In an earlier post, I assessed home ownership from an investment perspective and found that homes are terrible investments that barely keep pace with inflation.
This poor investment, however, does force the average American to save the money they’d otherwise spend.
The result? The median net worth of American home owners is over 30 times the median net worth of American renters. Home owners might not get back every dollar they put into a home, but they’re getting back a lot more than the American who rents.
But it need not be that way. Here is how any renter can beat the average American home owner in the long run.
First off, you need to save a down payment by age 33
That’s the average age of the first-time home buyer.
Instead of using it for a physical home, you’re putting a down payment on what I call a “money mansion.” You can’t live in your money mansion, but it will make you rich. According to the median American home price ($229,000), a 20 percent down payment is $45,800. Invest this in a brokerage account that tracks the market — where you can hope for a 7 percent annual return.
Here you have one major advantage over the home owner: You can open the account right away and begin collecting interest instead of piling up a lump sum in savings. Just make sure your money mansion is worth $45,800 by age 33. Assuming you collect 7 percent interest per year, you could save as little as $3,000 per year and still make it, even after taxes. Or you can play it safe and save $4,580 per year from 23 to 33 — on top of your 10 percent retirement savings.
Once your money mansion hits $45,800, you need to feed it a portion of your monthly income equal to what the home buyer spends on their mortgage. See, the home buyer is essentially saving this money because at the end of a 30-year mortgage, they own a house worth all the money they put into it, which has (hopefully) matched inflation. But this is the tricky part.
On average, home owners spend 15 percent of their after tax income on their mortgage, while renters spend 30 percent of their after tax income on rent. That means you need to put 15 percent of your income into your money mansion on top of your rental payment if you want to beat the average home owner. This would be the time to move into a one bedroom with your significant other to save on rent. Every dollar you don’t spend there is a dollar you can put toward your 15 percent.
If you take these steps, 45 percent of your take-home pay goes to rent (< 30 percent) + money mansion (> 15 percent). This means you’re living off of only 55 percent of your take-home pay. Do you currently do this? Probably not. But that’s what it takes to beat the home owner.
So, let’s talk numbers
If you manage to rent + save + invest, how much do you win in the end?
Using the average American household income of $54,000 as a guideline, your 15 percent money mansion contribution becomes roughly $5,100 per year after taxes. If you start with a “down payment” of $45,800 and contribute 15 percent of your monthly income every year for a “30-year mortgage,” you’ll have $728,000 in your money mansion (that’s after taxes, with a conservative 7 percent yearly return).
So the gamble you’re making is that today’s average American house will not exceed $728,000 in value after 30 years of appreciation. If our $229,000 house keeps pace with inflation, it will be worth only $555,000 — and that’s a big if. A hundred years of inflation-adjusted US housing prices suggest that a home increases only 0.1 percent in value per year on average. Your home probably won’t be the exception.
Looks like the renter wins
He or she gains 25 percent more net worth, and all of it liquid and free of closing costs. Some would say the liquid capital is worth a premium.
But the renter only gets to live on 55 percent of their take-home pay during their life while the home owner lives on 85 percent. That’s an extra 30 percent of income — not spent on rent — to spend on life. The home owner could easily invest the difference and beat the renter.
The home owner has other home-related expenses, however. Home upkeep and repair costs average 1 percent of the value of the home per year. On our $229,000 home, that’s $2,290 per year. But taking inflation into account, you can expect the costs to rise over time. Over 30 years, that could be $114,000 or more.
The home owner also pays property taxes. These vary widely by state and county. For the sake of simplicity, let’s assume our median American home owner pays a median American property tax of 1 percent of the home value per year — which is lower than many countries surrounding major metros.
So how does that figure in? Over 30 years, those home upkeep costs and property taxes will eat into 50 percent of the income the home owner isn’t spending on rent. So the home owner’s true take-home savings are just 15 percent of income. They get to live on 70 percent of their income, while the renter, on average, lives on just 55 percent. But at the end of the road, the renter is 20 percent richer.
Suddenly, home ownership doesn’t seem like such a great deal. By renting and investing, you can end up with enough money to buy a home in cash by the end of your life — and you will never pay a penny of interest, or property taxes, or buy a new sump pump along the way. What’s more, homes are risky investments. You never know how the community, city, or state will turn. By comparison, investing in the market seems like a pretty safe bet. I don’t know about you, but it’s a renter’s life for me.