Question about home equity (or alternative thereto)

Factual Questions
1

Mods: I couldn’t decide between GQ and IMHO. Move it if you’d like, obvs.

Dopers, please help me understand something basic that I wish I’d sussed out years ago: the viable alternatives, if any, to “home equity.”

I don’t particularly want the hassle of homeownership. I’m happy renting, and would continue forever if I could remain youngish (I’m 42) and employed. My wife and any hypothetical children may disagree, of course.

But despite my reluctance to buy real estate, I do want some assets to retire on someday, and people keep telling me I need “equity,” which I should build through owning a house or condo. By renting, says everyone, I’m “throwing [my] money down a hole.”

OK, so let’s say I need equity. But equity is just the value of what I own, right? So maybe it doesn’t matter if the thing I own is a house? Maybe it could be something more abstract, requiring less care and feeding?

I’m thinking I could estimate the mortgage + taxes + maintenance costs of a house in my price range, subtract my current rent, and invest the difference in something like bonds. If I did that year after year until retirement, I’d have some value built up on which to live in my golden years. That’s equity too, right?

I suspect I’m naïve, but I can’t see the flaw in my thinking. Can you?

Thanks in advance,
E.

2

I think your thinking is sound. Of course I’m biased because I also rent, and am planning on using investments (including a 401k plan, a Roth IRA, and an individual investment account) to support me in retirement.

There are two reasons owning a home can be valuable in retirement. The first is that it’s an asset that you may be able to sell to receive income. Recent events have shown that the future value of a home may be greater or less than its current value, or the value you paid for it. Since the same is true of other types of investments (stocks, bonds, etc.) you need to think about which will best serve your needs.

The other value to owning a home is that presumably by the time you retire, it will be paid off, and you will have a place to live rent-free. Of course if you’re living there, you won’t have the equity income from the home (although there may be options like reverse mortgages that will allow you to benefit). If you are a renter, you need to consider that your retirement nest egg needs to be big enough to pay for your daily living expenses and pay rent on wherever you are living. However with proper planning that is not an insurmountable problem.

Even if you own a home, you absolutely should have some kind of retirement savings plan set up. There are many options with differing tax benefits. If you don’t own a home, you just need to make sure that you take into account payment of future rent when you decide where and how much to invest.

3

I don’t think there is a flaw in your thinking. If rent is ‘thrown away’ then so are any maintenance costs of homeowners (priced a new roof lately?) and more importantly all the interest they’re paying (well, OK, except the deduction from the interest. So 3/4 of their interest is just thrown away).

4

As I understand the term as used in this context, equity is the difference between the value of the property, and the amount owed on the property. For example, lets say you own a home worth $100K, but you still owe $75K on your mortgage. This means you have $25K of equity in the home.

5

There’s no flaw, exactly. However, the utility of home ownership over other forms of investment is that, no matter what happens to the real estate market, you can still live in a house. It takes a LOT of bond certificates to build a shelter, and they don’t hold up well to the elements.

6

Pay a mortgage and you pay yourself something. Pay rent and it goes bye bye. You pay yourself because merely maintaining a home and paying the mortgage gives you equity. Equity is money.

Equity is most powerful and meaningful when home prices rise along traditional (not current) trends. Most people get equity this way. Very little is gained from paying into the home until the second half of the mortgage (because of amortization scales, you pay mostly interest for many years and never gain equity in the property until a good number of years, unless the prop value is shooting up).

My dad put kids through school/college with equity. My mom lives off the money (equity) from the sale of primary and secondary properties they owned for four decades.

.

7

If you’re disciplined enough (and make enough money) to pay your mortgage off early, that increases the benefit of home ownership and (greatly) decreases the final total cost of your house. As Nametag says, too, a house is an investment that you live in. Part of my husband and my retirement plans include having a paid-off house to live in.

8

Yes. Just as you would have equity if you exchanged your rent for a mortgage. You come out ahead if the eventual value of your home (mortgage paid off and 100 percent equity) exceeds the value of your investment. As to which is a better value, since you cannot predict the future, nor know the actual value of your home or your investment until that moment arrives, it’s a crap shoot. You roll the dice now and go for it. You can always start one and then convert to the other but that’s a crap shoot, too. At what future point is the sweet spot to convert and who’s to say the next day after you convert, things change?

Then there’s the big unknown of living. What if your landlord fails to pay his mortgage? If the bank foreclosures on your landlord, you are out the door with nowhere to live. Yes, you can find another place to rent, and all the added expense of moving plus a different rental rate (more? less?). If it’s more you have to readjust your investment plan. Also, there’s the expense of owning a home and the regular expenses that entails you think you don’t pay with renting. And so it goes …

What if the economy tanks? Say goodbye to your investment. Yes, the value of your home may go down in a similar scenario, but the physical property still exists.

