The need for shelter is basic, often closely followed by the desire for community. In the United States, this often translates into a desire to take on a very large mortgage to buy real estate. These basic human emotions drive much of the activity in real estate markets. Most people buy because it is the right time for them. Their career, age, family circumstances all come together to push people toward ownership at different times. Some are fortunate and buy at the bottom of the real estate cycle. Some are not so fortunate and buy at the peak.
The most damaging aspect of our current system is the price volatility. It capriciously rewards some and destroys others. Home price volatility creates a culture of Ponzi borrowing and dependency. The goal of government policy should be price stability, but lately it seems their goal is price maximization. The end result of their policies is an endless series of market stimuli and manipulations which creates even more volatility.
Reasons to buy a house
Many people choose to rent to avoid the negatives associated with home ownership, and many more rent because they can’t meet the down payment or credit requirements to qualify for home ownership. However, most people who hold down productive jobs have a choice. Anyone who chooses not to buy is making a choice to rent by default. There are many different reasons people chose to buy homes to live in, some of them are good reasons, and some of them are not.
Have a place to raise a family
The primary reasons to buy a home are emotional, not financial. At the top of the list is the desire to provide a safe and comfortable home to raise a family. It’s a primal urge. Although it shouldn’t make a difference, there is an emotional quality to home ownership that is not replicated by renting. Satisfying one’s emotional needs is an instinctive drive, and this compels many people to buy houses. Unfortunately, some people turn this emotional satisfaction from home ownership into a reason to feel superior to their renting brethren, a group they perceive as being less involved with family, neighborhood and community.
Be a part of a neighborhood and community
As people grow and develop during their life cycle, they first learn to take care of themselves, then their families, then their neighborhood and community, and finally the whole world. Being part of a broader community one can work to build and improve is a basic human need. Most people see this as a natural extension of buying a house. They dream of watching the children play with the others in the neighborhood, enjoying block parties, and participating in organized events. All things being equal with the house, people will chose to locate in neighborhoods with others of their same demographic with whom they can make friends and socialize.
Following parent’s advice
Many people buy homes simply because their parents did. People grow up, get married, buy a house, have children, and become part of a community because that’s what their parents did, and often this behavior is strongly encouraged by the parents who will even help with down payment money to get started. There’s nothing wrong with this. Parents generally have good advice due to their broader life experience. Unfortunately, parents can sometimes be mistaken as many were that pushed their children into home ownership at the peak of the housing bubble.
Build equity and hedge inflation
Houses tend to go up in resale value over time as workers in a community earn higher wages. The inflation of wages translates into more buying power that allows potential buyers to bid up the price of residential real estate. There is a strong connection between local wages and local house prices. The rising value of real estate serves as a hedge against the ravages of inflation preserving the value of an owners investment.
Also tied to the growth of wages in a community is the cost of rent. People who chose to rent rather than own face the likelihood of rising rents over time as they compete against other renters for available properties. There is no way for a renter to fix their cost of ownership. Sometimes they may find a landlord content to leave their rent alone for years at a time despite the rising rents around them, but once the renter wants to move, they bear the full brunt of increases in local market rents.
As wise homebuyers use fixed-rate mortgages, the loan amortization serves as a forced savings account. Fixed-rate amortizing mortgages are the best tools for retirement savings available to most Americans. The gradual increase in value and the gradual retirement of mortgage debt combine to create equity for homeowners. It is the primary benefit of long-term home ownership.
Acquire an asset to pass on
Many people buy homes because they are a tangible physical asset to pass on to heirs. Since these assets appreciate over the long term, houses become a reservoir of value and a great vehicle for passing wealth from one generation to the next.
Gain a tax deduction
Many people buy a house to obtain a tax deduction on the mortgage interest. As a general rule this is not wise because the borrower is incurring a dollar in expense to obtain a quarter in benefit. However, since most people finance real estate, and since the alternative to ownership is renting, which has its own costs, many people take on a mortgage because they save money on taxes for an expense they would have incurred anyway. Unfortunately, the mistake many borrowers make is to over-borrow to the point that the after-tax cost of home ownership is higher than a rental. Perhaps they believe they are throwing away money on rent, but they are throwing away even more money on interest. It doesn’t make much sense. However, if the net cost of home ownership after the tax break is positive, then the tax deduction has value. Whether the deduction has value or not, many perceive it does, and this motivates them to buy houses with very large mortgages.
