Borrowing

Stop Comparing Your Rent Payment to a Mortgage Payment

Why am I wasting $1000 on rent when I could spend $1000 on a mortgage payment?

How many times have you heard this from a friend? Better yet, how many times have you had this thought yourself?

If I can afford an $800 rent payment, I should be able to afford an $800 mortgage payment.

I’ve had this exact thought. My friends and I have had this conversation countless times. I’ve seen this reasoning from everyone, from a Wall Street Investment Banker to a Cashier at the local Fast Food restaurant. It’s very common to think this way, regardless of background or income.

Why would anyone want to throw away money (on rent) when they could buy a house and create wealth (via home equity)?

It’s a very logical question to ask.

But, it’s also very illogical. Making a rent payment is very simple, while buying a home is very complex. What may seem like similar transactions are actually extremely different.

Buying a home can easily create wealth, but it can just as easily destroy it.

If your justification for buying a house is that your current rent payment could cover a similar mortgage payment, I recommend you rethink your decision.

Your Rent Payment is NOT Comparable to a Mortgage Payment

Just because you can afford an $800 rent payment, does NOT mean that you can afford an $800 mortgage payment.

Your $800 rent payment is equivalent to a $400 mortgage payment. If this seems like a drastic difference to you, it’s because owning a home is drastically different from renting a home. I will walk you through the differences between rent payments and mortgage payments below.

If you are paying $800, your initial thought is that you can afford a mortgage payment of $800. If you do some simple math or plug numbers into a mortgage calculator, you’ll find that financing $150,000 will give you a mortgage payment of about $800. You see this and begin looking at houses that cost $150,000;

but, wait!

What About Taxes and Insurance?

Each year, you are required to pay taxes on the property that you own. The amount of this tax depends on where you live. It could range from .2% to 2%. Some homeowners decide to make this payment with their monthly mortgage payment, while other homeowners choose to pay their taxes annually.

In addition to the taxes, you will also have to maintain insurance on your property. Again, you can combine this payment with your taxes (usually referred to as escrow) and your monthly mortgage payment.

It’s always best to look up tax rates in your area, but I estimate 1.25% of the property value for taxes. Insurance will be about .5% on top of that.

After factoring in taxes and insurance, the $150,000 house that you were eyeing is suddenly out of your price range. Now you’re looking at a price of about $115,000. Here’s how I concluded that:

$115,000 financed for 30 years at 5%

  • Mortgage Payment: $617
  • Taxes: $120
  • Insurance: $50
  • Approximate Monthly Payment: $787

Your $800 rent payment is now comparable to a $600 mortgage payment.

But, wait!

What About Maintenance Costs?

When you are renting a home or apartment, your landlord is (or should be) a phone call away. If something breaks, they will fix it. If something stops working, they will replace it. Unless you are the one that caused the damage, your landlord covers all maintenance and repair costs. This is one of the rudest awakenings when it comes to buying a home.

Regardless of the age of your house, you can expect something to break or stop working. My house is relatively new (born 1993) and there is always an unexpected expense of some kind. If you want to estimate what this expense could be, there are 2 decent approximations.

What You Can Expect to Pay for Monthly Home Repairs and Maintenance

  • 1% of your home’s value

(If you live in a $150,000 home, you can expect to spend $125/month on repairs and maintenance.)

  • 25% of your mortgage payment

(If your mortgage payment is $800, you can expect to pay $200/month on repairs and maintenance.)

Neither estimation is perfect, but it’s a place to start. When in doubt, assume it will cost more.

After factoring in monthly home repairs and maintenance, the $115,000 house that you were eyeing is suddenly out of your price range. Now you’re looking at a price of about $95,000. Here’s how I concluded that:

$95,000 financed for 30 years @ 5%

  • Monthly Mortgage Payment: $510
  • Taxes: $99
  • Insurance: $40
  • Monthly Maintenance: $128
  • Approximate Monthly Payment: $777

(*The taxes and insurance at this point are underestimations)

Your $800 rent payment is now comparable to a $500 mortgage payment.

But, wait!

What About a Down Payment?

Traditionally, mortgages have been 80/20. This means that the lender will finance 80% of the home if you put down 20%. In other words, you would be required to have $20,000 as a down payment if you wish to buy a home priced at $100,000.

If you want to set yourself up for success, I would recommend following this tradition.

If you do not have 20% to put down, there are other financing options available. With a FHA (Federal Housing Administration) loan, you may only be required to put down 3.5%. In order to purchase the same $100,000 house, you only need to put down $3,500.

