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Is buying a home always better?

The math of renting vs. buying a home. Challenging the notion that it is always better to buy. Created by Sal Khan.

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  • leaf green style avatar for user Tarek Seif El Nasr
    why did he end up paying 26,000 in rent
    (19 votes)
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  • mr pants pink style avatar for user james.lemur
    There are considerations other than money, though. If you're renting, in many situations, you can lose your home suddenly if the landlord decides he wants to move in, move in a relative, or increase the rent so high you can't afford it anymore. The cost of moving and potential adjustments to jobs and schools can be very high, monetarily and emotionally.
    (25 votes)
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  • blobby green style avatar for user ips3275
    for the renting scenario, don't you have to pay taxes on the 10K interest earnings?
    (14 votes)
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  • piceratops tree style avatar for user Scott
    I felt as if this video was trying to talk people out of buying a home, but statistically speaking people who own a house are 26 percent wealthier. If you buy a house with a 6 percent interest rate you probably should not have bought it in the first place. Also, if two identical houses are next to each other it would cost more to rent and cheaper to buy, because nobody would buy a house and rent it out to lose money on their return on investment. Something does not add up in this video.
    (8 votes)
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    • blobby green style avatar for user John Doe
      There are a load of variables going on here that vary year by year and city by city. There's no right or wrong answer. Right now, in the specific city in Southern California where I live, if you put 20% down on a $1M home your monthly payment is cheaper than renting that same place. I know because I put 20% down on exactly a $1M purchase price at a 3.625% 30 year fixed rate and the monthly payment is $3650. Literally next door is an almost identical place and it rents for $4200/month. And that's true all over where I'm at.

      But that's not true everywhere, and may not be true where I'm at in 2-3 years when rates are higher. The point is it's not black and white.

      But what I do know is the example in this video isn't a good snapshot of reality (that is, the video assumes mortgage rates of 6% which are way higher than the average rate today of around 4%, and it assumes the home buyer is on an interest only loan which is not a smart loan to get in general, let alone when you are putting 25% down). And the video is assuming for now that the home is not going to increase in value (which again, over the long run, isn't true),

      If you are doing a 1 year comparison, you could demonstrate renting is better than buying. If you're doing a 5 year comparison, not so much. And if you're renting at $800/month more than the mortgage, the home owner is saving thousands of dollars more per year than the renter plus paying off principal that he'll get back on the eventual sale.
      (11 votes)
  • leaf green style avatar for user Jo Van
    Isn't this scenario unrealistic? How can someone earning $100K per annum buy a home for 1 Million? I know, maybe the $250K was a gift or inheritance, but the wages of 100K could never sustain something like this. Maybe put the $250K towards a home affordable with that kind of income and your scenario would change. Most people who have money DO NOT SAVE it, but putting it towards a home forces them to pay something off and after 15-20-25 years, at least they have something they own outright.
    (10 votes)
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  • blobby green style avatar for user londonrealestate
    All I can say is that I can get money... on a 10 yr term here in Ontario Canada for 3.7%... I can get 4 year money at under 3%. The math is fundamentally true, I think the tax implication vary depending on where you are.
    (3 votes)
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    • leaf green style avatar for user Dwade Reinsch
      I live in Texas. His example is correct, but it is not typical of the historical relationship between cost of house and rent charged. A million dollar house should have a mortage payment of about 10,000 per month (princial, interest, taxes) and a million dollar house should rent for about 10,000 per month. Then renting is better for short term, buying is better if you are going to live in the house for 4 plus years. The numbers he is using are the numbers that have been generated by the housing bubble and the real estate colapse.
      (10 votes)
  • male robot donald style avatar for user Nick Goehring
    is it possible, if you take out a slightly larger loan and hold on to some of your cash that would be earning interest that would reduce your out of pocket per year costs?
    (4 votes)
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    • old spice man green style avatar for user oompa loompa
      It's probably not possible in the example you've given. The bank is loaning you the money because they can always take the house away if you fail to pay them back. If they've given you more money than the house is worth, and you fail to pay, the bank has now lost more money and can't even get that back by selling the house again. However, if you want to take out a larger loan and use the extra money to make improvements on the house, the bank will probably allow that because you're increasing the value of the house and if you fail to payback the loan, the bank now has a house that matches the value of money they gave you.

