The True Cost of a Lifetime of Renting
In 2019, the U.S. Federal Reserve Survey of Consumer Finances revealed that households that own their homes had a median net worth of $255,000, more than 40 times greater than households that rent, which had a median net worth of $6,300.
Let’s dig into the numbers and find out why.
Typical Homeowner
Costs for homeowners can be broken down into two categories: (1) initial costs and (2) recurring costs.
Initial Costs
Initial costs are the downpayment and closing costs — things like the home inspection, home appraisal, buyer’s share of recording fees and transfer taxes, which usually come to about 3% of the purchase price.
A typical downpayment is 20%. There are programs that allow first time homebuyers to put down as little as 3.5%. However, in 2022's red-hot market, putting down at least 20% makes an offer more competitive and means you don’t have to pay mortgage insurance.
Now, to the numbers…
As of Q1 2021, the U.S. median home sale price was $303,425.
- Closing costs (3%) — $9,103
- Downpayment (20%) — $60,685
Total Initial Costs: $69,788
Recurring Costs
Recurring costs include:
- Mortgage payments (average 2.97% for a new home purchase in 2021) —$1,023/mo
- Insurance (average 0.9% of home value annually) — $228/mo
- Property tax (averaged 1.1%) — $278/mo
- Maintenance (at the national average of $125/sf, that’s a ~2500 square foot house… factor in a typical maintenance budget of $1/sf per year)—$208/mo
Total Recurring Costs: $1,737/mo
Net Profit/Loss
Buyers of this median house will benefit from price appreciation, preferential tax policies, and gains in equity as mortgage principal is paid off.
So how much is their net P/L after x years?
- Average annual home price appreciation (Federal Reserve 2000–2020 data) — 3.5%
- Cost of selling (“closing cost”) — 7%
- Inflation: assume 2% annual inflation for taxes, insurance, and maintenance costs
Are you surprised to see that the typical homeowner does not break even until close to year 30?
Don’t forget — they’re getting a place to live!
Building houses costs money, and so does maintaining them. If you think about it, it’s kind of absurd that we expect not only to enjoying the luxury of having a roof over our head for our entire lives, but also to MAKE money off it.
As they say, “there’s no such thing as a free lunch.”
Unless of course you own a home for 30 years. And then yes, there’s free lunch.
Typical Renter
How does the typical renter fare over the same period of time? The cost of renting is easier to calculate. All we need are three numbers:
- Average monthly rent for new rental, Q1 2021 — $1,736
- Average annual rent increase (US Census Bureau 2000–2020 data) — 3%
The third number is the Return on Initial Savings. Remember, our homebuyer paid nearly $70k in initial costs. Our renter can invest that $70k in other assets. This return is more variable. They could buy super-safe treasury bonds or riskier assets like stocks or cryptocurrency. In this model I have set the return at 5% per year, which is a reasonable expectation from a mix of stocks and bonds.
No surprise — even when you invest your initial savings, renting is always a loss for the median renter.
I know there are plenty of folks on YouTube who say that renting is better than owning. In certain situations they might be right. It all depends on your personal choices. If you’re single and rent a small room with roommates in a cheap market, restrain your spending, and invest your savings wisely, you might be better off renting. It’s possible. I once lived in a bamboo bungalow in Southeast Asia for nine months for $125/mo, invested my savings in cryptocurrency, and loved every minute of it.
The point of this model is not to study what individuals CAN do. It’s not a recommendation for personal financial planning. There are plenty of ways individuals can hustle both as renters and as owners — house hacking, roommates, tiny homes, Airbnb, etc.
The point is to compare the MEDIAN owner with the MEDIAN renter. And for those typical households, owning is much better than renting.
Owning vs. Renting
Here’s a side-by-side comparison:
Remember that Federal Reserve statistic from the beginning of this article, that the median owner household has net worth approximately $250,000 greater than the median renter household?
You can see that effect here on this graph by just after year 20.
Caveats
This is a very blunt model, designed to make a point. A few of the many caveats that could be voiced:
- The average renter doesn’t have $70k to invest. If they did, they would probably buy a house instead. 90% of Millennials who are not homeowners aspire to be.
- Americans are terrible savers. Our personal savings rate is less than half of Europeans and less than a third of Japanese. If we have any excess savings, we’re more likely to spend than invest. Owning a home and paying the mortgage forces us to save, which is a good thing in the long run.
- The median age to buy a house is 34 years old. Most people won’t rent their whole lives, and young professionals in big cities exert upward pressure on the median rent. Most people who rent their whole lives do so because they can’t afford to buy, and so the typical rent of long-term (20 years+) renters will be less than the median.
Buying a House vs. Going to College
So what costs more, a lifetime of renting, or not going to college?
(Yes, there are skilled trade professionals who make much more money than college graduates. As always, we’re talking about medians, not about what individuals CAN make with any particular strategy).
A study by Georgetown University found that people with a Bachelor’s degree have expected lifetime earnings of $2.7 million (2019 dollars) over a 40-year career vs. $1.85 million (2019 dollars) for those with a high school diploma.
Factoring in the typical cost of a public, 4-year college ($25,000/year x 4 years), plus an extra four years of earnings ($38,900/year) for high school graduates, the difference in lifetime expected earnings is about $600,000.
According to the model above, homeowners save that much vs. renting by about year 45.
Look, I’m not saying you should take that $100k cost of college and invest it in buying a house instead. Everybody is different and money is just one part of life. There are plenty of reasons to go to college or buy a house that have nothing to do with money. And there are plenty of strategies in personal finance that depend on individual lifestyle choice.
Conclusion
Unfortunately, for the nearly 35% of American who do not own a home, it’s not a question of choice. As mentioned above, 90% of Millennials who don’t own a house want to own a house.
Unfortunately, the ability to buy a home depends to a large degree on intergenerational wealth. More than 50% of first time homebuyers get help on the downpayment from friends and family. Much of the racial wealth gap we see in the United States today is due to decades of redlining, steering, appraisal bias, and predatory lending, and other racist practices in real estate.
The point I want to make with this article is that when folks are locked out of the housing market, the problem compounds. You need money to buy a house, but if you don’t have it, you’re likely losing enormous amounts of money by renting, and it becomes a vicious cycle.
In recent years, massive amounts of private money has flooded the single family housing market — from hedge funds to crowdfunding platforms. The price of housing is skyrocketing, and the homeownership rate has dropped.
Given the devastating long term effects of renting on personal wealth, we must think hard about what these trends mean for the American middle class. Personal residences are still the number one source of wealth for middle class Americans, accounting for 61% of all middle class wealth.
It is critical that middle class Americans not get crowded out and forced into a life of rentership. It could cost close each of us close to $1 million.