Reasons not to buy and rent instead
Between 35% and 40% of Americans chose not to buy and rent their primary residence instead. This is generally a lifestyle choice although during the housing bubble it also became a wise financial move. The reasons vary, but they all generally relate to commitment and finance. It’s said that the decision to own is emotional whereas the decision to rent is financial.
Flexibility to move
The primary reason people chose to rent is to have flexibility. Selling a house takes time and effort, and with real estate commissions and closing costs, considerable expense. Renters face none of these issues. For a renter, at the end of their lease, they simply pack up and move, and they have no further financial obligation to the property. Owners don’t have it so easy.
As a general rule, it costs an owner about 8% of the resale value to move (6% commission plus closing costs). If houses appreciate 3% to 5% per year, it takes two or three years of ownership before an owner can reasonably expect to get out at breakeven. Most people who recognize their current living situation is not likely to last more than two or three years generally chose to rent, and wisely so. Unless they want to become landlords or take a loss, people who must move within two or three years of buying a house give up their freedom of movement.
No money spent on upkeep
Homeowners must pay all the costs of upkeep on their properties. If a dishwasher or water heater goes out, if the roof springs a leak, or any of a number of other maladies strike, the homeowner must pay for it. Renters don’t face these unexpected and sometimes costly expenses. Renting eliminates the unknowns. Renters know how much their housing is going to cost and they know what they will leave with, at best their deposit. Owners face uncertainty as to the costs of ownership, and they don’t know how much they will leave the property with. Sometimes it’s a gold mine, and owners obtain a significant equity check at closing. Sometimes, the end up with nothing but bad credit after a short sale or foreclosure. Ownership is a giant lottery.
Monthly payments exceed comparable rental
One of the best reasons to rent is to save money. In volatile markets like California, prices often get bid up so high by the kool aid intoxicated that the monthly cost of ownership greatly exceeds the cost of a comparable rental. This is also the telltale sign of a housing bubble ready to pop. Rental rates establish where property values should be. Rental Parity is a balance point where there is no financial advantage to choosing renting or owning; a point of theoretical indifference.
If we had a group of theoretically indifferent people who always acted rationally based on perfect information, prices would always be at Rental Parity; any price below rental parity would be perceived a bargain and bid upward, and any price above rental parity would be perceived as too high, and there would be no bid interest. Of course, we all know that people are not indifferent; in fact, they can become very emotional about buying and selling real estate. When they participate in a market, they get caught up with the herd and move prices without regard to fundamentals; short-term price movements become accepted as the market’s long-term trajectory. Trees really can grow to the sky.
Rental parity becomes a baseline — a fundamental. Prices are loosely tethered and may depart for long periods, but prices always manage to return to rental parity in time because as a logical point of indifference; it is the natural resting point for a market purged of kool aid intoxication.
Take on too much debt
Another reason many opt not to buy houses is due to their total cost. Even if very low interest rates make the payments affordable, people get uncomfortable borrowing five or six times their total yearly gross income, and rightly so. Many people blithely take on this debt believing they will not have to pay it off, their future buyer will take care of that. The folly of that attitude became apparent when people discovered that real estate does not always go up in value.
Ties up too much savings
Many people do not buy homes because it ties up a substantial amount of their personal savings. Money tied up in a down payment has an opportunity cost. For people with attractive investment opportunities, it may be wiser to invest that money rather than sinking it into a house. Money put into a house reduces the mortgage payment, so the return on that money is equal to the mortgage. If other investment opportunities provide a greater return than the current mortgage interest rate, then putting money into a house is counterproductive.
Mistakes and fallacies about renting or owning
Sometimes people buy for the wrong reasons. People make rational purchase decisions based on faulty reasoning and irrational beliefs. Most of these center around false assumptions on the financial rewards of owning real estate.
