How To Stop Paying Rent
As you know, renting has two big problems - the rent can go up, and you don't have anything to show for it except a pile of rent receipts. Me, I like knowing that every month I'm $50 or $100 richer, no matter what. That doesn't sound like much, but if you saw a $100 bill lying on the ground, you'd sure as heck pick it up, wouldn't you? Owning a home is like that - Uncle Sam gives you such incredible incentives, they're just lying there on the ground, and yet some people step right over them, and never scoop them up.
In this article, I will show you in real dollars how you can benefit by owning a home. Maybe no one's ever explained it to you in detail before, or you didn't "get it". Well, if you stick with me though this discussion, I think the light will go on for you.
One of the facts of life is that if you want to have a roof over your head, you have to pay somebody for that roof. In real estate we have a saying, "Whether you rent or whether you buy, you pay for the space you occupy."
You might be thinking, "I can barely make the rent, how in the world can I afford to buy?" There's an answer to that, and I'll get to it later on. But first, let's start with why it's to your advantage to own your own home, then we'll figure out how to make it happen.
Renting is being out of control - the rent can go up, or the owner can tell you that you have to move. Owning your own home is a rock of stability that can't be taken from you. It gives you a stake in the community, a sense of belonging. And for most people, it is the majority of their net worth.
Look at it this way - in 30 years, if you rented at $1000 a month, you would have paid out $360,000 and have nothing to show for it. But if you bought a home today for $250,000, at the end of 30 years you would have paid it off and you would own it free and clear.
Obviously this example is way too simple, because we all know that rents go up, so you would have paid much more than $360,000. And we all know that home prices go up too, so the house would be worth much more than $250,000. How much more? How does a million dollars sound?
The Rule Of 72
Now might be a good time to bring up the "rule of 72". This rule tells you how long it takes your money to double at a given interest rate. For example, if the interest rate were 5%, it would take 72/5, or 14.4 years for your money to double.
Did you know that home prices have gone up 7% a year on average for the last 30 years? Now I'm not talking about Hawaii, I'm talking about the entire country, in good times and bad, the average was 7% a year, according to the National Association of Realtors. This means that if we see only average appreciation, home prices will double in 72/7 or 10.3 years!
Yes, in fact it was about 10.3 years ago when I remember them saying "We've just sold the last house under $100,000 in Escondido". And just this last week I read in the paper a similar article declaring, "Homes under $200,000 are just about extinct in Escondido."
Become A Millionaire
So how do you become a millionaire? Buy a house for $250,000 and pay it off in 20.6 years and you'll be one. How? In 10.3 years the house will be worth $500,000 and in another 10.3 years it'll be a million. Oh, you haven't paid off the loan yet? That's right, you still owe around $100,000 on it, so really you have $900,000 in equity, which is what we call the difference between what the house is worth and what you owe on it. OK, so you have 9 more years to go, but in any event, at the end of the 30 years you'll own the house free and clear, and it'll be actually worth closer to $2 million by then.
I know this sounds ridiculously hard to believe, but consider that 30 years ago people were buying houses for $40,000. Then consider the Bay Area around San Francisco where small old houses, like the $200,000 Escondido ones, are going for $600,000 today. Is it so ridiculous to imagine that this area might become like that in the next 30 years? Most cities in San Diego County have no building room left, or are very close to it. After that, watch prices take off.
I mean, imagine you're on the moon, looking at the earth, looking at the USA from far above. Now imagine everyone in the USA all wanting to live in the little strip of land in the middle of the Pacific Ocean. Got the picture? I realize not everyone wants to live here, but I want you to understand that a great many people do.
In Hawaii, prices are expected to continue to rise because our population is increasing faster than we are building houses. That's the bottom line. People are coming from other states, from other countries, and we're having babies. Unless some disaster causes the number of people to decrease, home prices are expected to continue to climb.
So the question is, what do you do about it? Continue to watch? Or participate and take control of your financial future?
But I Can't Afford A Home!
Let's say you'd like to buy a home of your own, but think you can't afford to do it. I would say just the opposite - that you can't afford not to do it. Let's see if I can make it easier for you to swallow.
The government doesn't want you to pay rent your whole life and end up being dependent on the state, and so Uncle Sam is willing to subsidize your home purchase! Your mortgage interest and real estate taxes are tax-deductible. I'll explain.
Before you get your paycheck, your employer takes out the taxes, and then you get what's left to pay your rent, put gas in your car, whatever. But when you buy a house, you take your house payment out of your salary first, and then pay tax on what's left.
This is such a huge, critical, and important difference that I need to repeat it. As a renter, you're used to the idea of the government getting their share first and you living on what's left. As a homeowner, you use your salary to pay for your home first, and then let the government have a share of what's left. This is how the wealthy think. They think "how much tax do I want to pay?" not "gee, I wonder how much I'll have left after taxes are taken out." And owning your own home is a key step in starting to think like the wealthy.
Look At These Numbers!
In practice, it works like this. Let's say your family income is $70,000 and you pay $1200 in rent. If you buy a home for $240,000 with 20% down, your payment might be $1558 a month. Don't get upset about the 20% for now, just follow me here for the sake of discussion.
The $1558 comes from a home loan at 7%, real estate taxes, and insurance.
I know $1558 per month is more than $1200, but wait! $1479 of that is a tax deduction, meaning in the first full year of homeownership, you would pay taxes on an income of $52,255 instead of $70,000. Since you are in the 28% tax bracket, you would save $4969 a year in taxes, or $414.05 a month!
(Disclaimer! I'm not a CPA, so I'm not qualified to give tax advice. The numbers I used assume you are already itemizing deductions on Schedule A. Consult your tax professional to see how the numbers work out on your specific tax return.)