      Also, generally the loan you get for a house is going to be cost more than the interest you earn for a CD. As of right now a 1 year CD will get you about 2.5% and you will pay 3.7% on a house loan. You'd be losing 1.2% of your money doing this.
      (5 votes)
  • leafers seed style avatar for user gamason
    Mr. Khan uses a 6% interest rate for a 30 year fixed rate mortgage, but mortgage rates are actually in the neighborhood of 3.5%, and haven't been as high as 6% since 2008. Making such an unrealistic assumption drastically skews the results in favor of renting. Viewers who are trying to learn this subject should be aware of this.
    (4 votes)
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    • leaf green style avatar for user Ryan
      Well, the video was uploaded to youtube in 2008...

      He could redo the whole video with 3.5% and in four years it would be out of date again. But in my opinion that wasn't the point of the video. The point of the video is to show that it is possible that renting is cheaper than buying and shows you the basics of how to figure it out. I think that's important because it is still a very common misconception among young people that renting is throwing money away.
      (7 votes)
  • mr pants teal style avatar for user hakanmhmd
    When I take an interest-only loan and I pay back every month the interest only when do I acually pay the principal ?
    (5 votes)
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  • blobby green style avatar for user Dave Nantz
    It's not all about the math. It's about pride of ownership, neighbors, stability.
    (3 votes)
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Video transcript