Buying for rapid appreciation
Buying a home for rapid appreciation is a fools game. Most would-be Donald Trumps base their opinion of long-term home price appreciation on short-term market trends. By the time the general public becomes convinced house prices will go up forever, they have already been rising in an unsustainable manner for far too long and most likely ready to crash.
Real estate investors during the housing bubble put their money to work on faith. There is no logical reason to believe house prices only go up. In fact, there have been two prior periods in California’s recent history where house prices did, in fact, go down. However, with kool aid intoxication, otherwise known as faith-based investing, reality is ignored.
For investors who truly believe house prices only go up, no price is too high, and they don’t have to worry about a backup plan if house prices don’t go up. There is only one viable backup plan when a speculative play on appreciation does not pan out: renting the property until they get out at breakeven. For most people, this was as far as they take their analysis. A glib idea of renting it out gives them all the assurance they need to pull the trigger on a foolish deal. If they stop to do the math, they would quickly realize rents would only cover a portion of their monthly cost of ownership. A wise person would recognized this risk and pass on the speculative bet. Investors during the housing bubble were not very wise.
Everyone who participated in the housing bubble claims a collective ignorance; “Nobody could have seen the crash coming” or some other such nonsense. Any investor who bothered to consider their plan B would have quickly realized the risk of an extended period of negative cashflow was an unacceptable risk. Prices didn’t have to crash to make this risk a pocketbook-burning reality. Even a flattening of prices for an extended period would have been a problem.
The people who ignored this risk and bought properties are now bagholders. They own property consuming their income and providing no benefit to them whatsoever. Many still cling to their denial and hope for rapid appreciation to bail them out, but many others capitulate to the market and sell. As they sell they keep prices from rising and discourage others. One by one, each market participant moves from denial to acceptance and capitulates by selling at a loss. Such is the fate of most who buy for rapid appreciation.
Renting is throwing away money
There are two legal ways to obtain the beneficial use of real estate; owning and renting. Since most people borrow money to buy homes, people are actually choosing between renting money to “own” real estate or renting real estate directly. Both forms of rentership have a cost. Owners pay the cost of renting money in the form of interest payments, and renters pay the rental rate in their lease agreement.
There are many forms of money rentership, some have fixed payment rates and some do not. The primary advantages of owning versus renting over the long term are the ability to lock in a fixed cost of ownership, and the ability to accumulate equity through loan amortization and appreciation. Of course, most people overestimate the benefits of appreciation, and this causes many of them to overpay or use adjustable-rate mortgages which negate the advantage of a fixed cost of ownership.
The key point here is that renting is not throwing away money. A renter does not participate in the change in value of the property, which in the long term is generally a benefit for a homeowner. However, if the homeowner pays far more in interest than a renter pays in rent, the renter gains a substantial short-term advantage. Further, if the owner buys at the wrong time –something often tied to paying far more in interest than in rent — the owner may participate in a decline in property values that makes their decision to buy even more costly. Renting is an insurance against a decline in home prices, and it’s a particularly valuable policy when owners are paying a premium to own near the peak of a housing bubble.
Owners are better people than renters
One of the most galling fallacies in the owning versus renting debate is the smug belief among homeowners that they are superior human beings, mentally, emotionally, spiritually superior. Their children do better in school, they demonstrate greater financial control and sophistication, they take better care of their property, and they are more valuable members of their neighborhoods and communities. Of course, the fact that they believe these things is the proof that none of it is true. Some renters do not meet the necessary qualifications for home ownership because they have emotional and behavioral problems, but the majority of renters are either young people just starting out who are on the path to home ownership, or people later in life you enjoy the freedoms of rentership. People who choose to rent are just as valuable to God and society as those who chose to buy.
Consistent Ponzis
The former owners of today’s featured property were very consistent. They consistently borrowed and spent every penny of appreciation the moment it appeared. The put very little down, and they more than doubled their original mortgage.
