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  • Narrator: What I want to do in this video

  • is give ourselves a framework for thinking about

  • the rent versus buy decision for a home.

  • The key takeaway I hope you have after this video

  • is there's not just a simple right answer,

  • that it's always better to rent

  • or that it's always better to buy.

  • For full disclosure, I own a house

  • and I bought it for a whole series of reasons,

  • some of them emotional, some of them potentially economic.

  • It depends on your personal context,

  • where you are in your life,

  • and what part of the world you live in,

  • and what the economy is doing at that moment,

  • and what rents are versus what housing prices are.

  • Hopefully this video will give you a framework

  • for at least how to think about them.

  • Let's say this house in on the market,

  • and it's on the market for rental at 1,500 a month.

  • 1,500 per month, which is the same thing as 18,000 a year.

  • 18,000 a year; so, that's one option that you have.

  • Let's say there's an identical neighboring

  • house that's on the market for sale,

  • and you are in a position to buy it.

  • Let's say that house is $400,000,

  • is the price that you can get it at.

  • You don't have $400,000, you're going

  • to have to borrow some money.

  • You saved 100,000 for your down payment.

  • 100,000 down payment. Down payment.

  • You're going to have to take the remainder out as a loan.

  • You're going to take out a 300,000 loan.

  • Now, a traditional mortgage, one that has a fixed term;

  • maybe it's a 15 year fixed mortgage, or a 30 year fixed mortgage.

  • Every month you pay your mortgage bill,

  • and some of it goes to, in a traditional mortgage,

  • some of it goes it towards the loan and some of it

  • goes to pay down the interest, and the rest of it

  • will go down to pay down the loan.

  • For example, let's say that your mortgage payment is 1,800.

  • 1,800 per month.

  • Early on it might be disproportionately interest.

  • It might be, say, 1,500 a month in interest

  • and $300 to actually pay down your loan,

  • to actually pay down this $300,000 loan,

  • and then as that loan is paid down

  • near the end of the term of your mortgage

  • it might have gone the other way where

  • each month you're paying much more to pay down your loan.

  • Maybe by that time it's 1,500, and the interest,

  • since it's interest on a lower amount by that much

  • because you've paid down the loan so much,

  • your interest might be lower.

  • This would be a traditional process of a traditional mortgage.

  • To simplify our analysis, I'll assume

  • that you're taking an interest-only loan;

  • a loan where you're only required to pay

  • the interest portion of it, and you could

  • pay down your loan as you want to.

  • Let's say that this is interest-only.

  • This is going to help just simplify things,

  • and obviously if we want to get really detailed

  • we'd probably have to get a spread sheet out

  • to really analyze things and see how

  • the interest payment changes

  • as we go through the life of the loan.

  • Let's assume it's interest-only at 6%, 6% interest.

  • Interest-only at 6% interest.

  • That means on an annual basis,

  • you're going to pay 18,000 in interest.

  • 18,000 in interest; 6% of 300,000. 18,000 in interest.

  • Now, depending where you live

  • and what your income level is,

  • in a lot of places, you can deduct mortgage interest

  • from your income, so this doesn't mean that you get

  • all of the 18,000 back, this is saying if you're making

  • 100,000 a year, instead of paying, say, 30%

  • on 100,000, you're now going to pay your taxes

  • on 100,000 - 18,000.

  • Your taxable income would go down to 82,000.

  • You'll save, roughly, your tax rate as a percentage of this.

  • Let's say you save, roughly, a third of this

  • on reduced taxes; so, that's reduced taxes.

  • So, you're effective interest that you're paying

  • after the tax break, let's say it's $12,000.

  • $12,000 is out-of-pocket, or the effective.

  • Effective cost of interest. Cost of interest.

  • We're not done; we know that there are costs of home ownership.

  • You'll have to pay, usually, some type of property tax.

  • Let's say it's 1% property tax. 1% of 400,000

  • would be 4,000 in property tax. Property tax.

  • You, of course, have to upkeep the house.

  • Maybe you have a gardener.

  • maybe you have to repair things,

  • you get things painted; who knows what it might be.

  • These are things that you usually would not

  • have to pay if you are renting;

  • so, let's say, although it might be different,

  • once again, depending on the situation.

  • Let's say there's 2,000 a year.

  • 2,000 per year in upkeep. In upkeep.

  • Now, the reason why I listed all of these things,

  • and obviously we can go into more depth

  • and more detail and think about other things

  • that are more particular to different circumstances,

  • but this is a list in either of these cases,

  • are the things that are essentially

  • are going out the door.

  • If you're renting, that $18,000 a year,

  • that's just going out the door;

  • that's what you have to pay for the benefit

  • of living in this house.

  • If you buy, things that are just going out the door

  • are your effective cost of interest, your property tax, your upkeep.

  • This will all add up to, let's see,

  • 4,000 + 2,000 is 6,000 + 12,000 is 18,000. 18,000.

  • Just like that, it looks like our annual costs

  • that are just going out the door,

  • given the assumptions, in every different

  • circumstance you're going to have different

  • assumptions, so this is just a framework.

  • Your what's going out the door is $18,000 a year in either case.

  • But, we are not done yet.

