228 | Renting vs Buying a Home: Navigating the Housing Market in 2024

Hilary Hendershott: Welcome back to Love, your Money! I’m your host, Hilary Hendershott, and today, I’ll be delving into a topic that I know is on most people’s minds, and that is navigating the current real estate and mortgage interest rate market and what that means for your home buying plans and prospects.

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And now, let’s talk the real deal with real estate. Of course, if you’re a buyer or seller, you do want to stay informed and have the right information to be strategic. In this episode, I’m going to uncover the ins and outs of today’s market and equip you with actionable insights to make informed decisions. Let’s start by unpacking the trends that are shaping the housing market from dwindling inventory to surging demand, and the seismic lifestyle shifts brought about by the significant adoption of remote work after the pandemic. It’s worth your time to understand the relevant trends in interest rates, home prices, and especially the financials of home purchase versus renting so that you can be successful whether you’re buying or selling.

Now, for those considering a purchase or sale, which I am this year, I imagine you’re wanting to talk and understand how to navigate a market that’s in flux. Whether you’re a first-time buyer or you’re looking for your forever home, I’m going to share strategies to optimize your outcomes. I’m sure that’s what you want to do is optimize your outcome.

And let’s not forget about the financial planning side of things from squirreling away for that first down payment to snagging the best mortgage interest rates. I’m going to cover it all, ensuring you’re making savvy financial choices throughout your real estate journey. Because here at Love, your Money, I’m all about arming you with the knowledge and support you need to flourish in today’s real estate market. Whether you are a seasoned real estate pro or just dipping your toes into the market for the first time, get ready to soak up some invaluable insights.

But let’s kick things off with a question that’s top of mind for many home buyers: Should I keep waiting to buy? So, obviously, the rise in interest rates has caused many potential home buyers to backburner their home purchase plans. For many years, we got used to rates in the 2’s and 3’s, but ever since the Federal Reserve started raising its target rate to slow the economy, those rates have been climbing and some people were seeing rate estimates as high as 7%.

Most mortgages are now pricing close to the low 6’s, but they’ve come down a little since those highs. But of course, 6 is 200% higher than 2. And that makes your potential payment potentially 200% higher than it would have been back in the day.

One thing to note is that jumbo loans have higher mortgage rates attached to them than conforming loans. The smaller loans are sometimes referred to as conforming loans, and those loans conform to the guidelines of the federal government and thus are subsidized by and sometimes insured by the federal government, so they get those lower rates. As of the publication of this episode, the maximum conforming loan rate for a single-family home was $647,200. However, this limit can vary depending on location and can be higher in high-cost areas, so you need to consult with a mortgage person where you live.

One thing to really grapple with is that much of the hesitancy about buying at these relatively higher rates comes down to a cognitive bias called anchoring bias. Simply said, we got used to 2% and 3% so now we’re making the mistake of thinking rates should be that low, but that is not the case. The average interest rate in the 1980s was 12.7%, and the long-term average interest rate since 1971 is 7.75%. So, I do not agree that rates are currently higher than they should be.

And of course, housing prices haven’t come down much in most areas, so the price of the mortgage went up. The homes continued to be either sideways or trending up in price, so the homeownership affordability is very, very low. In fact, I hear an unfortunate number of people telling me that they’re going to wait for the next housing recession to buy. It’s always tough to wait on something that’s really important to you, and it sometimes hurts my heart when I hear that people are waiting for something like a real estate recession that truly cannot be predicted.

I think many people who went through the painful economic and liquidity-based recession of 2007, well, it started 2007, maybe 2006, and bottomed out in 2009. And because housing was in a slump for so long, started thinking that real estate recessions are as common as economic recessions, which is not true. It’s almost certain that all the factors that caused that particular recession have been resolved – as is the case with most bad economic outcomes. When bad things happen, private enterprise creates new products and protocols to ensure they won’t happen again, and at the same time, governments put regulations in place to ensure they won’t happen again.

