I read the article from MSN Money "Why rent? To get Richer" and I must say I totally disagree with everything this article says.
Its sad when irresponsible journalism like this is allowed to be widely distributed from a "somewhat well respected" financial publication.
Clearly information like this is doing nothing more than confusing the working public, and encouraging them to make bad financial decisions.
To summarize the article, the author rents an apartment despite having the capital and financial wherewithal to own a home.
She than makes an inflation adjusted comparison of stocks versus homes noting that stocks return 7% and homes return 0.
4%.
She correctly discards recent dramatic swings in both markets arguing for the long term return.
She than goes on to argue that the historic and current P/E ratio for stocks is 16 and the equivalent ratio for houses (price / rent) has "swelled" from 9 in 1940 to 20 in 2005.
This argument states that on a comparable basis stocks are cheaper than homes.
In her words: "shares right now cost 16 times earnings and over long periods return 7% a year after inflation.
Houses right now cost 19 times their "earnings" and over long periods return zero after inflation.
And they look likely to return less than that for a while.
" Now for the rebuttal: First, she mentions the difference between having $300,000 invested in a house or $300,000 invested in stocks - not wrong necessarily, but most people I know don't have $300,000 and they had to take a mortgage out to "buy" their house.
So, lets do the math: If you put 10% down on a $300,000 house you need $30,000.
$30K at 7% yields $2,100 in the first year add that to the total than repeat, year two yields $2,247, year three $2,404, etc, etc, etc .
.
.
at the end of 30 years you have "made" $228,368 - not bad.
Now keep in mind in this instance you still need to pay for rent! Now let's look at the house, you put $30K in and you get yourself somewhere to live.
Instead of paying rent, you pay the mortgage - over 30 years.
Combine this with the measly 0.
4% yield that single family homes have traditionally garnered and you end up with .
.
.
wow - $338,000.
$110,000 more from buying than renting! Put simply the terminal value of the buildup in equity in the house is worth more after 30 years than the improved yield from stocks! Now I will admit that this little mental exercise does exclude minor things like transaction costs and maintenance but depending on your situation these can be minimized (or deducted from your $110,000 additional profits)! Second, our author departs from a very serious issue - inflation itself.
All of her returns are based on an average inflation rate of approximately 3% (a safe assumption I will admit).
She fails to take this into account for her own situation.
Again, back to the math: When you take out that $270,000 mortgage your principal and interest payments are $1,700 per month - quite a bit of money.
However, your interest rate doesn't change so you pay $1,700 each and every month for the next 30 years.
Interestingly, our author notes paying $1250 per month for her apartment, a savings of $450 every month.
Where her logic goes askew is in the subsequent years, her low rent of $1250 slowly climbs by 3% every year due to inflation .
.
.
by year 11 she is paying more than $1700 a month, and by year 20 she is paying more than $2,200 per month, and in the final year she will be handing over more than $3,000 per month.
This doesn't look like such a good deal any more does it? Lastly, our author out of hand dismisses the tax deduction saying that the returns (an argument which we effectively dismissed in step one) don't make sense when compared to the deduction.
This is nonsense .
.
.
to stick with our example on your $300K house with the 270K mortgage, your payments are $1,700 per month - most of which (at least 90%+) is interest and tax deductible.
$1,700 per month times 12 months is $20,400.
90% (conservatively) is interest, or approximately $18,360.
If you are in a 28% tax bracket, you would save $5,140 per year! This is enough savings to effectively drop your monthly payment to approximately $1,271.
Its sad when irresponsible journalism like this is allowed to be widely distributed from a "somewhat well respected" financial publication.
Clearly information like this is doing nothing more than confusing the working public, and encouraging them to make bad financial decisions.
To summarize the article, the author rents an apartment despite having the capital and financial wherewithal to own a home.
She than makes an inflation adjusted comparison of stocks versus homes noting that stocks return 7% and homes return 0.
4%.
She correctly discards recent dramatic swings in both markets arguing for the long term return.
She than goes on to argue that the historic and current P/E ratio for stocks is 16 and the equivalent ratio for houses (price / rent) has "swelled" from 9 in 1940 to 20 in 2005.
This argument states that on a comparable basis stocks are cheaper than homes.
In her words: "shares right now cost 16 times earnings and over long periods return 7% a year after inflation.
Houses right now cost 19 times their "earnings" and over long periods return zero after inflation.
And they look likely to return less than that for a while.
" Now for the rebuttal: First, she mentions the difference between having $300,000 invested in a house or $300,000 invested in stocks - not wrong necessarily, but most people I know don't have $300,000 and they had to take a mortgage out to "buy" their house.
So, lets do the math: If you put 10% down on a $300,000 house you need $30,000.
$30K at 7% yields $2,100 in the first year add that to the total than repeat, year two yields $2,247, year three $2,404, etc, etc, etc .
.
.
at the end of 30 years you have "made" $228,368 - not bad.
Now keep in mind in this instance you still need to pay for rent! Now let's look at the house, you put $30K in and you get yourself somewhere to live.
Instead of paying rent, you pay the mortgage - over 30 years.
Combine this with the measly 0.
4% yield that single family homes have traditionally garnered and you end up with .
.
.
wow - $338,000.
$110,000 more from buying than renting! Put simply the terminal value of the buildup in equity in the house is worth more after 30 years than the improved yield from stocks! Now I will admit that this little mental exercise does exclude minor things like transaction costs and maintenance but depending on your situation these can be minimized (or deducted from your $110,000 additional profits)! Second, our author departs from a very serious issue - inflation itself.
All of her returns are based on an average inflation rate of approximately 3% (a safe assumption I will admit).
She fails to take this into account for her own situation.
Again, back to the math: When you take out that $270,000 mortgage your principal and interest payments are $1,700 per month - quite a bit of money.
However, your interest rate doesn't change so you pay $1,700 each and every month for the next 30 years.
Interestingly, our author notes paying $1250 per month for her apartment, a savings of $450 every month.
Where her logic goes askew is in the subsequent years, her low rent of $1250 slowly climbs by 3% every year due to inflation .
.
.
by year 11 she is paying more than $1700 a month, and by year 20 she is paying more than $2,200 per month, and in the final year she will be handing over more than $3,000 per month.
This doesn't look like such a good deal any more does it? Lastly, our author out of hand dismisses the tax deduction saying that the returns (an argument which we effectively dismissed in step one) don't make sense when compared to the deduction.
This is nonsense .
.
.
to stick with our example on your $300K house with the 270K mortgage, your payments are $1,700 per month - most of which (at least 90%+) is interest and tax deductible.
$1,700 per month times 12 months is $20,400.
90% (conservatively) is interest, or approximately $18,360.
If you are in a 28% tax bracket, you would save $5,140 per year! This is enough savings to effectively drop your monthly payment to approximately $1,271.
Source...