"I cannot wait to spend every weekend mowing this lawn and fixing things!"

“I cannot wait to spend every weekend mowing this lawn and fixing things!”

Before hitting the road, we had the best living conditions of every person in the Seattle area. We lived in a 1 bedroom apartment on the top floor of a 1930’s era 20-unit apartment building near the University. We were a block from the farmer’s market, a block from a Safeway, a block from our garden patch, 4 blocks from a huge park and nature trail, 5 blocks from the library, 7 blocks from Trader Joe’s, and one block from the main business street and bus artery, where we had our choice of 50 different restaurants and easy bus access to anywhere in town.

A little under 900 sq. ft, we had more space than we knew what to do with and an excessive amount of storage and closet space. We didn’t even use the free basement storage space available to us because we didn’t have a lot of extra stuff. We paid the electric bill and our DSL bill, but hot and cold water, sewer, and garbage service were all included.

Free bike storage at street level provided easy access to our main vehicles for getting around town.  Since we were within easy walking and biking distance of everything, and we could hop on a bus to anywhere, we didn’t own a car.

The total price for all of this greatness: $980, a significant increase over our previous $465 a month apartment.  We were living large in a small space

We loved that apartment, the neighborhood, and the overall convenience of everything. Despite our own feelings on the matter, some friends and coworkers felt a duty to suggest improvements to our lives. “You guys should really buy a house and get out of that old apartment.” “You rode your bike to work? That’s crazy. Why don’t you get a car, you can afford it.” “Housing prices are going to go up and you’ll get a tax deduction, you should really look into getting a house.”

Few people are as obsessed with financial optimization as me, and of course I had done the math on these things. The truth is, in a market such as Seattle, it makes ZERO FINANCIAL SENSE TO BUY A HOUSE!!!

The average home price in the Seattle area is ~$400,000. The 4 bedroom place everybody wants for “resale value” comes in at $515,000. Live in one of the trendier neighborhoods (like where we lived), and that home will cost you $914,000. If you are looking to buy in San Francisco, Boston, New York, or Washington, DC, the prices will be even higher. (Data from zillow.com on March 25, 2013.)

After that little financial meltdown incident in 2008, odds are a reasonable down payment will be required to buy a house. Historically that was 20%. If we use the national average 30 year fixed mortgage rate from Bankrate.com (3.78% on March 25, 2013), and assume tax filing is done as married filing jointly, this table summarizes the monthly housing finances

Table 1: Monthly payments for various Seattle homes
Purchase Price

$400,000

$515,000

$914,000

Down Payment

$80,000

$103,000

$182,800

Mortgage Payment

$1,487

$1,915

$3,399

Property Taxes

$250

$322

$571

Insurance

$67

$86

$152

Utilities (W/S/G)

$100

$100

$150

Maintenance (1%)

$333

$429

$762

Monthly Cost

$2,237

$2,852

$5,034

In the best case, we would pay over $1,000 more per month to live in a house.  In the apartment, we paid $0 annually for maintenance, didn’t need to own a ladder or a lawn mower, and our weekends were completely free of maintenance duty.  Paying $1,000 extra a month to live in more space than we need, comes with uncertain maintenance and repair responsibilities, is further away from the places we buy groceries and hang out with friends, and places obligations on more of our free time seems to be a poor trade

But haven’t you heard about the free money the government is giving away?  It’s called a tax deduction, and you get one when you buy a house.

This is sometimes true, but generally only if you pay annual interest and property taxes that exceeds the Federal Standard Deduction.  For the typical married couple, in 2012 this required paying more than $11,900 in taxes and interest.  (In atypical situations where there are a lot of personal itemizable deductions then this gets more complicated.)

This table summarizes the tax differences between renting and buying for the representative Seattle homes:

Table 2: Value of the Mortgage Interest Tax Deduction
Purchase Price

$400,000

$515,000

$914,000

Down Payment

$80,000

$103,000

$182,800

1st year interest

$11,995

$15,444

$27,409

Property Taxes

$3,000

$3,863

$6,855

Sales Tax Deduction

$1,635

$1,635

$1,635

Total Possible Deduction

$16,630

$20,941

$35,899

Tax Savings @ 25% tax rate (Monthly)

$99

$188

$500

Capital One 360 Interest* (Monthly)

$50

$64

$114

* If you open a Capital One 360 Savings Account via this link, you will get a free $25 and we will get $10.

For the $400,000 home, the monthly savings in tax would be about $99.  If the down payment money had instead been invested in a Capital One 360 savings account* at 0.75% interest, it would have earned $50 a month.  In other words, for the majority of people the interest deduction doesn’t do jack, and it diminishes each year of the mortgage due to annual increase in the standard deduction and the mortgage amortization schedule

Paying tax at the 25% marginal rate requires an Adjusted Gross Income of between $70,700 and $142,700 for a married couple.  The median household income in the US in 2012 was $45,018.  You have to be in the top 20% to earn $100k.  In other words this tax deduction only helps people buying houses worth more than about $500,000 and with incomes over $100,000.  It’s an interesting point to note for those interested in the concept of economic inequality

But what about the equity that you are building?  You don’t want to just throw your money away on rent.  What’s the point of spending all that money if you are just building somebody else’s equity?

Unless it is for the purpose of understanding the value of becoming a landlord myself, I don’t find the financial situation of the landlord or how much equity she / he may be gaining each month as important. What is important is whether my own net worth benefits from renting or owning.  In a city like Seattle, renting is better.  Your city may be the same.  (Like in Taipei, for example, Winnie’s hometown.)

Every month, a portion of the mortgage payments will be used to pay down the principal, but in all cases this amount is not even close to the amount saved by renting. In the case of the $400,000 home, the principal portion is about $500 a month in the first year. In the case of renting, I save over $1000.  The equity portion of the home won’t help pay for groceries in an emergency, but the savings account is always available.  A house has ridiculous selling fees.  A savings account has none

But housing prices are going up, a lot of people get rich off of real estate.

Housing prices always go up.  Except when they don’t.  After 2008, this argument for home ownership is used less often, but it is still used despite the data not supporting it.

Over the entire history of tracking housing prices in the US, the value of a home has roughly tracked the rate of inflation.  It has deviated substantially at times, as it did in the years up to 2008, but a home purchased in 1955 would cost the same in 2013 when adjusted for inflation.  Meanwhile the stock market has increased 6X and paid dividends along the way

A house is not an investment, it’s a place to sleep and store your stuff.
(In the Seattle area, multifamily properties have much better investment returns)

Housing Prices Always Go Up. Except When They Don’t
(Adjusted for Inflation)

After all of that math, what does all of it mean?  In a market like Seattle’s (or Boston’s, SF’s, NYC’s, or Washington DC’s) renting is your ticket to Living Large.  Many people will try to convince you to buy a home, especially real estate agents.  Do the math yourself.

Before you know it, enjoying your life in a small apartment will yield an impressive investment account.  In the case of the $400k home, 10 years of investing the savings from renting vs owning at 6% return will result in an extra $100k in your investment account.  The easy walking and biking access to all your neighborhood has to offer will allow you to live car free, increasing the bank account further. Living in a smaller space means you will have less room for stuff, and having no TV will ensure you don’t feel a need to buy more.

In less than a decade, financial independence will be a reality.  That’s when the true meaning of living large will become apparent:  You can choose to never work another day in your life.  That amount of freedom can’t be contained in any amount of space, big or small.

Retire Early.

Travel the World.

Let's do this.

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