What’s the best housing situation for your money and life?

Why Your Living Situation is a Big Decision

How and where we choose to live is one of the most important decisions we can make in our lives. It has a huge effect on how we spend our time each day, in terms of commuting to and from work, how much exercise we get, where we buy our food and the people we spend time with. And speaking about who we spend the most time with, it’s likely that the friends/family you see most will be the ones that live closest to you.

So overall, it’s a pretty important decision. And there are so many things to consider when making a move, so we don’t just want to consider one without thinking about the others.

But this is a personal finance blog, so let’s talk about the financial aspect of our living situation. Whether we rent or buy, and the respective costs of either of those choices, can greatly affect what type of life you live.

Some say that renting is like throwing money down that drain. But then it also gives you freedom to move as you please and avoid buying a home in an expensive housing market.

Buying a home can be a great investment and allow you to make a house into a home. But it also leaves you with the expense of mortgage interest and all costs of the property, such as taxes and repairs.

Then there are the other resulting financial effects of your living situation, such as your costs for transportation, income taxes, quality of life and more.

So what makes a the housing situation we choose not only a great life decision, but also a great financial decision? Well, let’s break it down and find out….

Let’s look at the financials

In general, you want to put your money into assets, not liabilities. Assets make you money or at least hold value, whereas liabilities cost you money with no return.

So in general, large financial decisions should be focused on things that will generate a return, and since we spend on average 20-40% of our income on housing, I would say it’s a pretty big financial decision.

Now you might be thinking, “If that’s the case then you would never want to rent, since there is no return on that money!” But there are many other costs associate with buying a home, along with the missed opportunity costs when putting such as large sum of money into a single investment.

Let’s work through a few examples to see what we mean here…

Example – In both cases below, we have $40,000 cash to invest, whether it be into a home or something else. Let’s see what happens

Buying a Home

You put down a $40k down payment on $200k home. Let’s review the figure below for your costs:

The total cost is $1,000/month for a 30-year mortgage with 4% interest rate. Let’s take note of a few things:

Over the full 30 years, you will pay $114,991.21 in interest and $160,000 in principle. That’s a lot of money to hand over the a bank. However, you can avoid this by paying off the mortgage earlier.
You pay about $200/month in property taxes or $2,400/year

Then on average, housing prices rise by somewhere between 1-5% each year, depending on your location and the current state of the economy. But we’ll say that over a 30 years period your home’s value rises by a 3% each year. This is generous for most markets and does not account for inflation.

In this case, your $200,000 home will be worth $491,000 after 30 years.

Financial summary: You initially invest $40,000 to have a $491,000 home after 30 years, and then you pay $72,000 in property taxes, (assuming no rise), $114,991 in interest and a total of $417,000 in payments (see figure above). It would also be worthwhile to take into account 1-2% inflation each year, which would make your home less valuable in the future.

Opinion: You would make about $74,000 in this situation, but to real make this a great financial decision, you would want to buy into a housing market that is going to see some serious increase in value, live there for a long time and also pay off the mortgage as soon as possible to avoid the interest expense. Also, avoid moving and having to pay 4-5% closing costs on selling your home. This will eat away at your home investments gains very quickly.

Renting a Home

In this example, you still have $40,000 to invest, but instead of buying a home, you choose to keep renting your $1,000/month apartment and put your money into the stock market. You simply put your $40k into index funds via a robo-advisor, such as Wealthfront.

After the same 30-year period as the housing example, you’re $40k becomes $179k without you having to do anything or even invest more money, assuming a 5% annual return which accounts for taxes and inflation. That’s a pretty nice $159k for not having to do anything. But you also will have paid $360,000 in rent during this time…

Financial Summary: You spent $360k in order for you to make $179k.

Opinion: Renting for such a long period of time really isn’t a smart financial decision. Simply spending money on something that could be generating some return on investment just doesn’t make sense over the long term. In the short term though, it’s probably a great financial decision since you don’t have to worry about home repairs and moving costs, and you also can live in more expensive areas with higher income potentials. Also, buying into an overpriced housing market can be a TERRIBLE move. Best to do your research and understand the best time and location to buy (Hint: If the rest of world thinks it’s a hot time/location to buy into, then it’s probably not a great move).

Other Options

Here’s the fun part. What about leveraging a combination of buying and renting? “What do I mean?” you say…

Example 1: You want to be a free spirit and keep renting so you have the ability to live in an expensive city neighborhood and not be tied down to a single location. However, you have some money to invest and buy a rental property in a cheaper area nearby that you believe is up and coming. Your return on investment will depend on a variety of factors (mortgage value, rent you can charge, property management, etc). However, it’s a great option to get into the real estate market without being tied down.

Financial Summary: You have a mortgage payment, taxes and management costs, as well as your own rent, but hopefully your rental income should be able to cover all of the rental property costs plus some of your own rent.

Opinion: As long as your rental property is generating a small profit, you could could offset your personal rent expense each month, all while building up the value of an investment property at no cost to you! Just hope you have good tenants and nothing breaks….

Example 2: You buy a home that you plan to live in, but you rent out one or more rooms to offset some or all of your costs. If you have 3 bedroom house in a desirable location, it’s very likely to that you could cut your mortgage payment significantly or actually profit each month from this situation, if you rent out all the extra rooms. You could either find permanent housemates or use AirBnb to rent the rooms to tourists.

Financial Summary: You have typical mortgage payments, taxes and maintenance costs that you would have no matter what, but you are also generating some rental income to offset these costs.

Opinion: This is probably the best financial move because it gives you the most options. You can live alone, rent out some rooms to make extra money, kick out your roommates or move out of the property yourself and keep renting to others, all while generating a profit!

But life isn’t all about money

Your housing situation is impossible to make from a purely financial perspective. I would say at best it is only 50% financial at best.

Sometimes you want to build a home, have the security of consistent monthly payments and no landlord forcing you out.

Or maybe you want to live in a great neighborhood that you can’t afford to buy into and have the ability to pick up and move as you please. And maybe you don’t need a lot of space at this time in your life.

Neither buying, renting or any combination thereof is a bad decision. However, you do need to take an honest look at your life and ask “what do I need right now?”. Do you need little space and the freedom to move as you please? Or are you ready to put down roots and stay somewhere for at least the next 10 years?

I bought a condo in Chicago because I wanted my own, nice place, and I thought I’d stick around Chicago for a long time. Well it turns out at 25, I still didn’t know what I wanted to do with my life and ended up moving to Australia with no plans to return to Chicago. Luckily, the place is rented now, but I will have to deal with selling it in the future.

Ask yourself the right questions and research all of the options available to figure out what is best for you. In general, the only bad decision is one you rush into or don’t make at all.

Question: Have you recently made any big changes to your living situation? How did it affect you financially?