Why Renting is a Financial Disaster (course class 3)

Transcript

Most renters are losing thousands of dollars a year and they have no idea about how much they're actually losing, and that's what this chapter is going to be all about. Analyzing the differences between what I call the real cost of renting and home ownership. Because in most cases, home ownership is actually cheaper than renting. But because most renters don't know the total cost of renting versus the total cost of owning and so, we're going to get into that scenario, that analysis. The majority of renters are never able to retire. Now, all of us want to be financially secure and at least have the choice to retire, now whether you choose to retire is another issue.

But being in a place where you have enough income coming in, non-employment income coming in, so that you can choose whether you want to work, or if you want to work, do whatever you want to do. But for renters, that's almost an impossibility and here's why. You can never pay rent off. How many bills do you want that you can never pay off? That every year they just keep going up and up and up and the inflation of the cost of living and for most people, housing is their their number one cost. So inflation keeps affecting them and the monthly rent payment just keeps going higher and higher, and that becomes a real struggle for them. All right, so let's analyze the real cost of renting. Let's say hypothetically, you're paying $2,600 a month in rent. Now, depending on what part of the country you're in, that might be low a rent, that might be a really high rent.

But we'll use this as a median number to start with. You're paying $2,600 a month in rent, and you're looking at buying, it could be a house, a condominium or a townhouse. And your total cost is going to be $2,917. A lot of renters would look at that and go ... And let's look at this from this perspective. Let's say you're talking about buying the place that you're living in. So why would I pay $2,900 for the same place that I'm currently renting for $2,600? So we're going to get into the math of that. If the purchase price of the property is $500,000 and you get a conventional loan and there's lots of different types of financing, but we need the conventional loan using an interest rate of 3.75, so that's three and three eighths percent. Here's how the actual costs work in comparison to renting.

The first significant thing is, and we've talked about this before with the five economic benefits of real estate. One of them is tax write-offs. So on your home, you can write off the mortgage interest deduction, the $16,000, that's the interest, so that's a significant write-off. Now this would be the property tax deduction. The most recent Tax Reform Act that came to pass, I think, it was in 2016 when it started and I think it was officially enacted in 2017. Here's part of that Tax Reform. There are couples limitations. One, on your mortgage interest deduction it's on loan amounts up to $750,000. So in this case, we could write off all of it. So if you buy a property with a million dollar loan, you're going to have a cap at $750,000 on the interest. And next on the property tax is the maximum State income tax that you can write-off is $10,000.

So if you look at your property tax and if your employment, your State employment tax, the combination of two cannot exceed $10,000. So you can see, it's $6,250. If you paid more than let's say, what would that be? $3,750 in personal income tax to the State, that's where you'd hit the ceiling. So total adductions for the year, you can see we're only using the mortgage interest. So if you're a higher income earner, and let's say you're paying $10,000 a year in State income tax, you're not getting this property tax deduction. So you may or may not just depending on what level, if you're buying a property in this range based on the income it takes to qualify, you probably are going to be able to write off some of the property tax along with your income tax, your State income tax deduction.

But I always like to be conservative, so in these numbers, we're eliminating or omitting any State income tax deduction. We're only using the mortgage interest deduction. So odds are, if you're in this price range, you're going to have more tax deductions than what we're using here and the numbers are actually going to even be better. So we're using a State and federal income tax bracket of 30%. So this is basically factoring in 20 to 25% for federal income tax and five to 10% for State. Now some States there are no taxes, there's no income tax. California is one of the highest income tax States. State of California is 12, 13% for most people, in some cases, it can even go a little bit higher than that. But we're using 30%, so this is a good median number. Your tax savings is $4,867.

Now this is a significant adjustment as far as tax savings, and if we divide this out by 12, you're talking about $400 a month almost. Now here's the point of this. Very often when I'm talking to a renter about buying their first property and in their mind they're saying, "Okay, I'm paying $2,600 a month. I don't really have any money left over, so I can't afford for my payment to be higher than this." But what they're not factoring in is this tax deduction. What they can now do is they can adjust their number of dependents and adjust their take home pay, and they can adjust that take home pay up pretty significantly. So in their mind, they don't have this calculated or factored in. So when we do this analysis and say, "Look, if your take home pay went up $3, $4, $500 a month, isn't that going to help you to make an increased payment?"

