Transcript
I’m a multi-millionaire and I rent my house. In fact, I’ve rented for 20 years and I’ve made more money renting than I would have owning a place. But should you do the same? In fact, should you rent or buy your house?
A lot of us have been told buying is the best thing ever, build equity, renting is throwing your money away. I think that for the biggest purchase of our lives, we need to go into more detail. So in this video, I’m gonna give you four specific steps to break down if you should rent or buy with an exact address so you can follow along with the analysis.
And I’ll give you a clear set of rules to make sure you make the right decision for you. Starting with step number one, change your mindset around renting. The first thing I want you to do is to accept the fact that yes, renting can make financial sense in a lot of cases.
And if you’re gonna truly use this video to come to the right decision, I want you to understand why. People do not like to even think that renting can be a good financial decision because we have been told renting is throwing your money away. But I’m gonna prove this to you with actual numbers.
Let’s take a look at a specific unit that has been both bought and rented. 776 Bryant Street in Palo Alto, California. This is a two bed, two bath, 1,521 square foot condo. It was sold in 2018 for $2.15 million.
Now this is Palo Alto, it’s extremely expensive. Now I’m starting with this example in Palo Alto because you’re gonna see the numbers and they are insane. But don’t just think that because Palo Alto is expensive, this only applies there. You’re gonna learn how to do the analysis so you can try it for your own city.
By the way, if you look online, you can see that the current price estimate has decreased by $154,000 since it sold. Now that’s just an estimate. We don’t really know what the sale price would be today. But you have to remember that prices go up and prices go down.
we really only talk about when prices go up. Let’s take a look. Instead of being worth $2.15 million, it’s now estimated at $1.9 million. Again, just an estimate.
If you put 20% down at the current average interest rate for mortgages of 7%, you’d pay about $10,624 a month on your mortgage alone. Okay, just the mortgage. Now that we know how much this place would cost to own, let’s see how much it would cost to rent. If you were to rent this same unit, it would cost you $5,400 a month, which is exactly what it rented for in January of this year.
That’s about half of what it would cost you per month to own. And that’s not even factoring in what I call phantom costs of ownership. Things like maintenance or closing costs or all kinds of hidden or counterintuitive fees that would make renting an even better financial decision. Okay, now we see it, black and white.
It is clear that sometimes renting can be a better financial decision. Let’s move on to step number two, understand the myths around housing. After you’ve acknowledged that renting can sometimes be a better financial decision, the next thing you got to do is get to the bottom of a lot of housing myths.
Now, you’ve heard these repeated so many times that a lot of people actually just believe them. But I want you to go deeper. I want you to stop being trapped by these myths that might not actually be true. Buying a house in America is rarely a carefully measured purchase.
In my estimate, less than 5% of people carefully run the numbers. Instead, most of us make the biggest purchase of our lives based on what we think we should do, based on how we feel, based on what we have been told by some random person. These expectations and myths surrounding renting and home ownership are so heavily embedded in our culture that almost all of us believe they’re simply…
It’s caused so many people to buy a house when they’re not ready or worse when it’s not even the right choice for them. Let me break down three common housing myths for you so we can get to the truth. Myth renting a house means you’re just paying your landlord’s mortgage.
All right, let me explain how people think landlords operate. They think a landlord owns a place that cost them $1,000 a month. So they go $1,000 a month. Let me add on 10% for profit.
They’re paying my mortgage. I could go on vacation because of my tenants. Listen, your landlord can only charge you what the market will bear. They cannot simply take whatever they bought, add on a profit margin and go.
If they could do that, why would they stop at 5% or 10%? Why wouldn’t they go to 15% or 100%? The answer is they can’t simply charge you whatever they want. Sometimes landlords make a profit.
Sometimes they lose money. A lot of times they don’t even know how much their costs actually are. Please stop thinking of landlords as these omniscient observers who know all their numbers. No, you don’t even know how much that roof repair costs.
