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The narrator starts by saying the goal is to give viewers a framework for thinking about the rent-versus-buy decision for a home. The key takeaway is that there is not a simple right answer, and it is not always better to rent or always better to buy. The narrator discloses that they own a house and bought it for a whole series of reasons, some emotional and some potentially economic. The right choice depends on your personal context, where you are in your life, what part of the world you live in, what the economy is doing at that moment, and what rents are compared with housing prices.
Consider a house on the market for rent at 1,500 a month, which is the same as 18,000 a year. That is one option. Now consider an identical neighboring house that is on the market for sale at $400,000, which you are in a position to buy. You do not have $400,000, so you will need to borrow. You have saved $100,000 for a down payment, and you will take out a $300,000 loan for the remainder.
With a traditional mortgage, which has a fixed term such as a 15-year or 30-year fixed mortgage, you pay a monthly bill, and part of it goes toward interest and part toward paying down the loan. For example, the mortgage payment might be $1,800 per month. Early on, a disproportionate share might be interest, perhaps $1,500 a month in interest and $300 going to pay down the $300,000 loan. Near the end of the term, the split reverses: much more goes to principal, and because the balance is smaller, the interest portion is lower.
To simplify the analysis, the narrator assumes an interest-only loan, where you are only required to pay the interest and can pay down the loan as you choose. For a more detailed analysis, you would need a spreadsheet to see how the interest payment changes over the life of the loan. Assume the loan is interest-only at 6 percent interest. That means you pay $18,000 in interest per year, which is 6 percent of $300,000.
Depending on where you live and your income level, in many places you can deduct mortgage interest from your income. So you do not get all $18,000 back. If you earn $100,000 a year, instead of paying tax on $100,000, you pay tax on $100,000 minus $18,000, which is $82,000. Your savings are roughly your tax rate applied to that deduction. Assuming you save roughly a third of the interest on reduced taxes, the effective interest cost after the tax break is about $12,000 out of pocket. This is the effective cost of interest.
There are also costs of homeownership. You usually have to pay some type of property tax. Assume a 1 percent property tax, which is $4,000 on a $400,000 house. You also have to maintain the house, perhaps paying a gardener, making repairs, or having things painted. These are costs you usually would not pay when renting. Assume about $2,000 per year in upkeep, though this will vary by situation.
The reason for listing all of these costs is that they represent money going out the door. If you rent, the $18,000 per year is simply the price of living in the house. If you buy, the money going out the door is the effective interest cost, the property tax, and upkeep. Adding these up gives $4,000 plus $2,000 plus $12,000, which equals $18,000. Under these assumptions, your annual out-of-pocket cost is $18,000 in either case. These assumptions will differ in each situation, so this is a framework rather than a fixed answer.
The analysis is not finished yet. In the buying case, the $100,000 is used for the down payment, but in the renting case that $100,000 is still invested. You would earn income from it that you would not earn if you bought. If the money sits in a very safe bank account, you might earn 1 or 2 percent, but if it is invested in a portfolio, you might earn 4 percent or more. You need to consider what you could have earned from the down payment by investing that incremental money. For the sake of argument, assume a 2 percent annual return, which is $2,000 in investment income. Netting that investment income against your rent brings your out-of-pocket cost to $16,000 per year.
In the way the numbers were set up for this video, purely on the economics for this year, renting may make sense for this individual. As the narrator notes, things might change in later years. The analysis changes completely depending on the numbers. If the house were cheaper, if the interest rate were lower, or if the rent were much higher, the comparison would shift. A weaker investment return would also change the result. The key is to analyze your actual out-of-pocket costs.
Psychologically, a mortgage can force you to save, and that is a real form of forced saving. In theory, though, you could achieve something similar by renting. You could take the equivalent of the interest portion of your loan as your rent, and then save the remaining $300 a month and put it into an investment pool. After 30 years, that pool might contain a substantial amount of money generating significant income. There is no clear-cut answer that renting is always better or that buying is always better. It depends on the circumstances. This is a back-of-the-envelope version, and future videos will go into more depth.
Beyond the numbers, there are intangibles to consider on both sides. The biggest reason the narrator gives for buying, which was the reason for buying a house a few years earlier, is stability. You might get a great deal on a rental, with an owner who takes care of the property in a great neighborhood, but the owner may want to rent to someone else or move in themselves, forcing you to move. If you buy, as long as you pay the mortgage, eventually pay off the house, and pay the property taxes, you are fairly guaranteed to stay. Another reason to buy is that rents are unpredictable and could go up. In a rapidly appreciating rental market, such as Manhattan or San Francisco, a fixed mortgage payment offers protection from the uncertainty of what rents might do as demand for housing in that location grows. Another advantage is customization. The narrator recalls that when the family was renting, many places looked much nicer if a bathroom or kitchen had been changed or a yellow wall had not been painted. When you own, you can make those same improvements.
Intangibles also favor renting. If you are settling into an area and want to understand the lay of the land, you may not want to commit to one neighborhood or house before understanding things better. Renting offers flexibility. Buying and selling houses involves significant costs, especially brokerage fees. You might prefer a six-month or one-year lease, then buy or rent in a different neighborhood once you understand things better. The narrator also points to the 2003 to 2008 period, when housing bubbles occurred and the economics went far out of whack, with housing prices over-priced relative to rent. The big takeaway is that the decision depends on context, and the framework is meant to help you think through the rent-versus-buy decision.