Housing: Buy vs. Rent (December 27, 2008)
One of the most important financial decisions most people will make is whether to buy or rent a home. There no shortage of information to help you decide.
Here is a site from Suze Orman, The Buy vs. Rent Decision. She is a popular source of financial advice, dispensing it on the Internet and her own TV show. But even someone as knowledgeable as Ms. Orman can miss some of the finer, but critical points.
Let’s test some of the common perceptions regarding purchase of a home.
1. Does Home Mortgage Interest Reduce Tax Liability?
Claims of tax savings due to home mortgage interest are not always true. For people who have tax deductions exceeding the Standard Deduction of Federal Income Tax, at least part of home mortgage interest may reduce taxes. To get a deduction, you must have more that $5,700 in tax deductions if you are single and more that $11,400 in deductions if you are married.
For example, let’s assume your home mortgage interest payments in 2008 were $12,000 and you had no other tax-deductible expenses. You would only be able to deduct $600 ($12,000 - $11,400) when submitting a joint return.
If deductible interest was $10,000 and filing jointly, there would be no tax benefit unless there were other substantial deductions available to you.
Keep in mind, too, the standard deduction is supposed to be increased every year with inflation, while at the same time the amount of interest paid decreases over time under the terms of most fixed-rate mortgages. Just because interest is deductible one year, doesn’t mean it will be deductible next year.
All of a sudden the home mortgage interest is not so attractive for many people. Examine your own tax situation to see if home mortgage interest will really be deductible for your situation. You can use an online mortgage calculator to determine the actual interest charges based on the loan amount, term and interest rate. Use Federal Form 1040 Schedule A (pdf) to learn other deductible expenses.
2. Once the mortgage is paid, you live rent free
This is another fallacy. You are still likely to have ever increasing property taxes unless you live where there is no property tax. After 20 years in my home, the taxes far exceed the mortgage payment.
Don’t forget about maintenance. I’ve replaced the septic system, roof, furnace, windows, well pump, and water softener (twice). Many of these were expensive.
3. A Home is the Best Investment
Estimates are a full 10% of home owners are in the process of losing their homes to foreclosure. The rest of us have seen substantial declines in the value of our homes. There are few signs that our pain has ended and we have reached the bottom of the housing market.
If we look at housing prices starting in 1975, we can see the inflation-adjusted price of homes has only increased slightly until 2000. With easy credit, prices of home increased dramatically, until recent events burst the housing bubble.
Clearly, we the evidence suggests, we should NOT be thinking of a house as a safe or “best” investment. Housing prices do decline just like other assets such as stocks or bonds, just as we are experiencing today.
I am sure there are many times when buying a house makes sense. We need to have new guidelines that will help us buy a home–or rent a home or apartment–under a Sustainable Financial Plan.
Next time: When to rent and when to buy
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What is Sustainable Financial Planning? (December 26, 2008)
For years, I’ve followed the conventional wisdom offered by the financial community such as make periodic investments in low-cost mutual funds and maintain consistent asset allocations across stocks and bonds. For years this strategy seemed to work very well, until 2008 when we witnessed a dramatic drop in global financial markets along with higher unemployment.
The value of my portfolio has decreased dramatically and my job at a large corporation is at great risk. These events have made me realize that I failed to balance the desire for high returns with the need to sustain an appropriate (maybe more modest) standard of living.
I don’t believe that the so-called experts are providing appropriate advice, especially in challenging times many of us will face. Advice that may have worked prior to 2008, may no longer be appropriate.
Some of the advice is self-serving like financial companies encouraging investments in stocks, bonds, 401Ks and IRAs. Or real estate firms talking about the benefits of home ownership.
It is nice that stocks grow at 10% on average over decades. In theory, each of us should get 10% on our stock investments. But, we don’t have 10% growth every year. Some years there are declines. When stock prices do decline, it is often when we are more likely to need our savings.
We face a future that is less certain, taxes are probably going up to finance large government deficits, financial institutions have tightened lending standards, corporate pensions are being eliminated, Social Security benefits may need to be cut, and we’ve experienced shifting of traditional middle-class jobs like manufacturing to other parts of the world. Our focus in financial planning needs to be modified to reflect changes going on all around us. I believe we need to adjust our planning from maximizing returns to building a plan that is capable of sustaining our families through tough times.
I call this Sustainable Financial Planning. A sustainable plan helps us deal with the loss of a job, severe downturn in the market, loss of a house to tornado or hurricane or even birth of a child with disabilities.
I don’t pretend to have all the answers, but neither do the “experts”. Top achieve a comfortable standard of living in the future, we need to challenge the conventional wisdom and examine the motivations of people who provide us with financial advice.
As we explore the topic of Sustainable Financial Plans, I look forward to your thoughts and comments.
