JONTILLMAN.COM | part of the problem since 1976

After my previous entries about mortgage debt and home ownership, I have received a bunch of email on the subject, so I thought I’d reopen the topic sort of, and respond directly to some of the points raised:

Point 1) “Paying rent is just like throwing money down the drain because you don’t build equity.”

This sounds sensible. But it misses a key point. When you rent, you pay for use of the house or apartment while you’re there. When you buy, you pay not just for use of the property while you’re there, but also for the right to sell it when you move out. You can rest assured this right to sell costs you extra.

Tax-deferred mutual funds are a heck of a lot better way to build you wealth than “equity” any day of the week.

Point 2) “But the interest is tax deductable.”

First off, the mortgage interest deduction lowers your tax bill only if your deductions exceed the standard deduction, which is $4,300 for single filers and $7,200 for joint filers. Secondly, even if you do exceed the standard, you probably won’t save much.

Assume your deductions total $10,000, all due to buying a house, and that your tax bracket is 28 percent. If you file a joint return, your tax savings will total just $784 a year ($2,800 x 28 percent). Why so little? Because you could have taken the $7,200 standard deduction even if you had not bought a house. Assuming a modest 1% maintainance cost on the house, you had to spend $1000 to save $784. Not such a hot plan now, is it?

Of course, this point also pretends that renters do not benefit from these types of tax breaks. Owners of rental properties also get tax breaks and–in a reasonably competitive market–those savings get passed on to renters.

Point 3) “Because you don’t pay for the house up front, your small downpayment provides leverage that outperforms the stock market.”

Yikes! That’s quite a bit of economics for me to deal with, but here goes: The reason your expected return is higher when you’re leveraged is because you’re taking a bigger risk. If the price of your house falls by 20 percent or more–as has happened in recent decades in Texas, California and New England–you’ve got a serious loss. And while a loss of 20 percent may sound bad, it’s actually much worse if you’re leveraged. If you put down $10,000 on a $100,000 home–which then drops in value by $20,000– your return isn’t negative 20 percent, but negative 200 percent.