So let's recap. Your rent was $1200, and now your mortgage payment is $1558, but Uncle Sam is giving you $414.05 of it! So your new cost to have that roof over your head is really $1143.95, less than you were paying in rent!
But it's actually better than that, because I haven't figured any state income tax savings. Oh, and remember that $50-100 a month I talked about back at the beginning of this article? That's the part of the loan that goes towards paying it back, called "principle reduction". I didn't figure that into the calculation either, but that's like putting that money every month right into the bank, the bank of your own home.
But you say, "getting money back from Uncle Sam is great, but how can I possibly make the $1558 payment with my current take home pay?" Well, you don't have to, you can take the extra money out of your check now, and let Uncle Sam tax what's left, remember? You do this by telling your employer to take less taxes out of your check using a W-4 form. This way, you get the extra $414 a month now to make the mortgage payment with, rather than getting a huge tax refund at the end of the year!
"But I still have a big problem", you're thinking, "Where do I get the 20% down, that's $48,000!" Yes, it is. Now we get to where the rubber meets the road. You have to really want your own home, really believe that this is what you have to do for yourself or for your family.
You can of course, buy with 10% down, 5% down, or even zero down, but in those cases, your monthly housing expense will be higher than rent, even after figuring the tax savings. If you can handle the payment, it still works out in your favor, because remember the 7% a year? That $240,000 house will be worth $256,800 next year, an increase of $16,800! So you might have to spend $200 a month more than you did in rent, but look - you paid $2400 a year more, but you gained $16,800. That's an amazing return, way better than a 401K, even a company matched 401K! If it were me, I'd put less in the stock market and buy my own home instead.
The Amazing Power Of Leverage
That reminds me of one of the best advantages to buying real estate, the benefit of leverage. As I said, if you buy a house for $300,000 in ten years it'll be worth $600,000 so you doubled your money in 10 years. In fact, we own a house in Carlsbad that we bought for $300,000 five years ago, and now it's worth $450,000, a 50% increase, right on schedule.
But here's my point - you didn't have to come up with the whole $300,000 for the house, you only put 10% down. You only invested $30,000! So when your $30,000 becomes $300,000, that isn't a double, it's a ten-fold increase in your money!
More Benefits Down The Road
Oh, and there's more - once the value of your home increases, you can borrow against it and use the money for whatever you want. The money is tax-free, and the interest on this money is tax deductible. So while your renting buddies are paying 11% on their car loans with after tax money, you're deducting the interest on your car payment because you're a homeowner.
I know people who have used this method to pay for college for their kids, get the down payment to buy a second home or an investment property, or just borrowing against the house for tax-free retirement income.
And here's the best one - when you sell that $600,000 house that you paid $300,000 for, you can pocket the gain tax-free, up to $500,000 for a married couple. The money in your 401K may grow tax-deferred, but when you take out the money to spend in your retirement, you must pay taxes on it. With your personal residence that you've lived in for 2 years, you just put the gains in your pocket and pay no tax. This is incredible advantage that no other investment can offer! In fact, there are some interesting ways to retire using these tax-free gains, but that's another subject.
I challenge you to find me an investment other than real estate that gives you appreciation, leverage, tax deductions and tax-free capital gain.
Until you can do that, I think I'll keep my money in real estate.
How To Get That First House
So if you're convinced that you should own a home, how do you actually go about it? What if it's just too darn expensive in Honolulu? Well, there are a number of special first time buyer programs to make it easier, and we'll definitely explore those together. But what if it's still too expensive?
In that case, "you gotta do what you gotta do". You could get a 4 bedroom place and rent out a couple of the bedrooms to roommates to help pay for it. You could go where real estate is cheaper, like Ewa Plain or Mililani to get your first house. Some people who work in Honolulu are going even further than that to get their foot in the door. I know it's hard, and it wasn't easy for me to get my first place either. You just have to grit your teeth and do it. The hardships are temporary, but the benefits last a lifetime.
My advice to you is to just go for it. Even if the first house isn't your dream house, you have to start somewhere. Face your fears and get it done. It's not just me saying this. In the book, "The Millionaire Next Door", the author says that more millionaires were made through real estate that any other method. Robert Kiyosaki in his "Rich Dad-Poor Dad" series talks about the "3 mountains" of financial security - your own business, stocks, and real estate.
Why Now Is The Perfect Time?
Are you afraid it's the top of the market? With interest rates the lowest in 30 years, I think the risk is greater that the interest rates will go up, not that home prices will go down. But even if prices do go down a little, if interest rates tick up, the monthly payment on that house will be higher, even if the price is less. So your risk in trying to "pick the bottom" is that you'll miss out on today's very low interest rates. And besides, I don't believe that prices will fall in the entry-level price range, for a number of reasons that I'd be happy to share with you personally.
The next step is up to you. I'd suggest sending me an email or giving me a call and we'll see what can be done. Even if your lease isn't up yet, we should still get the ball rolling, because we may have some credit work to do, and that could take 3 months or more. If you're not ready to talk yet, but would like to be kept up to date with the real estate market, then sign up for my email newsletter.
Either way, do something. Get something to show for your efforts. Don't be like the old saying, "Work your fingers to the bone, and what do you get? Bony fingers." You know, next year at this time you could still be renting, or you could be in your own home building equity. You might even discover you're handy at doing home improvements, as some of my clients have done, and they've really increased the value of their properties quickly.
Who knows what you'll accomplish once you have this big unfinished business of not owning your home out of the way? You know you need to do it - it's like a big weight holding you back until you get it done. Today's a good a day as any.
Weekly Mortgage Rates
Freddie Mac National Averages
|30 Yr Fixed||3.87%|
|15 Yr Fixed||3.15%|
|5 Yr Fixed||3.01%|
|1 Yr Fixed||2.40%|