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Current time:0:00Total duration:11:38

Video transcript

what I want to do in this video is give ourselves a framework for thinking about the rent versus buy decision for a home and 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 but there's and but 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 what rents are versus what housing prices are and hopefully this video will give you a framework for at least how to think about them so let's say this house is on the market and it's on the market for rental at fifteen hundred a month so fifteen hundred per month which is the same thing as eighteen thousand a year eighteen thousand a year so that's one option that you have and 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 four hundred thousand dollars is the price that you can get it at you don't have four hundred thousand dollars you're gonna have to borrow some money you saved you've saved a hundred thousand for your down payment under a thousand down payment down payment and so you're going to take the remainder out as a loan so you're going to take out a three hundred thousand three hundred thousand 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 it's your but your every month you pay your your mortgage bill and some of it goes to in a traditional mortgage some of it goes towards the loan and some of it goes to or some of it goes to pay down the interest and the rest of it will go down to pay down the loan so 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 we say 1500 a month and 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 point it's 1,500 and the interest since your it's interest on a lower amount by that much because you've paid down the loan so much your interest might be lower so this would be kind of a traditional process of a traditional mortgage but 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 so 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 spreadsheet out to really analyze things and see how the interest and the how the interest payment changes as we go through the life of the loan but let's assume it's interest only at 6% 6% interest interest only at 6% interest and so that means on an annual basis you're going to pay 18,000 in interest 18,000 and interest 6% of 300,000 18,000 and interest now depending where you live and what your income level is in a lot of places you can deduct you can deduct mortgage interest from your income and so this doesn't mean that you get all of the 18,000 back this is saying if you're making a hundred thousand a year instead of paying say thirty percent on a hundred thousand you're now going to pay your taxes on a hundred thousand - eighteen thousand so it'll your your taxable income would go down to eighty two thousand and so you'll save roughly your tax rate as a percentage of this so let's say you save roughly a third of this on reduced taxes so that's reduced taxes and so your 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 and we're not done we know that there are thing there's there are costs of homeownership you'll have to pay usually some type of property tax let's say it's 1% property tax one percent of four hundred thousand would be four thousand four thousand in property tax property tax and you of course have to upkeep the house maybe you have maybe you're at you you have a gardener maybe you 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're renting and so let's say although it might be different once again depending on the situation let's say there's two thousand a year two thousand per year and upkeep and upkeep now the reason why I listed all of these things and obviously we could go into more depth in more detail and think about other things and and they're more particular to different circumstances but this is a list in either of these cases are the things that are essentially are are going out the door if you're renting that eighteen thousand dollars a year that's just going out the door that's that's that's the what you have to pay for the benefit of living in this house if you buy the things that are just going out the door are your effective cost of interest your property tax your upkeep and so this will all up this will all add up to let's see four thousand plus two thousand is six thousand plus twelve thousand is eighteen thousand eighteen thousand so 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 you're what's going out the door what's going out the door is 18 thousand dollars a year in either case but we are not done yet in this case we didn't talk about what we're doing with our hundred thousand dollars over here we had to use it for a down payment over here we still have a hundred thousand dollars invested 100 thousand invested so we're going to get some income from this hundred thousand that we wouldn't have gotten here and it depends what we're doing with it if we have it in a really safe bank account maybe we're getting 1% or 2% but maybe we're investing it in a portfolio of things and getting or percent or who knows what what we're doing here but we need to think about what we could have gotten from that down payment from that from investing this incremental money so let's just say for the sake of argument that you get a two percent return at two percent annual and you will return so you're getting $2,000 $2,000 in investment income investment income from that hundred thousand dollars so your actual out-of-pocket if you were to net your you net your 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 now your 16,000 now your 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 and of course this this this analysis completely changes depending on how these numbers change if this house were cheaper if you got lower interest whatever it might be Nelson this number might look better if the rent was a lot higher this number would look similarly would not look as good if you're a return on investing weren't that good this number would this number would be higher and it would not it would not look as good so the key thing to realize is is just try to analyze what your actual out-of-pocket costs are and one might want to well look you know just psychologically when I'm doing this mortgage at least it's forcing me it's forcing me to save and that's true it is kind of a forced saving that's happening here but in 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 of or generating a lot of income so 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 the other things that we should think about beyond just the numbers are the intangibles and so let's just think about those in a second let's think about the intangibles that favor renting and the intangibles that favor buying so the biggest reason and this is why we bought a house a few years ago is from 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 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 net pay pay off the house eventually you're pretty much and you can pay that 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 save someplace 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 wherever your your house might be and 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 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 and so when you buy a house you can make those same improvements but all the intangibles aren't just on the buying side they can 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 and 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 and so you might like the Flex ability you get into a six-month lease one-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 in the kind of 2003 to 2008 period sometimes you have housing bubbles and sometimes these economics go way out of whack and housing is just over priced housing overpriced relative relative to housing is overpriced relative to rent so once again big takeaway it all depends on the context but hopefully this gives you a little bit of a framework for thinking about the rent versus buy decision