For me it’s a no brainer. No matter what happens to the economy, no matter what happens to the housing market, once you’ve paid off your mortgage you own it. No one can throw you out of your home (property taxes notwithstanding). I have a 30-year mortgage I’m paying off at a 15-year rate. Once the mortgage is paid off I will continue to take that mortgage money and invest it. Once I retire I will enjoy the benefits of both.

9

There are many advantages in owning a home.

Take the interest paid for a mortage, add the maintenance costs that a landlord would pay, now substract the tax savings from owning. This will give you a figure to compair to monthly rent. and if paid off before retirement you lhave no rent or house payment.

Over the next 20 years how much will the rent number go up? The mortage will stay the same. When I bought 30 years ago rent was about 70% of what a mortage payment would be.

with owning I get to pain what colors I like, have the floors I like, new appliances that I choose, modify the property when and how I want (with in codes).

But the big one for owning is levearage!!!

If you buy bonds that yield you 10% you investment goes up 10%. Now here it is a definate time and rate. That is unless the bond holder faults. then you can get nothing.

If you buy a property with a 20% down and it goes up invalue you get the increase less selling costs. With a 20% down you are leveraged 5:1. If the property goes up 5% that means your investment went up 25%. Yes you do not get all the return because of selling cost.

two years ago I purchased a house for $250,000, $50,000 down, I put in $10,000 getting it ready to rent. The rent covers all my expenses and positive cash flows. Today I could sell the house for $310,000. If it cost me 10% to sell the house that would be $31,000. Leaving $279,000. Pay off the mortage and subtract my origional investment yeilds $19,000. In two years that is a total yield of 31+% or an average yeild of 15.8% per year. And if I wait 5, 10, or 20 years those numbers really improve.

And if the ecconomy tanks you still have the property and do not have to worry about how your land lord is doing.

10

The real calculation is:
How does the rental rate compare to the total cost of buying and paying down a house?
Theoretically they should work out the same, but depending on the supply and vagarities of the market, one or the other may be substatially higher.

Then there’s the “pay it off” issue; so your “cost of renting” calculation should include the cost of building a big enough fund to pay rent in the time - say 20 or 25 years down the road - compared to when your mortgage is paid off and the house ownership costs you much much less.

Stability is a two-edged sword. With renting, you can up and leave at a moment’s notice (OK, a month). However, you can be booted out too. With a house, if you have to move (relocate, new job) you are at the mercy of the market, which could change substantially in a matter of a year. However, later in life you may appreciate the stability that you cannot be asked to pack up and move at age 75 or 80.

You rely on a landlord for building maintenance, or you could get hit with sudden huge expenses if you own.

Your needs may be modest (1 bedroom apartment) or you may like the whole yard and garage workshop thing. That’s a lifestyle choice.

Generally, if you bought more than 10 years ago, the current value of your house should you need to sell will be much higher than what you bought. However, the same may be said for stock market investments or anything else if you time it right.

It’s a personal choice. Off the top of my head, owning is better unless you had to sell in the last year or two.

The biggest consideration is willpower. If you can actually take say $1000/month or whatever you calculate as the differnce, sock it away and not touch it for decades, then you may be better off. Who has that willpower?

11

The flaw in your thinking is that you are not taking the tax advantage of home ownership into account. Interest paid on a home mortgage is deductible.

12

Equity is the value of the assets you possess minus your outstanding liabilities/debts. Home equity is merely one type of equity, and is the current value of your home minus outstanding mortgage debt on the home.

Regarding renting being equivalent to “throwing money down a hole”, well, there are costs associated with owning and costs associated with renting. Owners pay interest and taxes (minus potential tax deductions claims), insurance, and maintenance costs. Renters pay rent and, in some cases, renter’s insurance. You compare the costs, consider the benefits of buying/renting, and make your choice on that basis.

Regarding retirement planning, the generalized planning method is to estimate how much money you will need for retirement, make a conservative estimate regarding annual rate-of-return, and then calculate how much money you need to save every time period to meet your retirement goals. (And then you contribute more than you calculate because, hey, better safe than sorry). Whether your retirement equity comes in the form of stocks, bonds, houses, or what have you is less relevant than making sure you have sufficient equity levels at retirement. This is from a pure equity perspective only; you and others have pointed out that there are very meaningful practical differences.