  • In this case, we didn't even talk about

  • what we're doing with our $100,000.

  • Over here we had to use it for our down payment.

  • Over here we still have $100,000 invested.

  • 100,000 invested, so we're going to get some income

  • from this 100,000 that we wouldn't have gotten here,

  • and it depends what we're doing with it,

  • if we have it in a really save bank account,

  • maybe we're getting 1% or 2%,

  • but maybe we're investing it in a portfolio of things

  • and getting 4%, or who knows what we're doing here,

  • but we need to think about what we

  • could have gotten from that down payment;

  • from investing this incremental money.

  • Let's just say, for the sake of argument, that you get a 2% return.

  • At 2% annual return;

  • so you're getting $2,000 in investment income.

  • Investment income, from that $100,000.

  • Your actual out-of-pocket, if you were to net

  • your income benefit that you didn't have to,

  • or the investment return that you didn't have

  • to use up on the down payment,

  • that netted against your rent and now you're 16,000.

  • Now you're 16,000 out-of-pocket.

  • 16,000 cost per year.

  • Now, the way that I rigged the numbers for this video,

  • it turns out that for this individual,

  • purely on the economics, purely for this year,

  • as we'll talk about in a few seconds,

  • things might change in the ensuing years,

  • but purely for this year, if we can assume

  • these numbers, it actually might make sense to rent a house.

  • Of course, this analysis completely changes

  • depending on how these numbers change;

  • if this house were cheaper, if you got lower interest,

  • whatever it might be, and all of a sudden,

  • this number might look better.

  • If the rent was a lot higher, this number

  • would look, similarly, would not look as good.

  • If your return on investing weren't that good,

  • this number would be higher and it would not look as good.

  • The key thing to realize is just try to analyze

  • what your actual out-of-pocket costs are.

  • Well, look, just psychologically,

  • when I'm doing this mortgage,

  • at least it's forcing me to save;

  • and that's true, it is a forced saving that's happening here.

  • But, in theory, you could do it here.

  • The equivalent amount that you would have paid

  • for interest, or the interest portion of your loan,

  • that's your rent, and above and beyond that

  • you could just save that $300 a month,

  • and put it into your investment pool,

  • and after 30 years, you might very well

  • have a good amount of money there

  • collecting a lot, or generating a lot of income.

  • There's no very clear-cut answer that renting

  • is always better than buying, or that buying

  • is always better than renting.

  • It really depends on the circumstances.

  • This is a back-of-the-envelope version;

  • in future videos we'll do a more in-depth version.

  • But, other things that we should think about

  • beyond just the numbers are the intangibles.

  • Let's just think about those in a second.

  • Let's think about the intangibles that favor renting,

  • and the intangibles that favor buying.

  • The biggest reason, and this is why

  • we bought a house a few years ago,

  • is for buying their stability.

  • There is stability.

  • You might get a great deal on a rental,

  • and the owner takes care of it,

  • and it's in a great neighborhood,

  • but maybe they want to rent it out to someone

  • else or maybe they want to move into the house

  • themselves and then you've got to move.

  • If you buy a house, as long as you pay the mortgage,

  • or you pay off the house eventually,

  • you're pretty much, and you can pay

  • the property taxes and things,

  • you're pretty much guaranteed that you can stay there.

  • Another reason that you might want to buy

  • is rents are unpredictable; rents could go up.

  • Rents could go up.

  • If you're in a really rapidly rental appreciating market,

  • say, some place like Manhattan or San Francisco,

  • it's nice to be able to say, "Oh, look, I got

  • "a fixed mortgage payment; this is what I got to pay.

  • Once I pay this thing down, I don't have to worry

  • about the craziness of what rents might do because

  • the economy is, because so many people

  • want to live wherever your house might be."

  • Then, another thing, and once again,

  • this isn't an exhaustive list, is that you

  • can customize, and you can make improvements.

  • Back when my family was renting,

  • I can't tell you how many places we saw

  • that looked really nice if they

  • had just changed this bathroom a little bit,

  • or if they just changed that kitchen a little bit,

  • or if they did not paint that one wall yellow.

  • When you buy a house you can make those same improvements.

  • All the intangibles aren't just on the buying side.

  • They could also be on the rental side.

  • If you're just settling down in an area

  • and you want to figure out the lay of the land,

  • you might not want to commit to one neighborhood

  • or one house without understanding things better,

  • so you might want to have the flexibility.

  • Flexibility of renting.

  • To keep buying and selling houses,

  • there's a lot of costs involved, especially

  • when the cost of the brokerage fees and whatnot;

  • so, you might like the flexibility,

  • you get into a 6 month lease, 1 year lease.

  • Once you understand things, then you might

  • want to buy a house or then you might

  • want to rent in another neighborhood,

  • and as we saw earlier in the 2003 to 2008 period,

  • sometimes you have housing bubbles,

  • and sometimes these economics go way out of wack

  • and housing is just over-priced.

  • Housing over-priced relative to

  • Housing is over-priced relative to rent.

  • Once again, big takeaway,

  • it all depends on the context.

  • Hopefully this gives you a little bit of a framework

  • for thinking about the rent versus buy decision.

Narrator: What I want to do in this video

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