You don’t know how to amortize that over 11 years. You’re just charging whatever the market will bear. And if they don’t like it, if there’s one month of vacancy wiping out your entire year’s profit, they go, oh, it’s so hard. Oh, government protect me.
This myth has led to so many people rushing into a house because they think someone else is getting the better end of a bargain. Myth. If you’re paying rent, you’re throwing money away. Well, I like to have a little fun with this topic.
So I posted a question on Twitter. I said, hey, I spent $30 on dinner in New York. Great food, great service. I plan to go back.
Did I throw money away on dinner? Wouldn’t you know? 95% of people said no, Rameet. That sounds like great.
Then I said, hey, I spent X thousand dollars renting an apartment last month in New York. And for the last 10 years, good location, good views, good roof. I plan to keep renting. Did I throw money away?
Notice this time it wasn’t 95%. It was only 81% who said no. In other words, 19% of people.
said, you threw money away. What do you notice? Virtually everyone agreed that when I paid for dinner, it was worth it. But when I said I rented an apartment, suddenly 19% of people thought that I threw money away on rent.
But I’m not throwing money away on rent. I’m paying for a roof over my head. I’m paying for a great view. I’m paying for somebody to fix issues so that I don’t ever have to go to Home Depot in my life.
That’s a rich life. When you pay rent, you are paying for value. When you go to a restaurant, you are paying for value. The value of knowledge of cooking, the dishes, someone to clean the dishes, and service.
The same concept applies when you pay for essentially anything. You’re not throwing money away on rent just as you’re not throwing money away at your local restaurant. Myth. You need to buy a house because you’re building equity.
In America, there’s a magic word. It doesn’t matter how much. It doesn’t matter how to get it. We don’t understand anything about it, but we love it.
And it’s called equity. I get a lot of criticism because people think I ignore equity. I don’t ignore equity. I actually understand it.
Now, yes, it is true that you can build equity with a house, but it actually takes a long time. And there’s a phrase in real estate, don’t pay a dollar to make a dime. Let me show you what I mean. I’ll use the same address from our first step.
Let’s assume that you have a 30-year mortgage at $1.59 million at 7% interest. Look at this amortization table, something that 99.999% of Americans have never even heard of. This is showing you how much you are paying in principle, in other words, equity, versus interest on your loan. You can see that it takes 21 years for you to start paying more towards principle than to interest.
So we might actually say, I don’t want to waste money on interest. Do you see how ridiculous
ridiculous these myths are. By the way, I’ll link the amortization calculator in the description for you. You should put your own numbers in there and play around. You are gonna be shocked.
Remember these myths and why they are untrue and you’ll be much more likely to make a choice that’s right for you. I encourage you to really take some time to decide if buying a house is right for you at this current season of life and if that is a rich life.
If it is, amazing, I support you. Buying a house is the biggest financial decision you’ll ever make and it’s also a lifestyle decision. You have to factor in all these things but what I’m specifically focused on here is helping you run the numbers. Here’s some good non-financial reasons to buy a house.
You have kids, you wanna stay in that school district or build memories in a certain house. Your parents are moving in with you. You wanna design a house together with your spouse. You love repairing and tinkering your house and renovating it or you just want to.
Notice what’s not on this list. You need the price of the house to go up. I’ll repeat myself again, buying a house doesn’t always mean building wealth. So factor it appropriately, buy for the right reasons.
Now before we move on to step three, hit that subscribe button and turn on notifications. I wanna keep sending you new videos with real numbers including money psychology going forward and thank you very much for watching. All right, now that you’ve stopped believing all those common housing myths, that brings me to step number three.
Run the numbers for renting versus buying. So far, you’ve learned that renting sometimes can be a better financial decision than buying. You’ve stopped believing these harmful housing myths and now we get to do something near and dear to my heart, run the numbers. Now before buying a house, you should always run the numbers and no, I don’t mean asking your freaking broker how much you can afford.
You should treat your broker like you should hold him out arms length away. I don’t, I trust a broker as far as I could throw him. Oh, broker’s so nice. Broker wants to make money from you, okay?
