If you're seeing this message, it means we're having trouble loading external resources on our website.

If you're behind a web filter, please make sure that the domains ***.kastatic.org** and ***.kasandbox.org** are unblocked.

Main content

Current time:0:00Total duration:9:40

welcome back I'm not gonna take a slight tangent and cover a topic that I think this is probably the single most important video that really anyone can watch I go to all of these parties where I go see family and you know my wife and I right now aren't we live in Northern California and we're renting and and I like to point out by choice and I have family members why don't you buy it's true at that stage in life that's a major milestone all of this there's a lot of pressure to buy and when I tell friends there I tell them well I'm not gonna buy because you know I think I'm pretty pretty convinced almost 100% convinced that housing prices are going to revert back and I'm going to do a bunch of presentations to justify why they will but then my friends they'll just throw out you know the statement that I hear from them that you hear from real estate agents because obviously they want you to buy is that well isn't buying always better than renting and I think that kind of common wisdom comes out of the notion of one when you're when you have a mortgage or when you when you borrow money to live in a house every month that that money that you give to the bank is kind of going into savings that's that's the perception while when you rent that money is just disappearing into a vacuum and in this video I'm going to well I guess work through that assumption and see if if that actually is the case so let's say I have a choice let's say there are two houses two houses this house number one and this is house number two and let's say that there are identical houses these are you know 3-bedroom 2bath townhouses someplace in in Silicon Valley which is where I live and I have a to choice I I want to live in one of these houses I'm indifferent into which house I live in because they are identical so living in them is the identical experience I can rent this house so I can rent this house for $3,000 a month 3,000 a month and or I could buy this house buy this house four million dollars and let's say that in my bank account right now let's say I have two hundred and fifty thousand dollars cash so let's see what happens in either scenario let's see how much money is is being burned so in this scenario what happens I put I'll take I'm renting so in a given year let's just see how much money comes out of my pocket so in a given year I paid three thousand three thousand times twelve months so I lose thirty six thousand so I'll put a negative there because that's what I spent in rent thirty-six thousand per year and per year in rent and then of course I have that two hundred fifty thousand two hundred fifty thousand I'm gonna put that into the bank cuz I have nothing else to do it I didn't buy a house with it and let's say that I can in the bank oh I don't know let's say I put in a CD and I get four percent on that so let's see two fifty that's what ten thousand dollars I think it's point oh four all right I get ten thousand dollars in interest a year on that so I get ten thousand dollars so plus ten thousand dollars a year an interest so out of my pocket for the privilege of living in this this this house in Silicon Valley with beautiful weather out of my pocket every year goes $26,000 $26,000 so that's scenario one scenario one so what happens if I give in to kind of the the peer pressure of family and and Realtors and the mortgage industry and I buy this house for $1,000,000 well I only have $250,000 which is more frankly than most people who buy a million dollar houses have but I have a two hundred I have two hundred fifty thousand dollars cash so I need to borrow seven hundred fifty thousand dollars so I take out a mortgage mortgage for seven hundred and fifty thousand dollars and I'm going to do a slight simplification and maybe in a future presentation I'll do kind of a more complicated one and a lot of mortgages when you pay your monthly payment most of your monthly payment at least initially is the interest on the amount that you're borrowing and you pay a little bit extra on that to bring this value down that's called paying off the principal you can also take an interest only loan it but the component of the interest is the same it will you essentially when you take a traditional mortgage kind of a 30-year fixed every month you're paying a little bit more than the interest just to take down the balance but for the simplicity of this argument I'm just going to say that we're doing an interest-only mortgage and then maybe with any extra savings I can pay down the principal and that's the same notion and right now if I'd do 25% down and I'm buying a million-dollar house you know I'll have to take a $750,000 mortgage I don't know what a good rate is 6% so let's say at 6% 6% interest 6% interest so to live in this house how much am I paying just an interest well I'm paying 750 thousand times 6 percent a year says so 750 times 0.06 is equal to 45 thousand dollars in interest $45,000 in interest that's coming out of my pocket and of course on a monthly basis that means an interest per month I'm being just to get an idea I'm paying about thirty seven hundred thirty eight hundred an interest a month my mortgage actually might be something like four thousand a month so I paid the interest and then I pay a little bit to you know chip away at this at the the whole value of the loan it takes 30 years to chip away at the whole thing and over time the interest component becomes less and the principal comes more but for simplicity this is the interest that I'm paying $45,000 a year and then of course at a party when I started paying this was like aha but interest on a mortgage is tax deductible and what tax deductible means is that this amount of money that I spend on on interest on my mortgage I can deduct from my taxes I can tell the IRS that I make forty five thousand dollars less than I actually did so if I'm getting taxed at let's say thirty percent what is the actual cash savings well I'll save thirty percent of this I'll have to pay fifteen thousand less in taxes how does that work well think about it let's say I earned a hundred thousand dollars in a year and I normally have to pay thirty percent so I normally pay thirty thousand dollars in taxes right this is if I didn't have this great tax shelter with this house now I have this interest deduction so now I tell the IRS that I actually making that I'm making $55,000 a year and then 55,000 and let's say my tax rate is still 30% it actually probably go down since I'm but let's just for simplicity assume might actually still thirty thousand so now I'm going to pay sixteen thousand and five hundred in taxes to the IRS so how much did I save in taxes minus plus 30 is equal to so I saved thirteen thousand and five hundred from taxes from being able to deduct this forty five thousand from my income so let's say tax savings tax savings the tax savings plus thirteen point five okay now what else goes into this equation do I get any interest on my two hundred fifty thousand well no I had to use that as part of the down payment on the house so I'm not getting interest there but what I do have to do is I have to pay taxes on on my property in California out here we have to pay one point two five percent in taxes of the value of the house so what's one point two so taxes his property tax and that's actually tax deductible two so it actually becomes more like I don't know point seven five or one percent so let's just say one percent just for simple simplicity property taxes so one percent times 1 million that equals what one percent of one million is another ten thousand dollars a year in property taxes and notice I'm not talking about what purse apart of my mortgage goes to pay prints well I'm just talking about money that's being burned by owning this house so what is the net effect I have I have a thirteen thousand five hundred tax savings I have to pay ten thousand actually have to pay a little bit more than that but we're giving a little bit of income tax savings on on the deduction on the property taxes and then I actually have to pay you know the forty five thousand dollars of interest that just goes out the door so I'm paying forty one thousand five hundred dollars so I'm paying forty one thousand five hundred notice none of the none of this 41,500 is building equity none of it is getting saved this is money that is just being burned so this is a completely comparable value to this $26,000 so in this example and this example is not that far off from real values I could I can out here the barrier I can I can rent a million dollar house for about three thousand dollars but in this situation I am burning every year forty one thousand five hundred where I could just rent the same house for twenty six thousand dollars out of my pocket when I adjust for everything and then people you know a couple years ago said oh but houses appreciate and that's what would make it up but now you know very recently we know that that's not the case in the next video I'll delve into this and a little bit more I'll see you soon