Eighteen months ago, I was approached to write an article about personal finance for the first issue of the revamped The Army Lawyer publication. Given that military members must move frequently, buying versus renting a home seemed like a natural topic. I thought the article could be thought-provoking, especially since I am often, but not always, opposed to conventional wisdom that home ownership is good even for active duty military members. Despite including a disclaimer that I am hypocrite (as I now own two homes!) and an acknowledgement that home ownership in certain situations works well, my attempts to avoid the ire of some in the military who own a home (or several) were unsuccessful.
Indeed, I received many responses that fell into two categories: 1) a few who understood the math that I laid out and felt validated in their decision not to buy a home; and 2) many who disagreed (including a 28-paragraph thought-provoking rebuttal from an Army Colonel). I suppose my editor’s decision to change the title from “Your Home Is a Terrible Investment” to “Rent Versus Buy” was a good call in retrospect (I have rectified that decision in the blog post). The thing is that I don’t disagree with many of the points made about why home ownership is a good idea. Moreover, I plan to write a future blog post about why home ownership in the military actually isn’t a terrible idea… sometimes.
In the meantime, to frame the debate properly, I am providing the substance of my original article (located here: https://tjaglcspublic.army.mil/documents/27431/3056598/July+August+2018.pdf/c41999f1-9b55-4456-9235-467f84bbfd97).* Admittedly, mortgage rates have come down slightly since the original piece ran, but the math still doesn’t favor ownership in many cases.
Do not buy a home at your next duty station. Seriously. Although we have been told home ownership is the cornerstone of the American Dream, homes are generally terrible investments. Home ownership is not a sensible investment for transient populations. Home ownership for Soldiers is actually, in most cases, a really bad investment.
Recognizing home ownership is a sacrosanct concept, this note may seem heretical and will likely generate hate mail from the field. Before you fire up the emails, let me confess that I own a home. Three years ago, I made a conscious decision to lose money on a mediocre investment because it was the best thing for my family (finding a fenced-in yard that will accommodate four dogs is like finding a unicorn in Charlottesville, Virginia). Before discounting the ramblings of a guy who owns four dogs, review the math behind why home ownership is often a terrible investment—especially for military:
Fees. Both buying and selling a house trigger numerous fees—fees that will eat you out of house and home (pun intended). Sellers pay more than just the six percent realtor commissions. Add in staging and maintenance costs, title fees, and attorney’s fees (sadly, not paid to you despite the fact that you are an attorney), home sellers typically see ten percent of the sale price go to cover sales-related expenses.1 Moreover, unless you can pay for your house outright, you are going to have a mortgage where the first few years of your payments are essentially going toward interest and not the principal on the house.2 Accordingly, unless the home has appreciated by more than ten percent, you will have to bring money to closing—potentially tens of thousands of dollars—just to sell this “investment.”
Mortgage Interest.If you decide to buy, the mortgage you use should be the shortest in duration possible. A fifteen-year fixed rate mortgage uses a first payment where sixty-six percent is paid to the principal of the home and thirty-four percent is paid in interest; with a thirty-year mortgage, you can swap those two numbers.3 For an apples-to-apples comparison, I am going to use the same interest rate for both loans, which is almost never the case as the shorter duration loan typically carries a lower rate. The basic math with a 4.5% mortgage loan looks more or less like Table 1.
Even if you selected the shorter 15-year loan, you still paid $94,246.98 in interest on a $250,000 loan; if you chose the thirty-year mortgage, you paid almost as much interest as principal. If you have less than stellar credit, you will pay a considerably higher interest rate, making the math much harder.5 Moreover, this situation has the potential to get significantly worse in the near future as the Federal Reserve continues to raise rates to combat potential inflation. 6
Taxes. “But wait, MAJ Goodell, you can deduct your mortgage interest from your taxes, so you aren’t being totally honest with us.” Well, that was partially true in the past, to the extent deductible items exceeded the standard deduction. However, Congress passed the Tax Jobs and Cuts Act of 2017, which essentially doubled the standard de- duction to $24,000 for married filing jointly couples.7 Unless your mortgage interest and other deductible amounts exceed this threshold, you will pay the exact same tax as if you rented. A final note on taxes: people often forget that owning a home means paying property taxes. This is a hidden cost that can set the homeowner back several thousand dollars per year.8 When comparing home ownership to renting, remember that home ownership is more than just the principal and interest payments.
