold on to your house including that $40,000 you could earn on the equity but forgo.

It’s true that renting is going to cost more over the years but if we assume your rent increases with inflation, it will cost you about $50,000 to rent when you retire. That’s still about $20,000 a year cheaper than owning your home.

Notice that the difference between renting and staying in your home is about $20,000 a year once you retire (in this example).  Actually it’s greater than that because the renter receives a renter’s tax credit but let’s ignore that for the moment. Of course, each year the renter’s savings increases because the cost of owning the home goes up a little faster than the rent.  And over 20 years, the person who stayed in the home spends almost $500,000 more than the person who rented.  Looked at another way, the renter has about $500,000 more to spend over that 20 years than the person who stayed in the home.

And this doesn’t even take into account the extra money a renter could save and invest because of his lower annual housing costs. Even if the renter only takes $8,000 per year and invests it at 4 percent, that extra savings and investment total almost an extra $450,000 over 30 years.

At 4 percent, that could generate another $18,000 a year. If you take that into account it means renting would be almost half as expensive as owning. And it probably wouldn’t be that difficult to find alternative investments that potentially earn more and therefore drive the cost of renting even lower.

Does this mean you should sell your home and rent once you pay off your home? Not necessarily. You have to look at your own numbers. And you have to be realistic about whether or not you’d be happy as a renter and whether or not you would actually save and invest your extra savings.

Bottom line: owning a home is not the financial panacea you may think it is. Examine your real costs and use simple online calculators to project out what the numbers might be down the line. You may discover that by renting you free up lots more cash and have a much fuller retirement life than you would if you hold on to your property.

Where do you line up in this debate? Why?

Neal Frankle is a Certified Financial Planner in Los Angeles. He is also the lead editor and publisher of Wealth Pilgrim.com and MCMHA.org.

Comments

  1. Thanks for allowing me to guest post Mark! It’s an honor!

  2. There’s a flaw in your tax benefits estimate. Instead of taking 30% of the total payment you should take 30% of the payment less the standard deduction (about $12k) that a renter would get. That would put the tax benefit closer to $4500, a difference of $3600 which makes the ownership equation even worse!

  3. Tom, Great point. I stand corrected sir! I am not a tax expert so this didn’t occur to me. But I did a little research and I agree. Thank you!

  4. This is indeed a dilemma for many gearing up for retirement. I would agree, the decision will still depend upon personal preference, though money is a major factor, of course. Nevertheless, if you’re talking of investment, wouldn’t it be better to pay for a property that you can call your own?

  5. Except not everyone has a $400K house. A landlord passes the cost of maintenance on to the renter. My house is >$150K, even after nearly 20 years there. My payments are far less than renting a similar sized home, and it should be paid for in 5-6 years. No HOA fee, only taxes, insurance, upkeep after being paid off. Since I upkeep with quality materials, such as lifetime shingles, maintenance when I retire should be minimal. This is a false calculation, I believe, for most people nearing or in retirement.

  6. just read an article about tax breaks from depreciation. That should factor in favor of the homeownership pros. Also how is the tax code likely to treat persons, particularly a 65 year old retiree, who collects rent from assignments they control in a house that they live in but is owned by a trust and they are not grantor but either they are beneficiary or have their own living trust as a beneficiary? would they probably be treated like an employee, and lose some SSA benefits?

  7. James Pratt says:

    Neal, I own some rentals that are cash flowing nicely. After reading your article, I’m now thinking about selling my home or renting it out and becoming a renter. The key word wasn’t money but FREEDOM! No more repairs, no worries while on vacation. There are some errors in your math but the overall picture is the same.

    Retired by age 42 with rental property. Retirement isn’t what people think it is, 80% boring, in my case because I do ALL the repairs myself. Living in Western WA. tends to rain a LOT! Scenario- sell some properties and rent a different place around the country every 3 or 4 months, now that would be a golden retirement.

    Thanks great article.

  8. Ellen Drollette says:

    My husband and I are retiring next year, at age 55, and moving to NC to rent. We have built and sold 4 homes over 35 years, and for us, owning is much more expensive. Not because of the mortgage. We haven’t had one in a decade so rent will be an added expense. It is the upkeep. We have always owned land – anywhere from 13 acres to 120 acres. We also live in northern NY (as in near the border with Canada. It snows. A lot). We have a $20,000.00 tarmac driveway, a $36,000.00 enclosed cab tractor with snowblower, a $10,000.00 4×4 UTV to ride our many trails, multiple perennial gardens that require fresh plants and mulch every spring, etc etc. All of this costs adds up. We have decided we want to stop owning stuff and start doing stuff. Time to sell this house and invest the money. Renting will be an adventure, but it will be nice to just lock the door and go. No more upkeep, repairs, new appliances, etc. I can’t wait.

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