February 2024
When you tell someone you rent, they sometimes reply with, “Isn’t renting a house just flushing money down the toilet?” My answer is, “Potentially.” You are putting money into someone else’s pocket instead of accumulating net worth for yourself. But the question is, compared to what? When you compare what you’re paying for rent to what you would pay to buy a house in this high-price, high-interest-rate environment, I see toilets on both sides of the fence.
I will say that this would be a different conversation if it was pre-2022, when prices and interest rates were substantially lower. But for my wife and me, the stars just never aligned for a home purchase during the good ole days. Banks don’t really like giving actors 30-year loans, since you never know when your next paycheck will arrive. And when we started new careers, every lender I spoke to needed to see two years of tax returns before they would consider approving us for a mortgage. In 2022, we were finally ready to buy a house . . . just in time for the steepest interest-rate-hike regimen the Federal Reserve has ever embarked upon.
We were living in Tennessee at the time, and we were about to put an offer down on a beautiful little house. This would have been a horrible decision, because at the time, I didn’t know that I would be moving back to California six months later to work for Morton Wealth. But even though I didn’t know the future, something inside me couldn’t do it. The math just “didn’t math.”
Now that we’re back in California, and interest rates are substantially higher, the math is “mathing” even less. Follow me down this road, as I know there area lot of people facing this same unsettling reality.
The average price of a home in California is about $750k, which makes my stomach drop slightly.
But the price of a home isn’t the only factor that makes purchasing expensive. For first-time buyers (who are the most likely demographic to be asking the “rent vs. buy” question), they usually have to borrow around 80% of the home price through a mortgage. With interest rates around 7% today, you would have to pay nearly $4,000/month in principal and interest to buy an average home/condo in California. That’s after spending $150k on the down payment, and doesn’t include property tax, homeowner’s insurance, or potential HOA fees.
So how much would you be “flushing down the toilet”? If you assume a property tax rate of 1%, maintenance costs of1% of the home value, and $200/month for homeowner’s insurance (which seems harder to get in California with each passing month), you’re flushing $1,450down the toilet each month. But then you have to break down that $3,991mortgage payment into interest and principal. Over the next seven years, 84% of your monthly payment ($3,360 on average) will be “flushed down the toilet” in interest payments if you’re not able to refinance in the meantime (the numbers below are cumulative).
Sure, you can write off the interest on your personal income tax, so let’s say you’re only flushing 2/3 of it down the toilet. That’s about $2,250/month spent on after-tax interest, added to the $1,450/month spent on property tax, insurance, and maintenance. Congratulations, you’re a homeowner! You’re flushing $3,700/month down the toilet to live in an average home.
Compared to what? The average rent in California is $2,750/month.
Just to be clear, this is NOT normal. The monthly costs of buying vs. renting are usually quite close to one another, though it varies by region. Since I live in L.A., let’s zoom inhere. The chart below shows how much more you will pay monthly if you buy a house rather than rent.
In the Greater Los Angeles/Orange County area it will cost you 115% more per month to buy an average house/condo than to rent an average house/apartment. More than twice as much. The only other time in history we saw anything like this was during the housing bubble of 2005–2006.
Don’t get me wrong, real estate can be a good investment. It’s one of the asset classes that we spend a lot of time and effort on for our clients. But just like any other investment, the price that you pay matters. And right now, the price I would pay for a primary residence is just too high.
So if you’re renting, like I am, you can keep your down payment, spend far less every month than you would if you bought, and invest the difference in other assets with better valuations. And when something breaks (say, a toilet), you can just call your landlord.
*Data/charts provided by Zillow, Bankrate.com, and Reventure App
Disclosure: Information presented is for educational purposes only and is not intended as financial or investment advice. Consult with your financial advisor before implementing any transactions and/or strategies concerning your finances. Although information contained in this report is from sources deemed to be reliable, Morton makes no representation as to the adequacy, accuracy or completeness of such information.