We do a pretty good job of solving the problems we know about. So, in most cases, they don’t repeat, also because, in the vast majority of desirable places to live, there are severe housing supply controls in place. Real estate is not a free market. It does not ebb and flow like the economy. So, in order for there to be another real estate recession, there would have to be some really big, unexpected exogenous factor that comes into play. I personally would not wait for that.

Circling back to mortgage rates, as I mentioned, they can significantly increase your potential monthly payments. Just a 1% increase in interest rates could tack on hundreds or thousands to your bill. So, let’s put that in perspective. Say, you’re eyeing a $300,000 mortgage with a 4% interest rate, you’re looking at a monthly bill of $1,432. Bump that rate up to 5%, and suddenly you’re shelling out roughly $1,610 monthly. So, that’s about 200 bucks more in your monthly budget.

But if you live in a high cost of living area, your mortgage might need to be as high as $1 million, which of course levers up the increased cost from rising rates. The monthly payment at a 4% interest rate on that size loan is $4,774. But if your rate goes to 5%, your payment goes to $5,368. So, with just a 1% increase in interest rates, the monthly payment increases by approximately $594. Of course, predicting the future of interest rates really is akin to crystal ball gazing, although I don’t think that really is the zeitgeist about it. I hear so many people talking about interest rates coming back, like it’s a foregone conclusion, but that is not the case.

Okay, let’s tackle another burning question. Hilary, is it a smart gamble to buy with the plan that I’ll just refinance at a lower rate in a couple of years? I definitely would not do that. Some might be tempted by this strategy, especially given the current climate, but I consider the strategy to be really dangerous. There is no guarantee of your future employment, your personal financial and health status, which is of course, what enables you to go qualify for a loan. There’s also no guarantee of what the underwriting guidelines at the banks and lenders will be at that time. Remember when, after the financial crisis, they just flat out stopped offering cash-out refis for several years. These were loans people were counting on, and the banks just weren’t offering them. The last thing I would recommend you do is get so attached to purchasing a home that you put yourself in a situation that risks your entire financial future. It’s not financially healthy and it’s just too risky.

Also, you don’t want to buy too much house. The reason for this is the zero-sum aspect of wealth building, and that’s this. You get to the end of your working years and you have two buckets of money. One you live in, and one you live off of. That one pays your bills. So, you could say you have a house bucket and a financial freedom bucket. So, over-buying in your house bucket can really cannibalize, like sabotage your other financial goal of being able to pay your expenses after you stop working. You have to manage both buckets.

Okay, before we start the conversation about renting versus buying, I do want to talk about inflation. Everyone knows inflation is up. So, one question I get all the time is, “Hilary, inflation is hot, it’s up, so obviously, the price of houses is going to keep going up, which means I need to get in on that.” But that’s not the case either. The inflation number they report to us only has housing costs as one small piece of that number. And the cost of houses in different areas can vary greatly, both from one another and from the inflation number. Since you are undoubtedly only considering buying one house to live in, it’s important to keep your focus on those specific prices, and not the inflation number calculated by the government.

In fact, when I talk with my clients about housing affordability, like how much house they can afford, I never even think about or mention the government-reported inflation number. So, here’s your permission to take that particular number out of your home buying considerations. I often read in the media about this concept of housing inflation, and what they like to do is tell you how unaffordable houses are as a multiple of average income. But you don’t have the average income. You have your income and you’re not buying or renting the average house. You’re pricing your house or the houses you’re willing and wanting to live in. So again, think of the economic trends as just that, they’re trends. If you want to be a politician or an activist or a lobbyist, that’s when you’d start digging into the macro numbers. It’s important in your personal finances to stay focused on your numbers.

