It is a common belief that, when deciding between owning a home and renting a home, homeownership is always a better choice. When the recession hit and home prices fell, this thinking changed: The belief that homes always increase in value has been challenged. Many hard-working families are finding themselves financially upside down in their home at the moment they need equity the most.
There was an evident shift in the the rent vs. own philosophy. In 2010, Arkansas had a 25% increase in people choosing to rent instead of buy. This number is staggering. The recession and economic instability is one of the main reasons for people choosing to rent, but there are also other reasons not tied to the financial crisis that indicate this philosophy may be more of a long term shift.
Americans are some of the most mobile people in the world. According to the U.S. Census Bureau, the average family moves every five years. This average has increased over the years. The growing divorce rate, influx of college attendees, higher average age of marriage, and ease of mobility have contributed to this increase. I would make the argument that my generation will move even more often than once every five years. Frequent relocation has become part of our culture.
Regardless of how the economy is doing, it is oftentimes more beneficial for a person to rent rather than purchase. Lets say, hypothetically, that your house will appreciate at the historically average rate of 3.7%. Home prices increased by 3.7% annually, on average, from 1968 to 2009 [according to the National Association of Realtors]. That means that if you purchase a house for $100,000 today, then it may be worth $119,920 five years from now, in a steady economy. That may look like a good investment on the surface, but does not take into consideration transaction costs and holding costs. On both the purchase and the sale there are lender’s fees, agents fees, and closing (title) expenses. Below is an example of a typical FHA loan and the most common transaction costs:
In the scenario of a steady economy, purchasing and selling a house after 5 years would give a $6,743.98 net profit as compared to to renting. Is that worth it? Would you invest $100,000.00 in a cyclical industry with the hope of an annual return of 1.25%? I hope not.
Buying with the hope of a return on investment is exactly what many Americans have done when purchasing homes. This doesn’t necessarily pose a problem, as long as the economy is humming along; but a slight setback in the economy can eliminate your profit. The next chart shows what would happen in an economy where the home was not appreciating:
In a stagnant economy, loss is probable. This homeowner lost $12,000 by purchasing and selling a house. Oftentimes people will not even realize the loss because the actual costs can be overlooked. Example: Bob and Roger.
Bob and Roger work at the same company, make the same salary, and live in the same neighborhood. Bob bought a house and Roger rented a house. After a few years, their company found it would be more profitable to relocate their headquarters to another city. Roger gave a 30 day notice to his landlord, and put a deposit on a new place within a week. Bob had to find a real estate agent, list his house, and wait. As it turns out, Bob was not eligible to buy another house until his current house sold because his debt to income ratio was too high. He spent the next month keeping his home spotless while making sure his family was mobile enough for a real estate professional to come in and show it to buyers. Since his house did not sell in 30 days (few ever do), he had to relocate his family to temporary housing in the new city he would be working in. A month later there was a contract on his house, and after some issues with the home inspection and stressful hiccups with the bank, they finally sold the house. Now they could finally START looking for their new place. At the same time, Bob also had to keep up with his job and other responsibilities.
Do you know what the most stressful event in a marriage is? Tricked you – #1 is actually just the act of getting married. But #2 is moving. Understandable. Bob’s scenario is more common than you may think. I see it every day. The system of purchasing a new house every five years requires that homes appreciate in value. The next chart shows what we’ve seen in the last 5 years:
So what lessons can we learn from this?
1) Home values are not guaranteed to increase.
2) We live in a different economy than our parents. Frequent relocation is the norm.
3) Conventional thinking that “it is always better to own a house than rent” is no longer a valid assumption.