A few weeks ago I read the book “The Millionaire Next Door”. This book talks all about how the average millionaire in America, despite the stereotype, is actually a frugal person who built his or her wealth over time, and doesn’t spend gratuitously.
To be honest, this didn’t entirely surprise me, nor did many of the traits of these millionaires they described. There was, however, one that really stood out to me. And that was the fact that 97% of the millionaires surveyed own their home.
Now, I knew that number would be high. After all, why wouldn’t a millionaire own a home? But still, 97%? That is a ridiculously high percentage. It was the trait that virtually all millionaires surveyed shared.
Obviously, correlation doesn’t equal causation, and therefore buying a home doesn’t make you a millionaire. Not to mention the fact that if you have a million dollars to throw around, owning a home would be fairly easy.
But, conversely, what if buying a home does HELP you build wealth, even if it doesn’t make you an automatic millionaire? And wouldn’t it be just as easy for a millionaire to rent if they wanted to instead of owning a home? After all, many of these people live mobile lifestyles, why would they want to be tied down to a single area?
So I decided to do a little bit of math/research on the subject of buying versus renting your primary residence. Spoiler alert, owning your home is almost always the smart choice.
Benefits of Home Ownership
Owning a home, even with an expensive monthly mortgage payment, has numerous benefits. Here are some of the biggest:
- Taxes: One of the biggest advantages homeowners have over their renter counterparts is that the interest paid on their mortgages is tax deductible. This means they pay less overall in federal income taxes each year.
- Building Equity: The biggest benefit of home ownership is the fact that your monthly mortgage payments aren’t just disappearing from your net worth entirely. As you pay off your mortgage, you build up equity in your home, until you finally own it outright. This process starts off slow at first, but it is substantial overtime, as you’ll see in the case study below.
- Appreciation: Tied along with the above is the fact that homes, on average, appreciate over time. So as you are paying off your house, it also slowly increases in value. That means that once you are ready to sell your home, you will likely make money on it. Even taking into account the recent home value bubble, this has averaged three to four percent per year.
- No Weird Fees: One thing that I absolutely hate about renting is all the little fees you get dinged with. Pet fees are one of the biggest, which have prevented me from owning a pet since I moved here. You can also get nailed with fees upon moving out of a rental. My landlord told me when I moved in that if I didn’t wipe down my counter-tops when I left they would charge me $13, and that was only one example of the many outrageous charges you can get hit with.
Benefits of Renting
I am currently renting, but the only reason I am is because I am a college student. If I knew where I would be living five years from now, I would be trying to buy a house right now. Despite that, there are some clear benefits to renting your residence.
- Consolidated Payments: One of the main advantages of renting is that instead of having to pay monthly insurance, mortgage payments, maintenance, taxes, and half a dozen utilities, you most often will only have one bill to pay each month. That makes things convenient, and likely cheaper.
- Ability to Move: Most experts agree that you should only buy a home if you plan on living there for at least five years. Buying and selling a home is a very expensive and time consuming process, so it makes moving often nearly impossible to do. If you like to move often, renting is really your only option. This is why I don’t own a home, seeing as once I graduate from college I will likely move somewhere else.
So to determine once and for all who comes out ahead in the renting versus owning debate, let’s do a quick case study. Bob is your average worker making $60,000 per year in Boise. He is looking to buy a home. He has $40,000 to make a down payment on a home, and has budgeted for a $1,150 per month mortgage. He buys a $240,000 home with a 30 year, $200,000 mortgage at 3.5% APR.
Fred has almost the exact same deal going. Same income, same amount saved up, but he decides to rent. He rents a home that is slightly smaller, but more than enough space, for $1,150 per month, making his monthly rent the same as Bob’s monthly mortgage payment. He takes his $40,000 and invests it in the stock market and gets a 7% return on his investment.
Thirty years later, Bob has paid off his mortgage and still lives in the same home. He has paid a grand total of $413,000 throughout the course of his mortgage, including interest, private mortgage insurance, and taxes. He also spent $50 per month on average in maintenance, which is lower than average because he did a lot of things DIY style. That rings up at a total of $18,000. Add in the initial $40,000 down payment, and his home cost him approximately $471,000. That may sound like a massive number, but let’s look at what he has now. His home appreciated at 3.5% per month like expected, and is now worth $673,000! That’s right, he made more than $200,000 just by owning his home! And now let’s look at the tax savings. He paid a total of approximately $121,000 in interest over the course of his loan. Because he is in the 25% tax bracket, we can assume that he saved approximately $30,250 in taxes over the last thirty years by deducting his interest payments. If we round out these numbers to make them easy to handle, he has added approximately $700,000 to his net worth while subtracting approximately $500,000, for a net gain of $200,000.
Meanwhile, Fred has spent the last thirty years renting. In total, he paid $413,000 to rent his home, the same as Bob’s mortgage. He didn’t have any maintenance costs, so he saved some money there. However, at the end of thirty years, he doesn’t have anything to show for all of the money he spent renting. He also didn’t get any tax savings like Bob did. The $40,000 he invested in the stock market did turn into $305,000, which is a nice chunk of change. But subtract his expenses, and he ended up with a net loss of $108,000.
Of course there are all kinds of other expenses that could be factored in. But we can assume that once you add up the utilities, insurance, and fees that they essentially cancel each other out.
So despite the fact that Bob and Fred had identical budgets and incomes, Bob came out more than $300,000 ahead of Fred by owning his home instead of renting. That is a pretty substantial amount of money, and it of course continues beyond those 30 years.
After doing that little example, it is pretty clear to me why 97% of millionaire own their homes. While it may take time for that amount of money to stack up in home equity, it really does have a huge impact on your net worth.
Do you own your home? Or do you have any other factors you think should be considered, or success stories of homeowners? Let us know in the comments!