FIRE: The Rent vs. Buy Debate ANSWERED
Rent vs buy vs nomad vs tiny house. What's our best option.
This is a classic question that all FI/RE chasers ask themself, "does it make more financial sense to buy a house rather than paying rent every month?".
Everyone in our community hates wasting money and housing expenses are by far the biggest portion of most of our annual expense totals.
I'm going to approach the question from a number of angles but I shall provide a quick caveat early on:
Financial decisions, although logical, are in a constant state of war with emotional decisions. You can explain to your partner a million times that living in a tent down by the river will allow you to retire 10 years early, but then you will also have to explain to everyone you know why you are single again.
Emotions & general human desires are a huge, incalculable, part of the equation. You can use these results to formulate a baseline but I personally recommend that you make sure you commit to the plan that will provide the best balance of happiness & financial prudence.
Now let's dive into the numbers.
- You are earning $50,000/year (after-tax of 22%: $39,000)
- You live in/near a major city (but, not a HCOL region - NY, Miami, San Fran, you get it)
This is a very generalized estimate, but the average rent for a 1-bedroom apartment is about $1,200.
There is obviously a wide variance between LCOL (Kansas) and HCOL (CA) states but for the sake of my sanity, we will run with $1,200.
At $1,200/month, you are spending $14,400/year on housing. That comes out to about 37% of your after-tax income. (18% of you're splitting rent with a partner)
Utilities will vary slightly depending on region but are generally the same.
Maintenance, as it is a rental, will almost entirely be paid by your landlord.
Flexibility will be strong as you are typically signing on for only 12-month periods. By flexibility I mean the ability to shift to a lower-cost/same value option yearly (moving costs aren't too crazy in 2020 with UHaul DIY).
Assuming that you rented for 50 years (30 until the average "kick the bucket" age" of 80) and inflation will be the same for all housing options (so no adjustment made), that would total approximately: $720,000 over a lifetime in rental payments.
By 60 (30-years if we're 30), we will have spent $432,000 on rental payments.
Both the long-term number and RE goal age will be used for the other options as well since the goal isn't just to save the most money before we croak but to save money in a fashion that allows us to obtain FI as quickly as possible.
I started with rent for the obvious reason that it is by far the most common for early-career professionals and doesn't actually require any major capital outlays. This is the benchmark to beat.
This is the one that all your non-FI article reading friends are rushing towards as we speak.
Wouldn't it suck if the McMansion buying, house poor, twenty-somethings got it right without a moment of thought?
Here's how I'm going to do this one:
I'm going to take the $1,200/month rental payment and back into a home value based on mortgage payments & a 20% repair cushion. I will also assume that you've saved $10,000 to use as a downpayment.
So our goal with the cushion is a $1,000 total mortgage payment (P&I, property taxes, insurance, mortgage insurance) on the house/apartment/townhouse/etc.
The total % of your income will be equivalent to renting initially but will actually improve every month/year as you pay down the principal on the home.
Rates are crazy right now, but life is always crazy, so let's run with the current lowest interest rate available on a 30-year traditional loan is 2.50%.
Thanks to our friends at Zillow for their great calculator, playing with total/payment amounts put our purchase home value equivalent at $175,000.
There will be some slight variance (+/-) $10,000 depending on: if there are local area property taxes, if there are HOA fees, if you can put down more to eliminate the mortgage insurance, etc). But this is a "good enough" estimate.
By 60, (over the 30-year mortgage period), you will have paid approximately $240,000 when you add-in insurance costs & interest payments - more if there is an HOA) and fully own the home.
The advantage here is that with 20-year of "golden years" to go, you've cut your housing payment to taxes, insurance, and maintenance costs (and possibly made a little bit in capital gains if you want to sell).
So our verdict on anyone buying a home for $175,000 or less (paying equal to or less than $1,000 in payments to the bank) is that you are winning financially vs renting.
Over a 30-year period, you are saving about $190,000 in housing payments (even with a maintenance buffer of 20%).
The con, which is obvious, is that you are locked into a fixed location.
There is zero flexibility when it comes to buying a home.
Yes, you can make the argument, "I could always sell it when the market value increases and buy a new home somewhere else". That's possible. But it's also possible the market tanks and you get locked in for the full 30.
My point being is that when you are buying this $175,000 dandy, you should do so with the intent of going the distance with it to really take advantage of the expense savings.
These are the most adventurous of the FI/RE community.
For those who have no idea what I'm talking about: digital nomads are FI/RE members who live out of there vehicle/trailer and travel the country all year rather than settling down in any particular city.
You have to have a very remote-working friendly job to pull this off (as you will be on the road 50-80% of the year). The downtime is likely holidays when you settle in for a bit of time.
The biggest expenses this lifestyle entails purchasing a reliable vehicle, purchasing a trailer/RV, fuel/vehicle maintenance costs, and paying for campsites.
I'll keep the selections, assumptions simple:
Toyota Tacoma 2018: $30,000 (replace every 10 years)
FifthWheel (various 2016 or newer): $45,000 (replace every 10 years)
Fuel Costs (week/month/year): $150/$600/$7,200
Truck & RV maintenance (week/month/year): $200/$800/$9,600
Camp sites average: (week/month/year - 80% of year): $250/$1000/$12,000
By 60 (again over 30 years) you will have paid a total of $1,089.000.
The killer here is the campsite costs essentially coming out to the cost of renting a 1-bedroom apartment.
So you may have an amazing 30 years on the road, but in all likelihood, you will have paid for it (4 times the cost of simply owning a home).
The caveat/obvious argument is that no one stays on the road for 30 years. My counter-argument is that is very rarely saves any money to be a road warrior and likely ends up costing 3 times what it would have cost to simply buy a home.
I saved the most trendy for last.
Most people have such a love/hate relationship with tiny houses. Mostly, boomers think they're ridiculous and millennials think they're awesome.
The biggest costs associated with the tiny house are the actual structure itself and the purchase of the land on which the new home will reside.
The land can be tricky to find and you will need to look out for zoning regulations & obtain a quote on how much it will cost to install plumbing/electric if the parcel is remote.
Land values can vary considerably by state/proximity to cities/etc but for general estimation purposes let's say that the 1 acre of land we will purchase will be $30,000.
Add to that the average cost of a tiny home of $60,000 (although they can be built for as little as $10,000), our total cost comes to $90,000.
You will typically need to put 20% for this loan (so $18,000) but the loan will convert to a traditional 30-year after the construction period ends (rates may be a bit higher before then).
So, if you can swing the extra $8,000 for a down payment, the total monthly cost will come to $410 (including property taxes & home insurance).
Let's add a 10% maintenance savings premium to that to get to $450/month.
The total cost over 30-years is $102,000, however, with monthly payments this low, you can likely pay it off in half the time.
This shifts the payments to $650/month or $86,415 over 15 years.
Clearly the cheapest option, the tiny house is restricting, literally, in the respect that they are typically 500 square feet or less.
They are also even last flexible than a traditional house since resale can be more difficult as it's a niche market of buyers.
That being said, this is the clear winner from a cost/FIRE perspective.
If you're willing to downsize your life, this option will save you a ton (hundreds of thousands, almost a million compared to the nomad) over 30 years) and let you retire the earliest.
Hope this helped & happy saving!