- This property was purchased for approximately $214,000 on 8/5/1999. The original first mortgage was $212,240 and there was a $5,000 stand-alone second. It’s likely the purchase prices is understated in the public record.
- On 7/30/2002 they refinanced with a $224,0000 first mortgage and took out a $32,646 stand-alone second.
- On 7/21/2004 they obtained a $310,000 first mortgage.
- On 12/1/2005 they refinanced with a $375,500 first mortgage.
- On 12/7/2006 they obtained a $65,000 stand-alone second.
The foreclosure seems to have been conducted quickly, but the outstanding mortgage balance was almost $75,000 larger than the original first mortgage which suggests they were squatting for quite a while before the foreclosure proceedings began.
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We're sorry, but we couldn't find MLS # P840413 in our database. This property may be a new listing or possibly taken off the market. Please check back again.
Proprietary OC Housing News home purchase analysis
13036 MAPLE Dr Garden Grove, CA 92843
$409,900 …….. Asking Price
$214,000 ………. Purchase Price
8/5/1999 ………. Purchase Date
$195,900 ………. Gross Gain (Loss)
($17,120) ………… Commissions and Costs at 8%
============================================
$178,780 ………. Net Gain (Loss)
============================================
91.5% ………. Gross Percent Change
83.5% ………. Net Percent Change
4.8% ………… Annual Appreciation
Cost of Home Ownership
——————————————————————————
$409,900 …….. Asking Price
$14,347 ………… 3.5% Down FHA Financing
3.41% …………. Mortgage Interest Rate
30 ……………… Number of Years
$395,554 …….. Mortgage
$108,045 ………. Income Requirement
$1,756 ………… Monthly Mortgage Payment
$355 ………… Property Tax at 1.04%
$25 ………… Mello Roos & Special Taxes
$102 ………… Homeowners Insurance at 0.3%
$412 ………… Private Mortgage Insurance
$140 ………… Homeowners Association Fees
============================================
$2,791 ………. Monthly Cash Outlays
($259) ………. Tax Savings
($632) ………. Equity Hidden in Payment
$15 ………….. Lost Income to Down Payment
$71 ………….. Maintenance and Replacement Reserves
============================================
$1,986 ………. Monthly Cost of Ownership
Cash Acquisition Demands
——————————————————————————
$5,599 ………… Furnishing and Move In at 1% + $1,500
$5,599 ………… Closing Costs at 1% + $1,500
$3,956 ………… Interest Points
$14,347 ………… Down Payment
============================================
$29,500 ………. Total Cash Costs
$30,400 ………. Emergency Cash Reserves
============================================
$59,900 ………. Total Savings Needed
The property above is available for sale on the MLS.
Contact us for a comparative market analysis, a cost of ownership analysis, or information on how you can make an offer today!
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21 Responses to “Reasons people buy homes and reasons people rent, including the bad ones”
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Happy Thanksgiving to everyone. Time to reflect on how really lucky we all are.
Thank you Larry for publishing this blog. I can’t imagine how much time you must spend researching, writing articles and moderating.
Your blog provides data and information that I would have great difficulty finding elsewhere. You provide a great community service.
And thanks to all my fellow bloggers who have contributed some keen insights into these markets.
It is always so refreshing to share notes and ideas with other free-thinking ,free-market and dare I say free government meddling individuals.
+1
+1 too IR.
Your work here is truely appreciated.
Thank you for the kind words. It’s good to know my work is appreciated. I wish you all a happy holiday.
Agreed. I have too many things to be thankful for this Thanksgiving (one of the reasons I self-censor when I begin to complain about my tax burden increasing). One of those things is this blog and community that keeps me grounded and well educated on a topic that everyone loves discussing, misinformed or not.
When someone pays rent, they receive shelter in-return so the old adage ”renters are throwing money away” is patently false.
“Homeowners must pay all the costs of upkeep on their properties. If a dishwasher or water heater goes out, if the roof springs a leak, or any of a number of other maladies strike, the homeowner must pay for it. Renters don’t face these unexpected and sometimes costly expenses.”