Broker’s using you to pay for their BMW. Do not.
Ask your broker how much you can afford. They’re not the person to ask. Run your own numbers. Now, very few people do this.
A lot of people get mad at me at even suggesting you should run the numbers. Why? Because housing always goes up in America, you freaks. Let me explain how this works.
Somebody sees two houses. One of them is a two-bedroom house renting for $2,000. Next door is a house that costs $2,000 a month for the mortgage. What would you do?
Almost everybody goes, I’ll get the mortgage because I’m building equity. Not so fast. They forget to factor in 30% to 50% of phantom costs. Things they didn’t even consider.
Closing costs, maintenance, opportunity costs, transaction costs, renovations, and on and on. Most people do not realize the total cost of ownership, TCO, until they’ve already bought the house. And I don’t want that for you. That is why I’m constantly reminding you rent is the maximum you will pay, but a mortgage is the minimum you will pay.
Now to figure out your total housing costs when renting, it’s pretty easy. It’s your monthly rent plus your utilities, like electric, water, internet, whatever utility bill your landlord charges. Sure, feel free to factor in other things. If you have somebody come and clean your house once a month, et cetera, factor it all in.
But basically that is your housing costs. On the other hand, your total housing costs when you own include not just the ordinary costs, but also the phantom costs that people often forget about. Let’s break them down. Your principal.
This is the part of the payment that goes towards paying down your principal. Closing costs. Buyers can expect to pay roughly two to 5% of the purchase price on closing costs. Interest.
You saw that in the amortization table. That can be quite high over the course of a 30-year loan. Property tax, which by the way, can increase and sometimes dramatically like we see in states like Florida. Insurance.
Maintenance is one.
that most people totally neglect. It doesn’t show up in most calculations. This is a cost to maintain the home, including utilities, yes, but also the roof repair that happens eight years from now, and that’s not even broken yet. You have to actually factor that in.
A simple guideline to use is one to 3% of your purchase price every year in maintenance. Then, of course, we have additional fees like HOA, condo fees, et cetera. Don’t forget transaction costs, like when you sell, and renovation, which Americans love to do, and then they deceive themselves by saying it’s an investment.
You almost never make your money back on renovations. So, to calculate your total housing costs if you own, add up the monthly costs of all of these items, and you can see, even without any numbers, that owning can cost a lot more. Now, let me show you a quick and easy way to run the numbers.
We’re gonna use the same unit I talked about earlier, 776 Bryant Street in Palo Alto, California. Now, I’m gonna pull up the New York Times Rent Versus Buy Calculator. I love this calculator because it has so many variables you can play around with. It makes it really easy to see if buying or renting is right for you, and I’ll link to it in the description below.
After plugging in that lower price of $1.9 million to buy and the $5,400 a month to rent, without factoring in anything else, we can quickly see that it never makes financial sense to buy this property. In fact, over 10 years, you would save $900,000 renting. That’s why when I post these funny pictures of me eating all this food and traveling and stuff, I go, ha ha ha ha, so glad that I can afford to travel here because I’m not throwing money away on interest, and then everybody on the internet gets mad because they don’t know how to run a single calculation, and then I’m just sitting there chomping on my pepperoni pizza going, what’s the problem, guys?
This calculator automatically sets how long you plan to stay in your house to 10 years, but it actually turns out that the average amount of time people spend in their home is only eight.
So I’ve reduced that number to eight. Now let’s look at the loan details. The current average 30 year fixed rate mortgage in the US is around 7%. So I’ve updated that to 7% on the calculator.
And just to be conservative, we’re gonna put a 20% down payment. Now a lot of people do not do this. I believe you should be able to before you buy. Let’s put 20% just to be conservative.
You can see that renting saves you $691,000 over eight years. You can see that by adjusting those numbers slightly, it didn’t really make much of a difference. It still makes more financial sense in this case to rent. Before we go on, just remember this.
Why is this so counterintuitive? Because every month people pay their rent and they feel like they’re losing a little piece of their soul. I don’t. I go, amazing, because I can invest literally thousands of dollars per month and make even more than I would have owning.
