Identifying the Opportunity Costs
Last year I purchased my first home. See the picture? It's adorable! I was so excited to become a homeowner and live the American Dream. As I was shopping at Home Depot for paint colors the week after moving in, my phone alerted me of a severe hail threat in my area. Not thinking much of it, I went along with my evening. Little did I know that the hail storm would be the worst in San Antonio’s history and would damage my roof beyond repair. Even with my homeowners insurance in place, I had to use emergency savings to meet my deductible and replace it. At that point I knew…I was no longer a renter.
Finding an answer to the great debate of buying verses renting has become muddied over the last decade (remember housing market crisis, millions of homeowners underwater, circa ’08?). Also, with the millennial generation relocating more often, on average, than previous generations, it begs the question…”Is home ownership really the goal?”
While we could crunch the numbers and make assumptions about interest rates, the housing market, and rental prices, it’s likely we would end up with the same conclusion…it depends. So let’s think about it from a different perspective, what is your opportunity cost?
If you recall from Economics 101, opportunity cost is the cost of making one decision over the other. For example, let’s say you moonlight as a lounge singer and get paid $200 per gig. Instead of performing tonight, you decide to stay in and binge the latest season of Stranger Things. Your opportunity cost is the $200 you gave up to stay home. Applying it to buying versus renting, there are opportunity costs that we don’t always consider on both sides.
Evaluating Opportunity Costs
Maybe you shouldn’t view your home as an investment? As we saw from the crisis of ’08, home prices do not always appreciate. Even if your home barely outpaces inflation, at the end of the day that house is yours, and that is worth something.
In order to secure financing, you already need to have decent credit. But buying a house and keeping up with your payments can make a big impact on your credit score. Renting, on the other hand, only influences your credit if the apartment complex reports that information to credit bureaus. Most of them don’t, so your opportunity cost here is giving up the benefits home ownership has on your score.
Buying a home requires a lot of cash. That cash could be used to grow your wealth in ways other than real estate. While there are no guarantees with investing, it’s certainly an opportunity cost to keep in mind.
Renting avoids paying a bank thousands of dollars in interest over the life of a mortgage. Money not spent on interest could be saved and invested, but the burden is on you to do it.
Do you plan to sit tight for 5 to 7 years? The opportunity cost of paying rent for a long time could mean a missed opportunity to build some equity in an asset.
Jake’s Two Cents
If you find yourself in this debate, consider these factors:
Tools Are Cool
The New York Times has an amazing rent vs. buy calculator available for free. This tool incorporates every important component of the home buying decision making process. From home price to the realtor’s fee, all of these expenses influence the outcome of your decision to buy versus rent. Check out the calculator here!
Jake Rivas, CFP® is a financial advisor and CERTIFIED FINANCIAL PLANNER™ at i*financial located at 1901 NW Military Hwy Ste. 102, San Antonio, TX 78216. He offers securities and advisory services as an Investment Adviser Representative of Commonwealth Financial Network®, Member FINRA/SIPC, a Registered Investment Adviser. He can be reached at 210-342-4346 or by email at firstname.lastname@example.org.