All right. Let’s talk about renting versus buying. Very controversial. Most people think owning their home is a must- an obligation. I must own my home, Hilary. Renting is bad and only to be done when you can’t afford to buy. But neither of those things are true. Here, we really need to slow down and understand the opportunity costs, which are the trade-offs of homeownership. I also hear people referring to renting as paying someone else’s mortgage. “Oh, don’t rent, you’re just paying your landlord’s mortgage.” Okay, fair enough, but that’s a very incomplete evaluation. There are pluses and minuses to both homeownership and renting. I’ve been a homeowner three times in my life, and I’ve been a renter far more times than that.

Let’s discuss. The benefits to homeownership include:

• You get privacy and security. No landlord is going to come check out how messy your dog is. You’re never going to have to move out because your landlord decides not to rent to you anymore. You can probably send the kids to 12 years of primary schooling in the same school district.
• Also, of course, you will probably enjoy some increase in equity value over time, which means you could sell the home at a profit, but the question remains whether you can spend that profit because most people just reinvest their proceeds in the next house. Remember that not all houses grow in value over all time periods and they usually don’t grow as fast as stock market investments.
• Also, you can paint, decorate, change the fixtures, and renovate a house you own, like you personalize it.
• If you have a mortgage, you get to enjoy the mortgage interest deduction to the extent your state and/or the feds allow it. The SALT or state and local taxes limitations of the Tax Cuts and Jobs Act really limit that benefit, especially for people who live in high-income tax states, but again, that’s something you need to discuss with your financial advisor or tax person.
• Also, benefit of owning a home, if you qualify for a HELOC, which is a home equity line of credit, you can take money out of your home to spend. Sometimes you just need the cash, but honestly, using that as a financial plan often leaves people pretty broke. Your house is not an ATM. And justified uses of the HELOC are generally limited to improvements on the home.

The downsides to home ownership, to some extent, are the upsides to renting. In other words, if you’re renting, you don’t suffer the yucky and expensive things homeowners do:

• If the roof breaks, you have to pay to replace it.
• Same with the washer/dryer and the tree in your yard that might come crashing down on your house, your neighbor’s house, or worse, your neighbor.
• In a housing slump, if you want to sell, sometimes you can’t. This does happen.
• You can’t spend a house. If you live in California or New York and you plunk down a half million dollars on a house or more, that money is stuck in the house. You now have to start over to grow your retirement nest egg.
• Especially right now, you’re very subject to the interest rate market, which sucks compared to three years ago. It doesn’t suck compared to 50 years ago when interest rates, as I said, were 13%, but nobody wants to talk about that.
• Property taxes are borne by the homeowner.
• And also, transaction costs are significant. It costs a pretty penny to sell a house. Right now, my husband and I are preparing to sell our California house, and we’re expecting to pay almost $40,000 just to prep and stage it, and then, another 6% of the home selling price to the agents who sell it. And that’s if it goes well. Some people who sell houses end up in court afterwards, which can cost tens of thousands of dollars in attorney fees.

The upsides to renting are:

• You have flexibility and mobility. You can pick up and move with your whims, with your jobs, or with your family’s adventurous spirit.
• If the roof breaks, you don’t have to pay to replace it, and you don’t have to pay for anything that goes wrong with that house because the owner owns it and he or she has to maintain their investment.
• The net or real dollar price to rent is typically lower than owning, even after the mortgage interest deduction. Those ratios can change, but for right now, in most places I know, the cost to rent is significantly lower than buying.

And the downsides to renting are, again, mostly just the converse of the upsides to owning:

• I mean, obviously, you aren’t building equity.
• You can have your lease terminated for one of many reasons and have to move at a very inopportune time for you and your family. This happened to me in 2017 when I had a brand-new baby and tickets to Europe. Honestly, this is the thing that swayed me from being a renter. I was like, I have a baby and it does not work for me to move right now. And the landlord, basically, response was, “We don’t care what works for you, Hilary.”
• Your landlord does control some of your lifestyle, like whether you have a pool or whether you can have pets.