Welcome back. I'm now going to take a slight tangent and cover a topic that, I think, this is probably the single most important video that really anyone can watch. I go to all of these parties where I go see family. And my wife and I right now, we live in Northern California. And we're renting. And I like to point out, by choice. And I have family members, why don't you buy? You're at that stage in life, that's a major milestone, all of this. There's a lot of pressure to buy. And when I tell friends, I tell them I'm not going to buy. Because I think I'm pretty convinced, almost 100% convinced, that housing prices are going to revert back. And I'm going to do a bunch of presentations to justify why they will. But then my friends, they'll just throw out the statement that I hear from them, that you hear from real estate agents, because obviously they want you to buy. Well, isn't buying always better than renting? And I think that kind of common wisdom comes out of the notion of, when you have a mortgage or when you borrow money to live in a house, every month that money that you give to the bank is kind of going into savings. That's the perception. While when you rent, that money's just disappearing into a vacuum. In this video I'm going to work through that assumption, and see if that actually is the case. So let's say I have a choice. Let's say there are two houses. This is house number one. And this is house number two. And let's say that they're identical houses. These are three bedroom, two bath, townhouses some place in Silicon Valley, which is where I live. And I want to live in one of these houses. I'm indifferent as to which house I live in, because they are identical. So living in them is the identical experience. I can rent this house for $3,000 a month. Or I could buy this house for $1 million. And let's say that in my bank account right now, let's say I have $250,000 cash. So let's see what happens in either scenario. Let's see how much money is being burned. So in this scenario what happens? I'm renting. So in a given year, let's just see how much money comes out of my pocket. So in a given year I pay $3,000. $3,000 times 12 months, so I lose $36,000. So I'll put a negative there, because that's what I spend in rent. $36,000 per year in rent. And then of course I have that $250,000. I'm going to put that into the bank, because I have nothing else to do with it. I didn't buy a house with it. And let's say that I can, in the bank, let's say I put it in a CD. And I get 4% on that. So let's see, 250, that's what? $10,000, I think. That's 0.04. Right, I get $10,000 in interest a year on that. So I get $10,000. So plus $10,000 a year in interest. So out of my pocket, for the privilege of living in this house, in Silicon Valley, with beautiful weather, out of my pocket every year goes $26,000. So that's scenario one. So what happens if I give in to the peer pressure of family, and realtors, and the mortgage industry, and I buy this house for $1 million? Well I only have $250,000, which is more, frankly, than most people who buy $1 million houses have. But I have $250,000 cash. So I need to borrow $750,000. So I take out a mortgage for $750,000. And I'm going to do a slight simplification. And maybe in a future presentation, I'll do kind of a more complicated one. In a lot of mortgages, when you pay your monthly payment, most of your monthly payment, at least initially, is the interest on the amount that you're borrowing. And you pay a little bit extra on that, to bring this value down. That's called paying off the principal. You can also take an interest-only loan, but the component of the interest is the same. Essentially, when you take a traditional mortgage, kind of a 30-year fixed, every month you're paying a little bit more than the interest, just to take down the balance. But for the simplicity of this argument, I'm just going to say that we're doing an interest-only mortgage. And then maybe with any extra savings, I can pay down the principal. And that's the same notion. And right now, if I do 25% down, and I'm buying a $1 million house, I'll have to take a $750,000 mortgage. I don't know what a good rate is, 6%? So let's say at 6% interest. So to live in this house, how much am I paying just in interest? Well I'm paying $750,000 times 6% a year. So $750,000 times 0.06 is equal to $45,000 in interest. That's coming out of my pocket. And of course, on a monthly basis, that means in interest per month, I'm paying, just to get an idea. I'm paying about $3,700, $3,800 in interest a month. My mortgage actually might be something like $4,000 a month. So I pay the interest. And then I pay a little bit to chip away at the whole value of the loan. It takes 30 years to chip away at the whole thing. And over time, the interest component becomes less, and the principal becomes more. But for simplicity, this is the interest that I'm paying. $45,000 a year. And then of course at a party, when I start to explain this, it's like, ah-ha. But interest on a mortgage is tax deductible. And what tax deductible means, is that this amount of money that I spend on interest on my mortgage, I can deduct from my taxes. I can tell the IRS that I make $45,000 less than I actually did. So if I'm getting taxed at, let's say 30%, what is the actual cash savings? Well I'll save 30% of this. I'll have to pay $15,000 less in taxes. How does that work? Well, think about it. Let's say I earned $100,000 in a year. And I normally have to pay 30%. So I normally pay $30,000 in taxes. Right? This is, if I didn't have this great tax shelter with this house. Now I have this interest deduction. So now I tell the IRS that I'm actually making $55,000 a year. And let's say my tax rate is still 30%. it actually will probably go down since I'm -- but let's, just for simplicity, assume my tax rate is still $30,000. So now I'm going to pay $16,500 in taxes to the IRS. So how much did I save in taxes? So I saved $13,500 from taxes, from being able to deduct this $45,000 from my income. So let's say tax savings, plus $13,500. Now what else goes into this equation? Do I get any interest on my $250,000? Well, no. I had to use that as part of the down payment on my house. So I'm not getting interest there. But what I do have to do is, I have to pay taxes on my property. In California, out here we have to pay 1.25% in taxes, of the value of the house. So what's 1.25%? So, taxes, this is property tax. And that's actually tax deductible too, so it actually becomes more like 0.75% or 1%. So let's just say 1% just for simplicity. Property taxes. So 1% times $1 million. That equals what? 1% of $1 million is another $10,000 a year in property taxes. And notice, I'm not talking about what percent of my mortgage goes to pay principal. I'm just talking about money that's being burned by owning this house. So what is the net effect? I have a $13,500 tax savings. I have to pay $10,000 -- actually I have to pay a little bit more than that, but we're getting a little bit of income tax savings on the deduction on the property taxes. And then I actually have to pay the $45,000 of interest that just goes out the door. So I'm paying $41,500. Notice, none of this $41,500 is building equity. None of it is getting saved. This is money that is just being burned. So this is a completely comparable value to this $26,000. So in this example -- this example is not that far off from real values. Out here in the Bay area, I can rent a $1 million house for about $3,000. But in this situation I am burning, every year $41,500, where I could just rent the same house for $26,000 out of my pocket, when I adjust for everything. And then people a couple of years ago said, oh, but houses appreciate. And that's what would make it up. But now you know, very recently -- we know that that's not the case. And in the next video, I'll delve into this, and a little bit more. I'll see you soon.