And the answer to that obviously is yes. All right, so here's our mortgage principal reduction. Now, whenever you make a mortgage payment, assuming you have a traditional mortgage that is fully amortize, like a 30 year, 25 year, 20 or 15 year, but they're fully amortized, fully amortized means the game plan is to pay it off. So you're paying a percentage of principal and interest. There are some loans out there that are called interest only loans, but not very many people get interest only loans. Those are usually bigger investors that are higher net worth, and they have some investment income that paying the mortgage off really becomes irrelevant to them. So on this analysis, we'd have $9,500 in principal reduction, so that's the long payment part, that's the mortgage balance that's going down. So here's the point.      

          This $9,500, you see we're adding it back because you're not losing that money. See, when you pay $2,600 in month in rent, that's lost money. You're never going to get that money back. You've paid that money for the usage of the property, so that is just lost money. But when you make a mortgage payment, the principal reduction, we're lowering the mortgage balance, so what we're doing is we're growing wealth. So essentially this $9,500 is a forced savings account. So this is equity in the property. All right, so our total homeowners savings, so we're saving the property or we're saving the income taxes, this is a tax savings with your tax write-off and here's our mortgage principal reduction. So our total is $13,374. So we take these total $13,374 divided by 12, and our homeowner savings is $1,198. So this is the difference in dollars.

So this is money back to you. So again, with rent, it's 100% lost money, with real estate you have the money coming back to you from income taxes and your principal reduction. So here's our homeowner cost to, oh, we have $2,900, $2,917 is our mortgage payment. So we're subtracting the savings on the property, which is the tax deductions and we're saving the principal reduction. The total homeowner cost to own is $1,720 a month. A significant difference. The rent is $2,600. Our homeowner cost, actual cost $1,720. We have savings of $880. We analyze it. Look at the difference. The difference in the cost to own versus rent is $10,560 a year. Now this doesn't include the most powerful benefit, which is the appreciation or the wealth growth of real estate. So that's a monumental difference between renting and owning.

So bonus advantage, purchase price. Here, we've only used 4% and remember, I say only because California's State average is 7.3%. The national average is 5% appreciation rate. At 4%, that's $20,000 a year, our real estate advantage in dollars per year with the savings is $10,560. Our real estate appreciation $20,000. And you can see the total difference per year and this is lost money, renting is $30,560 in lost dollars. That's a tremendous amount of money. Divide that by 12, you're talking $2,500 of money in lost money when you're renting versus owning. And again, the thing I want to emphasize to you is the rent is never going to be paid off. The key to wealth is winning the inflation battle. When you're renting, you're losing the inflation battle, the rent's just keep going up and up and up.

And to make a bad situation worse, when we retire, we eliminate our employment income. We generally take a big employment step down and as the years have gone by over 20, 25, 30, 35 years, if you've rented that long, now you're 60, 65 or 70 years old, your rent has just done this through the years, now you want to retire and reduce your expenses. And I'm going to share with you. When I first moved out of my parents' house, I was 18 years old and I moved into a little apartment with a high school friend of mine. We rented this apartment. Now this is 44 years ago. That little apartment rented for $315 a month and this was a nice apartment in a nice complex and we split that bill. Today that same place runs for about $2,500 a month. Now here's why I share that with you.

People have a hard time wrapping their mind around what inflation does to their expenses, and this is why it becomes so difficult to retire. Your rent expense just keeps going up and up and up and here's the reality. The majority of seniors that rent, if they're in a high cost area like Southern California, staying in Southern California really isn't an option. So what ends up happening is they either leave the State and go someplace where it's a lot cheaper or they'll move someplace, maybe look at a mobile home or something like that. But they cannot be renting a traditional house or townhouse because the cost is just too high. And to go on that fixed income it just doesn't work. So then this is why I say renting is a financial disaster. You have to buy something. We need to get you into something, a condominium, a townhouse, or a hospital. We have to get you in there.

And then we have to have a plan to eliminate that mortgage payment. There's a lot of different ways to do that. As we move forward in this course, we're going to show you how to do that, but we need to get rid of that mortgage payment because remember, financial security and retirement is really about just two numbers, how much money's coming in and how much money is going out. So in the how much money that's going out, we want to reduce that as the years go by and we want to get rid of your housing expense. If you have a residence, you have a roof over your head, you never have to worry about losing that home and there's no mortgage payment, what is that going to do to your quality of life and what is that going to do to allow you to be able to retire? It just makes everything better, right? It's way easier to retire and it's way easier to stay retired, so that's our class on why renting is a financial disaster.