I spent $6,000 on upkeep this year, unless something breaks again. If I add that to my mortgage, insurance, taxes, and HOA. It was cheaper to rent. I’m not even adding the cost of refinance which was about $2,000.
We bought a new house, so we haven’t spent much, if any, on upkeep; but “owning” makes you do things you wouldn’t renting.
e.g. Blinds are fine window treatment/light control devices. They’re cheap too. But when you own, plantation shutters are really nice. So we spent $7k installing those within a year of buying our house.
Typical closets work just fine with minor add-ins. But when you own, it’s nice to have built-ins in the master closet maximizing every square inch of space. We spend $4k on this a couple years ago.
Stacking crap up in a garage works well. But when you own, you want the crap hidden and more controlled. We spent another $3k on storage cabinets in the garage a couple years ago.
Yep. Those are all great personal investments in a property that only an owner would make because they don’t generally add value that exceeds their cost.
Forty-One AGs Sign Letter Urging Congress to Extend Debt Relief Act, Only Nine Resist Urge to Pander
Forty-one state attorneys general signed a letter Tuesday urging U.S. House and Senate leaders to extend the expiring Mortgage Debt Relief Act of 2007-. The attorneys general argued failure to extend the act would take away from the national mortgage settlement.
“Requiring a homeowner to pay income tax on forgiven or canceled mortgage debt would make the National Mortgage Settlement much less effective,” the letter states.
The act, which is set to expire December 31, 2012, allows taxpayers to be excluded from paying taxes on forgiven debt from a foreclosure, short sale, or loan modification.
In a release, Nevada Attorney General Catherine Cortez Masto explained the act is expiring at a time when homeowners are benefiting from the national mortgage settlement, which obligates five of the largest mortgage services to provide $20 billion in credited consumer relief. The relief must be provided within three years as of March.
“I urge Congress to extend this critical tax exclusion so that families in need are not stuck with an unexpected tax bill or deterred from participating in this historic settlement,” Masto said.
According to report from settlement monitor Joseph Smith, servicers have provided $13.1 billion in relief through short sales, or about or about $115,672 per borrower as of September 30, 2012. In addition, 21,833 borrowers received a first lien principal reduction modification and received $2.55 billion in relief, which averages to about $116,929 in debt forgiveness for each borrower.
The letter also points out that failure to extend the act could lead to $1.3 billion in tax increases, according to the Congressional Budget Office.
In February, the federal government and 49 state attorneys general announced a mortgage settlement with Bank of America, JPMorgan Chase, Wells Fargo, Citigroup, and Ally Financial. Oklahoma Attorney General Scott Pruitt opted out of the settlement and was also one of the attorneys general to not sign the letter.
Report: Repurchase Requests Stay High, Standards to Remain Tight
An analysis released by Keefe, Bruyette & Woods (KBW) found representation and warranty costs for loan repurchases remained elevated in Q3.
New mortgage repurchase requests in the third quarter were mixed for companies that reported them, while outstanding requests were mostly higher.
According to the report, current losses can mostly be attributed to loans sold to the GSEs.
Fannie Mae repurchases totaled $2.02 billion in Q3, and its balance of outstanding repurchase requests increased to $16.2 billion from $14.6 billion in Q2, the report says. Meanwhile, Freddie Mac repurchases totaled $819 million, and its outstanding requests ticked up to $2.94 billion from $2.91 billion at the end of the second quarter.
The outlier in terms of buybacks was Bank of America, which reported a decline in new repurchase claims even as it expanded its rep and warranty loss reserves.
According to the report, new claims declined significantly to $4.98 billion from $8.21 billion in the previous quarter, falling more in line with first-quarter levels of $4.7 billion. At the time, BofA noted “that the sharp increase [in Q2] reflected both higher private label claims and GSE claims as a result of the company’s ongoing dispute with Fannie Mae.”
Because BofA is “in a unique position,” KBW’s analysts say they “tend not to extrapolate from their numbers.”