All right, let’s keep going. Let’s factor in something a lot of people forget about, maintenance, as I mentioned, which is usually one to 3%. This unit is in California in a very expensive city. I’m gonna actually be conservative and change the maintenance to 2%.
Realistically, I think it’s probably more than 3%, but let’s just keep it at two. After factoring that in, you can see buying this house costs you more than $800,000 over eight years. Makes no financial sense to buy this property. Now let’s factor in another thing that very few people do, the opportunity cost of investing your down payment.
What I mean by that is, just let’s say that your down payment was $100,000. What if we took that $100,000 and simply invested it in the market? Let’s assume we make 7%, that’s a conservative estimate. Whoa, that amount you would save by renting just shot up to $1.1 million over eight years.
Again, we’re factoring these things in one by one. Renting saves you $1.1 million over eight years.
for eight years. Now, you can keep going. There’s so many more variables you should include. But you can see that just by using the simple New York Times rent versus buy calculator to quickly run the numbers, it never makes financial sense to buy this property.
Now, a lot of you going, well, what about equity, Ramit? What about equity? At the end of 30 years, I own the place. First of all, you’re not gonna stay there for 30 years.
Very few people do. I hope when you buy, you stay there for a long time because that’s when you really start to build actual equity. Second, if you rent, you need to be investing. That is the key to the entire thing.
If renting makes better financial sense, you still need to invest. That’s where real wealth is created. So use this tool to run the numbers yourself, play around with the different variables, play around in your own city. I want you to become really good at this.
Okay, you understand that renting can be a better financial decision. You’ve decided if buying or renting is right for you, and now you’ve run the numbers. Now it’s time for step four, figure out if you are ready to buy. Okay, listen up closely to this part.
There are actually two very important questions that I want you to ask yourself to decide if you are actually ready to buy. I don’t want you to get into trouble by skipping these questions. I want you to walk into the biggest purchase of your life ready to go.
Now I’m about to show you how you can calculate whether you can afford a house, how much you should put down, and how to even save for your down payment. But sometimes, especially if you have a more complex situation, you wanna know exactly how much you can afford for a house and how that one decision will affect your finances five years from now, 10, 20, 30 years from now.
You wanna know all different kinds of scenarios and how they’re gonna play out for your finances. This couple I just spoke to on Tuesday, Rob and Adrian, came to me with a lot of very specific questions about their financial situation. And they’re close to retirement age. They wanna know how their decisions, such as renting instead of owning and traveling, et cetera, would affect their retirement.
So I actually reached out to our partners at Facet, a financial planning service that offers a flat fee membership, and asked if they could run some scenarios for my guests.
We sent their net worth, income, expenses, social security, insurance, everything, and Facet put together three scenarios for how and when they can retire. It was really cool, really specific. If you are nearing retirement or you have a complex financial situation that you want a second set of eyes on, consider reaching out to the planners at Facet.
Instead of taking a percentage of your portfolio, they charge an affordable flat membership fee. Check out their new membership options at facet.com slash ramit or click the link in the description. Now, back to the two important questions you need to ask yourself to know if you’re actually ready to buy.
Question one, can I afford to buy a house based on my income and debt? I want to give you a little tool to use. Your total housing cost should be less than 28% of your gross monthly income or your total income before taxes, and your total household debt shouldn’t exceed more than 36% of your gross monthly income.
This is referred to as the 28-36 rule. Now, let me talk about that 28 part because it’s really hard these days, especially in expensive cities, to hit that number. Sure, you can stretch it to 29 or 32 or even 34, but the more you stretch your housing costs, the more risk you are taking, and you can become overwhelmed with expenses very quickly if something goes wrong, like an unexpected repair or a job loss.
Now, let’s talk about the 36 part. If your total household debt exceeds more than 36% of your gross monthly income, you might have difficulty getting a mortgage from lenders. More importantly, you’re putting your household at risk. Too much debt can sink you.
