This age old question has been debated by experts for years now. Some come to the conclusion it’s cheaper to buy while others proclaim renting is easier on your wallet.
When it comes to homes most people assume buying is cheaper than renting. Tell that to the residents of San Francisco or New York. In those cities it’s almost always cheaper to rent than buy. But if you live in cities like Detroit or Cleveland your answer may be different.
Truthfully deciding whether to rent or buy should be based on a lot more factors than geography and the price of the home.
An old boss of mine recently wrote an article where he debated whether to buy or rent a home in New York City so he could be closer to two of his sons. His letter detailed all the costs that go into buying an apartment there like property taxes, maintenance fees, association costs and insurance. In fact he went through a detailed cost analysis of both scenarios before deciding on which way to go.
This got me thinking about my own house. Mr. Patterson and I bought our home about three years ago.
When Mr. Patterson and I bought our first home we were so excited! I thought I finally found a place where I can paint the walls whatever colors my heart desired and put as many picture holes in the wall as I like.
We went to closing with our heads full of ideas on where we would place our furniture and the upcoming parties we couldn’t wait to throw. That is until we saw the paperwork. We quickly realized that although we were buying a home we didn’t really own it. After putting down enough money to cover a 20 percent down payment and closing costs we saw that we only owned one fifth of the home and the bank owned the other 80 percent.
The thought that the bank could take our home if our financial situation changed for the worse scared the crap out of us. So we have made paying off our mortgage an important priority. After we have maxed out our retirement accounts for the year we put whatever extra money we can towards the mortgage.
Fast forward to three years later and $55,000 in additional payments and we now own somewhere closer to 40 percent of our home. I think that works out to where we own our dining room, study, family room and master bedroom. Just two more bedrooms, a kitchen, living room and another bathroom to go before we own it all!
Ever since Mr. Patterson and I calculated how much of our home we actually own I’ve been thinking about what it will feel like to own our home outright. No more monthly payments to make ever again!
Oh wait, that’s not true I thought. Even after we pay off the mortgage and officially own the title to the house doesn’t mean this house won’t still cost money us each and every month.
No matter when I pay off my house I will continually receive bills for property taxes and insurance. Not to mention the monthly maintenance costs I’ll still be responsible for like our utility bills, yard maintenance, and pool.
We quickly realized that “owning” our home will still cost us tens of thousands of dollars a year. Even when we get the title to our house that tells us we now owned our home outright, we won’t be able to control future costs (we know our property taxes will go up eventually).
It dawned on me that these same principles applied to more than just my house. The same is true for furniture, exercise equipment, boats, and nearly everything else you buy. Just because you buy something doesn’t mean you own it and owning it doesn’t mean your item won’t cost you more money down the road.
While this financial lesson was an unhappy one, I can’t say it was all bad. Really it was just the opposite. It showed me how to calculate the true cost of my purchases and has helped me make better purchasing decisions ever since.
From then on when I considered any major purchase like a home or a car I factored in the total cost of ownership (TCO). The TCO of an item is the purchase price plus any and all costs the item will cost me to use it while I own it.
When buying a car, the TCO includes not only the sticker price, but the cost of any necessary repairs, new tires, insurance and such over the length of time I will likely own it for.
Let’s use the example of a car when deciding whether to buy a new or used car. Last year on Yahoo I read about one couple’s experience buying a new car and a used car around the same time. The wife got a brand new Mini Cooper for $24,000 and the husband got a used Jeep Wrangler for $4,000. After five years both cars were paid off.
They financed the Mini Cooper at a rate of 4.5 percent after putting $3,000 down. In the end the new car cost them about $27,000 in principal and interest. The Jeep was bought outright at the beginning so the cost remained the same at $4,000. At the end of the five years, the new car was worth about $10,000 for a net loss of $17,000. The Jeep, after the same amount of time is worth about $2,500 for a net loss of $1,500. In terms of depreciation and cost to own the used car wins.
But there are other factors to look at when it comes to the total cost of ownership, like routine maintenance. The brand new Mini Cooper came with a full warranty and maintenance package. It knocked the maintenance costs for the new car down to $0 over the course of five years. The Jeep was a different story. It came with no warranty and no maintenance package. Over the course of the five years he had to change the oil five times, change the brakes, get a new radiator, and have the tires rotated; all of which cost him about $1,400. So in this category the new car was the clear winner.
The total cost of ownership for the Jeep was $2,900 over five years ($4,000+$1400-$2500). While the total cost of ownership for the Mini Cooper was $17,000 ($27,000-$10,000). In the end the used car has a much lower cost of ownership over the same amount of time.
The next time you are making a big purchase decision, like buying a home or car, remember to think about the total cost of ownership. Look beyond the sticker price. Always remember to take into account all the costs involved. Then divide them by the number of years you expect to own or use the possession. This will give you the total cost of ownership.
This buying principle has the potential to save you tens of thousands of dollars, perhaps more if you begin using it now. My old boss used this principle to save himself about $200,000 over the course of ten years by realizing it’s cheaper to rent an apartment than to buy one. And I intend to use it the next time Mr. Patterson and I buy a house, car, or any other major purchase. I hope you will too.
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Keeping Money in Your Pocket,