While KBW expects claims to remain elevated through next year, the firm notes that trends suggest new rep and warranty claims from the GSEs seems to have peaked in 2011. However, given the high level of outstanding requests, “lenders are likely to see elevated levels of provisions over the next year as well.”
In September, the Federal Housing Finance Agency (FHFA) released an announcement outlining a new rep and warranty framework for conforming loans sold beginning in 2013. The major changes include a 36-month statute of limitations for repurchase obligations on loans that meet specific requirements. The new framework also includes a 12-month statute of limitations for HARP loans that meet the same conditions.
Private Mortgage Insurers Shun HAMP and HARP Loans, Government on Hook for Vast Majority
Mortgage Insurance Companies of America (MICA), an association of private mortgage insurers, reported Monday that since 2009, its members have insured $86.9 billion in mortgages modified or refinanced through the Home Affordable Modification Program (HAMP) and the Home Affordable Refinance Program (HARP) as well as in mortgages modified through other means.
The $86.9 billion is distributed among 496,961 homes across the nation.
MICA members insured 6,143 mortgages receiving HAMP modifications during the third quarter of this year. The total value of HAMP loans insured amounts to about $1.1 billion.
Additionally, private insurers who are members of MICA have assisted another 7,234 homeowners in receiving loan modifications that are not part of the HAMP or HARP programs. In this category, the insurers have backed about $1.4 billion in loans over the third quarter of this year.
MICA members have also insured 46,440 homeowners who refinanced their loans through HARP during the third quarter. These loans total about $9.05 billion.
MICA reports its third quarter data consists of data from Genworth Mortgage Insurance Corporation, Mortgage Guaranty Insurance Corporation, and Radian Guaranty Inc.
In total, the dollar volume of insurance written by these companies for loans qualifying for HAMP, HARP or other modifications during the third quarter of this year reached about $11.6 billion, up 62 percent from the third quarter of last year. Loan volume was roughly 59,817 during the quarter.
Since HAMP and HARP were initiated in 2009, MICA members have insured 127,516 HAMP loans, 217,109 HARP loans, and 152,336 other modified loans, amounting to nearly 500,000 modified and refinanced loans overall.
if there is a big downturn in home prices the Fannie Mae and Freddie Mac losses will be huge compared to the FHA losses. On top of the hundreds of billions spent of them already.
That’s one of the many reasons the federal reserve and the US government are united in their desire to make house prices go back up.
Happy early thanksgiving to all. The housing industry is one big scam, but you still need hard assets to protect against the erosion of the dollar. I have played within the system since 2008…and still retain ownership of my house, albeit having the can kicked down the road for 40 years. Ask me if I care? It’s less than rent with a subsidy from all you people who cannot afford to own, or will not own. Thank you for supplementing my income, I didn’t want it, nor think it should be legal, but YOU voted for the clowns in office so I’ll just accept that gift. Thank you, now where’s my damn rent money bums?
Good to see you are still reading, and you appear a bit less angry than before.
You may be obtaining a subsidy, but you paid a heavy price in stress to get where you are today. It’s not just renters who are paying for your payment reduction, but everyone who pays taxes, including other homeowners.
IR,
Happy Thanksgiving and thank you for all your time and effort on this blog and its educational value.
I don’t see rent dollars as throwing away money. Renting in Irvine provides shelter, a safe area to live, good schools for the kids and a short commute. The public servants (teachers, police and politicians) that I’ve met have been very diligent in their duties. The fire department is responsive (never used but see how faster they get to an accident). The roads, parks and library are well maintained. I’m thankful for those things.
“Houses tend to go up in resale value over time as workers in a community earn higher wages”
LOL!! not in my america, most people i know and work with have declining incomes….my best year ever was 1997 and it’s been all downhill (that’s what happens when an industry is gutted and shipped to China to save a penny a part) since then…i’m not EVEN close to that income level AND i’m working more hours than ever.
if this is a housing bottom, i’ll have to leave socal, i simple can not afford to live here.
Dont do that, just move to Grand Terrace or Southridge. We’re constantly getting outbid by buyers from Texas and South Dakota for example so I guess they think its better here than there at least.
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