The difference between the two popular (and only) housing options
By Jonathan Arad
Whether you’re a young couple looking for your first home, a family of 5 that needs more space, a real estate enthusiast or just an average Joe - you’re most likely either paying rent as a tenant, or paying your mortgage as a homeowner. Today in the US, there are 65.8% (~80M) homeowners vs. 34.2% (~44M) renters. That means more homeowners than last year - but still not as high as it was in 2004, when 69% of American households were homeowners.
The question which housing option is better varies from one household to the other, yet there are many factors we all have in common when we consider the alternatives. Let’s review some of these factors:
A. Benefits to Rent
Fixed payments - renters enjoy fixed payments and knowing how much they will pay every month till the end of their contract. Becoming a homeowner, on the other hand, involves many costs, some unforeseen. First, the down payment for a home is expensive, and for some households can be of astronomical proportions. Second, homeowners face additional costs for their ongoing property maintenance. As a result, some people have no choice but to rent in the current economic climate, with the constant rise in real estate prices and the recent uphill interest rates. While the monthly rent isn’t necessarily lower than the mortgage payment (research shows it can be as high as 20% of property value), renting remains the only option for some of the people. In the US alone there are tens of millions of households that are 100% eligible for a mortgage in terms of FICO/DTI, yet homeownership isn’t within reach simply because they cannot afford to pay the down payment and the other costs associated with buying a home (e.g., taxes, closing costs etc.)
Flexibility - renting allows you to move and change your location with minimal friction. Renters don’t need to sell their property, and can even secure a way out of their contract to maximize that flexibility. They have the privilege of more easily switching neighborhoods if one doesn’t fit their needs, testing different types of homes, and upgrading their housing choices when they improve their cash-flow situation. Furthermore, there are individuals who rely on that flexibility. Be it families who have temporarily relocated, professionals who constantly move on the job, digital nomads whose number is rapidly growing, students who plan to move after graduation, or heavy-weight travelers. These are just some of the people who will prefer to rent simply because it better suits their lifestyle.
No risk - renters are risking nothing when they are renting. If housing prices depreciate, homeowners bear all the risk. Their mortgage terms protect the lender, meaning that the reduction comes from their down payment and home-equity they accumulated. Homeowners are the ones who lose equity and are sometimes left with nothing. Renters, on the other hand, lose none of their equity when housing prices depreciate.
B. Benefits to Homeownership
Stability - let’s be honest, most of us aren’t digital nomads, unless you consider moving from the desk to the couch during lockdowns a shift in scenery. Owning a home and committing to a location creates stability for ourselves and our family. It removes a significant mental load, enabling homeowners to focus their efforts in one place and create life-long relationships within the community. Homeowners aren’t faced with the option of their contract being terminated. There’s no way to send them packing and looking for another home yet again. More importantly, homeowners enjoy economic stability since their payment plan is set up for years. Renters, however, don’t enjoy the same economic stability, since rent is set on short-term contracts, and the price per month can rise by 10%-20% year-over-year.
Investment - owning your own property is also an investment. If home value appreciates, your wealth increases. Mind you, that investment also includes the possibility of home value to depreciate. Common perception is that real estate usually increases in value over time, but history tells us a different story, as there are many examples of the opposite. Today’s reality gives yet another example as market expectations are for a softening real estate market. However, it’s still equity that hopefully guarantees that if you ever need a substantial amount of money, you will have it. For some people, that reassurance is all they need. Moreover, rent increases every year. From 1985 to 2020, the national median US rent price rose by 149%, while overall income grew just 35%. In the past 5 years, rent payments in the US have increased by an average of 18%. The money you pay for rent might have been better invested in other financial channels. Nonetheless, the fact is that while someone else is paying rent, you’re pursuing your life-goal to achieve more and more equity.
Renovations - anyone who ever rented knows that feeling of “if only”. If only you were the homeowner, you’d remodel that kitchen, right? Renters are constantly forced to settle for apartments less than ideal. Owning your home means you can make the necessary adjustments whenever needed, so your home can fit your needs for longer periods of time. Last but certainly not least - as a homeowner, when you revamp the property, you’re the one pocketing the property value increase. This is a dual benefit - homeowners enjoy the consumption of their renovated home, and own the extra wealth gained from increasing the value of their property.
C. The Risk
After reviewing these factors, let’s talk about the risk. 15 years ago, this one might have been a debate, but today we’re all well aware of the risk. Housing prices can go down, despite popular opinion, and if that happens, homeowners don't have the senior claim over their own property, the bank does. Since the homeowner is the borrower, he or she must bear the first losses associated with any house value depreciation. They can lose the only wealth they’ve ever accumulated, and for many that’s too much of a risk.
Moreover, up until now, becoming a homeowner meant that first, you had to answer two very different questions:
Where do I want to live? This question is probably the most important, since it has an immediate effect on our daily routine and it touches almost every aspect of our lives: our job, our family, our community, etc.
Where do I want to invest in real estate? By becoming a homeowner you necessarily turn into a real estate investor in your own property, whether you like it or not. It allows you to enjoy the upside when home-value appreciates, but it also means to suffer the loss in case of depreciation - all while having the junior claim over the property.
The problem is that the answers to these two questions do not necessarily intertwine. It’s not the same answer to both, and from an economic perspective - it shouldn’t be. The homeowner should have other options, that will allow him or her to transfer some of the risk in owner-occupied residential real-estate to another, who’s interested in the risk and can absorb the loss in case of value depreciation, and enjoy the reward if house value does appreciate.
Contigo Capital creates financial products facilitating the transfer of housing risk from households to investors in exchange for superior loan terms that enhance affordability for potential homeowners.
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