We need to talk. More specifically, we need to talk about one of the most common myths I see making its way around the personal finance world. That myth is: “Renting is throwing away money.” Multiple times per week I hear from people who want to buy a home because they’re worried they’re throwing …
Is Renting Throwing Away Money?
Why people say that renting is throwing away money
Before I talk about why renting is definitely not throwing away money, let’s cover the reasons why people think this is the case.
1. Your mortgage payment builds equity in your home
Every month when you pay your mortgage, a portion of your payment goes toward your principal, meaning the amount you initially borrowed.
Your equity is the difference between your home’s value and the principal you still owe on your mortgage. And so as you pay down your principal, your equity in the home increases.
2. Homeowners benefit from rising home values
The real estate market may ebb and flow, but home values generally increase over time. As a result, many homeowners are able to sell their homes for more than they paid for them, resulting in a capital gain.
I’m not going to argue the validity of either of these statements. It’s absolutely true that paying your mortgage builds equity in your home and that your home’s value is likely to rise over the years. But in the next couple of sections, we’ll talk about why those things don’t matter as much as you might think.
The return on investment of homeownership
It’s true that home values have consistently increased over the years. Since 1940, home values have increased an average of 5.5% per year.
Depending on your investing experience, you might think 5.5% sounds pretty good. But what about when you compare it to other investments?
According to the Securities and Exchange Commission, the stock market sees an average annual return of about 10% per year. That’s nearly twice as much as the increase in value of a home.
So just how different are those percentages?
Let’s say you invested $100 per month for 30 years into an investment with a 5.5% annual return. After 30 years, you’d have more than $87,000.
But if you had invested that same $100 per month into an investment a 10% return? Because of compound
interest, you’d end up with just shy of $200,000 — more than twice the return on a 5.5% investment.
It’s also important to note that the amount you pay for a house is far from the only investment you make into it. When you account for all the other expenses, it’s likely your returns from the increase in value are completely wiped out.