13

With modern technology, it takes a lot less willpower than you think to save for retirement. With a 401k plan, you can have your employer invest money automatically for you so you don’t even see it as it accumulates year-over-year. Many employers also offer direct deposit options that allow you to put a portion of your income into a savings or investment account each paycheck – again, you don’t see it, and it will accumulate for you without you having to take any action (the “automatic millionaire” idea). Even if your employer won’t do it, you can easily have an investment account set up that will automatically take money from your checking or savings account each month and add it to your retirement fund. Of course you have to resist removing that money and paying substantial penalties, but with a home you also have to resist taking out multiple home equity loans that reduce your equity in the home. It’s all a matter of which choice works best for your needs and your lifestyle.

14

Calling rent “Throwing money down a hole” is a really biased way to look at it (biased against renting, of course). There are a few things to look at.

First, look at monthly payments. In general, renting a property has a lower monthly payment than purchasing the same property. I managed a building that was converted to condos the year after I left. For $750 in rent, you got a nice 1-bedroom apartment. The mortgage payments on that same apartment as a condo? About $1,300.

Now, the nice thing about the mortgage payment is that it’s $1300 for life, until paid off. The rent is going to go up a little every year. In 30 years, the mortgage payment will be $0, but the rent will probably be $3,000. (Depending on inflation, of course). But, during your first 10 years or so, the apartment is the cheaper option.

But comparing those two payment is only part of the story because there are repairs, maintenance, landscaping and other costs paid by the landlord. Those are harder to pin down, but I think people have to look at how handy they are. If you want to be able to call the landlord to fix your plugged toilet, the cost is $0. If you own the home, you’ve now got a $100 plumbing bill. The more repairs and maintenance you do yourself on your home, the better owning looks compared to renting. For a lot of little old ladies (sorry for the stereotype), planning to rent for life might be a good prospect. When I managed apartments, our repair costs (averaged out) were about $200/unit per month. (That’s minor repairs, parking lots, roofs, appliances, carpets, painting, etc.)

You also have to look at rate of return. Real estate is a pretty decent investment, but it doesn’t perform as well as the stock market over time. In the first comparison, you had about $550 a month in savings by renting and another $200 a month using that number for repairs saved. Invest that money in the stock market and you’ll have some real cash 30 years later.

One other advantage to the stock market: you can sell half of it. A house is an all-or-nothing deal and is not very liquid.

So… there is no one answer that’s right for everyone.

15

The tax advantages are grossly overstated. As Dave Ramsey puts it – you’re giving the bank $8000 (or whatever) in order to not to pay the government $2000 (or whatever) in taxes. That’s not taking in account that itemizing means you don’t get your standard deduction – I had a shock as a first-time homebuyer and a first-time itemizer when I filed taxes and discovered I only saved $100 above and beyond taking only the standard deduction.

Home owning is a losing proposition in most cases, as others in this thread have pointed out. Mortgages are also horribly expensive, as also has been pointed out. However, as an inflation hedge, real estate is excellent. Having a mortgage is also excellent as a kind of a forced piggy bank in a spending-centric culture, which is kind of a sad commentary on society considering how little of a typical payment goes to principal and how a lot of it goes to interest, insurance, and escrow. And, finally, there are intangible benefits that attract many to home ownership.

16

I am not sure of this. Family owned some property. Purchased in 1893. I sold my section in 2000. Using my sell price per acre I calculated the land appriciated an average of 12.6% a year compounded annually over a 100+ years.

And stock can only be leveraged at 2:1. And if it drops in value you have to come up with the differance now.

17

But still must be taken into account if you are comparing monthly payments.

This is very true. I was lousy at saving money when I was an apartment dweller. A mortgage forces you to “invest” if you otherwise don’t have the discipline.

18

Thanks, everyone, for your answers (and more are welcome!). I’m learning a lot in this thread.

I do have a 401(k) – actually 403(b), the nonprofits’ equivalent – and an IRA, and I feed them both regularly, so I hope willpower won’t be a problem. Although I know that there’s no one right answer, and that I’ll buy real estate if it seems the right thing to do, it’s reassuring to hear that homeownership isn’t the whole story.

Further answers/advice welcome, of course.

19

I’m curious as to how this works. How did your dad make that equity liquid to put kids through college?
Do you mean he used that equity to secure loans to send kids through college?
Or did he sell the home and use the equity variance? And if he did this then where did he live afterwards? House downgrade? Now rents?

I have about $80K equity in my home but I have no real way to use it. I could use it to secure a new loan but that’s not free money, that’s money that needs to be paid back with interest. I could sell my house to get at it but then where am I going to live? Buy a cheaper house?