The glaring thing missing from the argument that renting is just paying your landlord’s mortgage is that, even as a landlord, part of your monthly housing cost is a consumption expense. It’s gone. You don’t get it back. For renters, that’s your monthly rent. For homeowners, it’s a little more difficult to calculate their total cost or monthly principal, interest, taxes, and insurance, which are often bundled, that PITI often comes out in one monthly payment. And then the lumpy expenses of maintaining a home, which can be really significant.

Let’s break that down. Part of your mortgage payment might come back to you when you sell your house assuming it goes up in value and assuming you sell the house. But if you amortize a $500,000, 5%, 30-year loan and make all those payments over 30 years, you’ve paid far more than $500,000. You’ve paid almost $1.7 million, right? That’s the cost of borrowing money for 30 years. So, part of your monthly mortgage payment is definitely not coming back to you.

Also, property taxes and homeowner’s insurance are a consumption expense. You never get those back. Also, the maintenance, the security system, having the rain gutters cleaned, replacing the roof and the appliances, getting new floors, updating carpets, replacing windows, all of those things are consumption items and they’re not cheap. When you’re a renter, you don’t have those expenses.

The final cost homeowners incur is lost earnings on their down payment. So, I mentioned this before, but houses rarely grow at the same rate as a simple buy and hold of an S&P 500 index fund. So, the losses there are the difference between the growth rate or internal rate of return on your house, which can only be calculated when you sell it and is calculated net of all selling, staging, and transaction costs, and the internal rate of return of an S&P 500 index fund.

So, internal rate of return, the acronym is IRR. You can just hear growth rate, right? I mean, I’m trying to be specific. I’m being specific, but that’s what I mean. Like, your house is going to grow at a particular rate. The S&P 500 index fund would have grown at a different rate over the hold period of your house, the date between when you bought it and when you sold it. And in order to do a real calculation of how much that opportunity cost was, you would have to say, “Well, what did my downpayment grow at and what would it have grown at if I had put it in the S&P 500 index fund?” There’s other indexes you can use that’s the most popular. But I mean, you certainly wouldn’t go pick the index fund that returned the highest rate or the lowest rate just to make yourself feel worse or better. But the S&P 500 index fund is a good risk-adjusted benchmark.

Okay, moving on. So, again, you compare what your down payment grew at to the growth rate of the S&P 500 index fund or whatever. You would have alternatively invested your down payment in over that same time period. And that is honestly, what most people never ever consider or even think of when it comes to the buying versus renting consideration.

So, here’s your permission slip, written from me to you, to rent forever, as long as you are proportionately saving more in your financial freedom bucket. Renting isn’t bad, but if you’re not going to build equity in a home you own, you do have to save more than most people do, so you can keep paying your rent after you stop working, right? There’s nothing wrong with that strategy, but definitely talk with a financial advisor who understands this math. And I’m sorry to say, most of them don’t.

Circling back to the idea of how much location matters. Market conditions can vary significantly from one area to another. So, take the time to assess your financial readiness and consult with local experts to make informed decisions. Talk to your financial advisor about how much you can afford. Get a rate estimate from a mortgage lender to get started. Consider other places you might live, especially given more and more companies will allow employees to work remotely. I know I do. I have team members all over the country. It might be a worthwhile consideration to move to a lower cost of living area, where you can afford to buy a house that you want to live in.

All right, before I wrap up, a final word of advice, definitely seek professional guidance. Real estate is a very unforgiving asset class and can always become litigious. Always work with a great real estate agent who’s sort of like your attorney on the purchase contract. Do not go that part alone. And also, make sure you’re in communication with your financial advisor. Again, once the real estate transaction is closed, you could be stuck, right? So, you don’t want to have to unwind that. Remember, whether you’re renting or buying, always make decisions that support your long-term financial well-being. This is Love, your Money. I’m Hilary Hendershott, and I’ll see you next week.