One of the financial cornerstones of many successful retirements is paying off mortgage debt before leaving the workforce. Life on a fixed income is a lot easier if you're not making a big payment every month to your lender.
That's easier said than done in today's market. Still, many people with mortgages seek to sell their homes and live mortgage-free in a smaller, less expensive home during their retirement years. If this transition might be in your future, it makes sense to carefully consider whether you should buy or rent your new home. Renting looks better than you might think.
Of course, you may never actually get to the stage of closely comparing the finances of owning or renting a home. There are major lifestyle, wealth and estate issues that might decisively tilt the decision in favor of either renting or owning:
- Do you like tending your own home, including gardening, lawn work, and home maintenance? Or would you like to get out from under many of these responsibilities?
- Do you like the flexibility of an annual lease that gives you the freedom each year of living wherever you want? Or do you prefer to be a long-term member of a community and stay in the same home for a long time?
Even if your answers to these questions cause you to lean strongly toward being a homeowner or renter, it's still smart to evaluate the financial trade-offs of this decision.
U.S. News Money reviewed nearly a dozen buy-versus-rent calculators at leading personal finance websites. Most of them did not compare buying a new home for cash. None let us figure out the benefits to renters of investing the amount of the new home and using the earnings to help pay the rent.
To help make sense of the trade-offs, we've developed a downsizing case study. It assumes you will be able to sell your home and have $250,000 left over after paying off your mortgage and all closing costs. You can either buy a new home with this amount or put the $250,000 in a safe investment fund and use the fund's earnings to help pay your rental expenses.
Owners of a $250,000 home would need to pay roughly 2% of their home's value each year for property taxes and the amount that home insurance exceeds the cost of renter's insurance. That totals $5,000 a year. Set aside another $5,000 for annual home maintenance expenditures. Utilities -- heating, cooling, water and sewage, cable, Internet, and phone expenses -- would generally be higher for homeowners than renters. To make the comparison easy, tack on $2,000 a year for those higher homeowner utilities. The total of these higher expenses for homeowners is $1,000 a month.
Three other key assumptions:
- Renters will earn 6% annual returns on their $250,000.
- State and local taxes will be 20% on investment income.
- Inflation will affect renters and homeowners equally.
If that $250,000 earns 6% a year, the individual could withdraw $1,250 a month forever and still have $250,000 left in the account. That's $1,000 after paying 20% in taxes. Adding in the $1,000 a month in lower renters' expenses provides renters with a $2,000 break-even rental budget.
So, what kind of home can you get with $2,000 a month in rent? A pretty nice one. Moody's Analytics maintains a set of "buy to rent" ratios for more than 50 metro areas throughout the country. It uses home prices from the National Association of Realtors and rental information from Property and Portfolio Research.
For each metro area, the ratio compares the median price of a single-family home with the annual rental cost of a typical apartment. The higher the ratio, the more expensive homes are relative to apartments. (New York Times economics writer David Leonhardt has used these ratios for several years in annual rent-versus-ownership pieces.)
)