It’s like swimming with too much weight on your back. So, to see if you can afford to buy a house based on your income and debt, let me break down the numbers for you. Total housing costs divided by your gross monthly income equals your monthly housing costs. Just multiply that number by 100 to get your percentage.
Is it lower than 28%?
It should be. Let me show you an example. Let’s say your total housing costs are $1,120 a month, and you make $4,000. $1,120 divided by $4,000 equals 0.28.
0.28 times 100, that’s 28%. Now, a couple of things I want to point out here. First of all, that total number. It says total housing costs are $1,120 a month.
Total does not just mean your monthly payment if you own. It’s the sprinklers. It’s the occasional repair. It’s even the gas to get to Home Depot.
It’s all of it, okay? Second, this number says 28%. Ideally, you would be a little lower than that. So you have some margin.
Although again, in high cost of living areas like New York, LA, or frankly, a lot of cities these days, most people have gotten above this. Next, calculate your 2836 number. See if your total monthly housing costs plus your total debt load would be lower than 36% of your gross monthly income.
That means factoring in things like credit card debt, student loans, car loans, all of it. The more debt you have, the riskier it is to lend to you. And that means you might not be able to get a home loan, but more importantly, you’re putting your household at risk.
Here’s how to calculate it. Amount of monthly debt you owe divided by gross monthly income equals debt to income ratio. Multiply that number by 100 to get your percentage. The lower the number is, the better.
The 2836 rule says that you should ideally have no more than 36% of your debt to income ratio. Here’s an example. Let’s say that you’re spending 28% of your gross income on housing and you wanna figure out your 2836 number. Well, to find out the 36 number, we look at the rest of your debt.
Say you’re spending $1,000 a month paying off credit card debt, making $75,000 a year or 6,250 a month. 1,000 divided by 6,250 is 0.16. Multiply that by 100, that’s 16%. Well, guess what?
In this case, you’re already spending 28% of your gross income on housing. When you…
Add the 16%, you have a 2844 number. That’s higher than 36%. That means you’re in serious risk. This would be troubling if I saw this.
So I want you to calculate your own 2836 number. Now, there are a few exceptions to this rule. If you live in a high cost of living area like New York, LA, SF, again, some people stretch that number even up to 34, 35%, but it becomes very, very risky. Next, if you have no debt, like no car payment, no student loans, no credit card debt, you might stretch your housing number a little bit.
I would personally consider going to around 33%, but I’m very conservative with my finances. If your income is reasonably expected to go up soon, such as a promotion, again, maybe you stretch the numbers a little, but I would be very hesitant about doing this. After all this, you should still be able to save and invest money.
Otherwise, you will not be building true wealth. When you factor in all these other things, you should still be able to save five to 10% of your take-home pay and invest roughly 10% of your take-home pay. If you can’t do that, you’re spending too much. Question two, have I saved a 20% down payment?
If you haven’t saved a 20% down payment, in my opinion, you’re not ready to buy a house. Now, this might sound like some old fuddy-duddy advice, but I wanna tell you something, and it’s not just because of PMI, which is an additional fee you’ll often pay when you get a mortgage without 20% down.
The real reason I believe in saving 20% before buying is counterintuitive. Building the habit of saving is critical before you buy and have all these unexpected housing expenses, like a broken water heater or unexpected tax expense. I frequently get frustrated comments about how impractical this rule is. How am I supposed to save 20%?
This will take years. Yes, it will, which is exactly why you should start saving now. Saving is a habit which is better practiced before your mortgage is at risk. Now, note, I don’t mean that you have to put 20%.
down. In some cases, such as low interest rates, many people intentionally chose to put a smaller amount down. That’s fine. That’s just a math decision.
But in my opinion, you should be able to put down 20%. All right, I hope this video helps you decide if renting or buying is the right decision for you. And I hope you save money in the process. As you can see, when you make the right decision, it can often save you a million dollars over the course of your life.
Let me know in the comments what you found after you run the numbers. And check out this video popping up on screen to watch more.