But, wait!

What About Private Mortgage Insurance?

If you only make a down payment of $3,500 on a $100,000; then your mortgage balance will be $96,500. Since the value of the collateral (house) is so close to the loan amount, you will be required to pay Private Mortgage Insurance (PMI) to insure the lender against default (if you stop paying). You will be required to pay this insurance each month until your Loan-to-Value (LTV) is less than 80%. Therefore, once the balance that you owe drops below $80,000, you will (likely) no longer be required to pay this premium.

In order to stay true to the example in this article, we are looking at homes priced at $95,000. Therefore, a down payment of $3,325 would be required. The PMI that you would have to pay monthly is about $88.

After factoring in a down payment and private mortgage insurance, the $95,000 house that you were eyeing is suddenly out of your price range. Now you’re looking at a price of about $85,000. Here’s how I concluded that:

$85,000 financed for 30 years @ 5%

  • Monthly Mortgage Payment: $456
  • Taxes: $89
  • Insurance: $35
  • Monthly Maintenance: $114
  • Down Payment: $2,975
  • Private Mortgage Insurance: $79
  • Approximate Monthly Payment: $773

Your $800 rent payment is now comparable to a $400 mortgage payment.

Summary

Buying a house is a HUGE decision. Just because you are comfortable with your rent payment does not mean that you’ll be comfortable with a similar mortgage payment. There are so many costs associated with buying and maintaining a home that you never see while renting a home. Before you take the plunge into home ownership, please consider what I said earlier:

Buying a home can quickly create wealth, but it can destroy it just as quickly.

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18 thoughts on “Stop Comparing Your Rent Payment to a Mortgage Payment

  1. Thank you, thank you, thank you, this is exactly what I try to tell my wife, in-laws, and co-workers. Everyone is so dead set on the idea that a house is the perfect investment that they just through common sense out the window. Real Estate can be a great investment, but if you aren’t careful and do some real analysis you can get yourself into a lot of trouble.

  2. This is an awesome article. I think it’s amazing how naive some people can be about the costs of owning a house. You did a great job explaining the extra costs. Banks are just helping people get into trouble by pre approving them for more than they can afford, too.

  3. Owning is definitely more expensive by a long shot, but it is worth it to me. I just bought a house that was much less than the banks said I could afford and it has worked out well so far! Just don’t be stupid (be realistic) when comparing the two and you should be fine :)

  4. Great breakdown! I love how you progress through each additional cost to show step by step how much different the two are. Owning a house can be a great long term decision, but many people don’t understand this full analysis and get themselves into trouble by buying more than they can actually afford. This should be a must read for anyone looking into purchasing their first house.

  5. I really liked this article. Too many people think $1,000 in rent is the same as a $1,000 mortgage payment, except that the rent money is totally gone while the mortgage payment is purportedly not. And yet paying rent does not involve purchasing a huge, illiquid asset and entering into a 30 year debt contract! Also, except for the principal portion of the mortgage payment, the rest of it also goes out the window just like rent money.

  6. Applause. Standing ovation. East Tennessee State (I believe) did a study a couple years ago that showed nearly half the people who bought a home the year before would have been better off renting. That’s a big-ass number.

    The “throwing money away” thing makes me vomit. Someone who doesn’t want to “throw money away” ends up with landscaping and interior decorating bills alongside the maintenance and tax responsibilities you mention. There’s no mention by real estate people on “throwing away” that money!

    • My brother-in-law just bought a house and we were touring the place. As we went into every room he would tell us about what was going to be in there. I wanted to punch him, then scream “YOU’RE AN IDIOT” and get the crap out of that money sucking hole. I think it would have damaged the relationship.

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  10. Good point. I do want to own a home eventually. If a $800 rent is equivalent to a $400 mortgage, when it is paid off, you are left with $400 of payments for insurance, taxes, and maintenance. But the rent never ends. But when we go to buy, we will look for something with a mortgage payment well under what our rent is (half seems like a good number, that would buy us a $150k home, which would be a basic 2 bedroom single-family in this area).

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  12. Great break down. Too often people just look at the numbers at start. For the apts you don’t have to fix anything or do any landscaping. Power goes out or frig stops working they fix it. Homes you have HOA, home insurance, yard work, and a lot of other things you mentioned. They are just not in the same ball park but some people you can not tell anything. They see it how they want to see it.

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