Veterans Administration (VA) Loan Funding Fee. Another hidden cost that hits many Soldiers’ wallets is the VA Loan Funding Fee, which requires up to 3.3% of the loan amount as a fee for the privilege of not putting any money down.9 A Soldier using the VA Loan for $250,000 is going to pay up to $8,250 in fees to the VA before making their first mortgage payment. The alternative is to pay a twenty percent down payment or pay Private Mortgage Insurance (PMI), which is typically between 0.5% and 1.0% of the loan and does not go to the principal of the loan.10 Soldiers who cannot make a twenty percent down payment should carefully review their finances before committing to a VA or PMI backed loan. These programs help borrowers qualify for a loan, but they come with fees and costs that make home ownership a less valuable “investment.”
Costs of Being a Landlord. The primary counterargument to these issues is clear: “When I have a Change of Station (PCS), I will continue to hold on to my house and rent it out.” Because American homes only appreciate at approximately three percent per year on average,11 for a transient population like the military, this means that if you buy a house, you need to be willing to be the owner for the long haul; the math outlined above does not change, and what is worse, now you are a landlord with a large mortgage debt and a potentially difficult tenant. Every time something goes wrong with your investment, you have to pay to fix it. If you are renting your house out near a large military installation, as the landlord, you face the obvious, increased risk of multiple tenants over short periods of time. In addition to the time and money spent advertising the home for rent, this also means an increase in the likelihood that the property experiences stretches of time where it goes unrented, and the homeowner must cover the mortgage payment out of pocket. However, vacancy is not the only problem.
Whatever tax savings you earn from depreciation when you file your taxes are effectively offset when you consider the capital gains you will pay in the end when you sell the house.12 You are going to pay ten to twenty percent more for insurance as a landlord than you did as the home owner.13 Plus, instead of getting your landlord to fix the broken toilet, now you have to find the plumber to fix the broken toilet. Having likely moved far away after a PCS, you may have difficulty getting someone to fix that toilet. Factoring these mundane upkeep costs as well as bigger ticket items like roofing or siding replacements, home- owners can expect to spend an average of approximately two percent on maintenance costs for the property every year.14 Alternatively, you could hire a property manager to coordinate these issues, alleviating you of the stress but adding yet another fee. These fees typically run six to eight percent,15 but potentially higher in military areas with high demand.
In Sum. If you or your clients are still determined to own your piece of the American Dream, I strongly encourage you “do the math,” so that you know exactly what owning your home will really cost you. The internet has lots of dynamic calculators to help you make this analysis.16 Go into this enormous investment—and assumption of debt—with eyes wide open.
Our parents’ and grandparents’ generations became wealthy with housing; however, when they offer advice that housing is a “sure path to wealth,” they conveniently overlook that they had three major factors available to them: reasonable housing prices, falling interest rates for a thirty-five year period, and a low cost-to- earnings ratio.17 Additionally, they were likely living in this investment for long periods of time. Times have changed.18 Unless this will be the service member’s forever home, it is almost always better to rent below the applicable Basic Allowance for Housing (BAH) rates than to buy… and consider saving the difference in your TSP, using the power of compounding interest to grow your nest egg.
* The Professional Communications Program Director kindly gave me permission to republish this article from The Army Lawyer July/August 2018 Issue, and I highly recommend The Army Lawyer to anyone interested in military personal finance because the publication typically has a topical article in each issue.
Endnotes
1. Benjamin H. Harris et aL., New Perspectives on Homeownership Tax Incentives. 1315–32. ( Tax Policy Center, Tax Note 2013), http://www.taxpolicycenter. org/publications/new-perspectives-homeowner- ship-tax-incentives/full.
2. https://www.suzeorman.com/blog/4-signs-you- should-rent-not-buy/.
3. https://themortgagereports.com/19308/15-year-vs- 30-year-mortgage-rates-comparison.
4. https://www.mortgagecalculator.org/calculators/ which-loan-is-better.php. I did not assign any fees or closing costs in this analysis. The math used here is exceedingly basic to prove the underlying point about interest paid, and I assumed a 4.5% rate because that this is roughly the current rate available at many banks. Id.
5. Orman, supra note 2.
6. March 1, 2018. US mortgage rates up for 8th week; 30-year at 4.43 percent. https://federalnewsradio.com/ business-news/2018/03/us-mortgage-rates-up-for- 8th-week-30-year-at-4-43-percent/.
7. https://www.forbes.com/sites/kellyphillipserb/2017/12/17/what-the-2018-tax-brackets-stan- darddeduction-amounts-and-more-look-like-under- tax-reform/#e31d47614017.
8. http://www.tax-rates.org/taxtables/property-tax- by-state.
9. https://www.benefits.va.gov/homeloans/documents/docs/funding_fee_table.pdf.
10. https://www.investopedia.com/articles/pf/07/ avoid_pmi.asp.
11. https://www.census.gov/hhes/www/housing/ census/historic/values.html.
12. https://www.irs.gov/pub/irs-pdf/p527.pdf. See also https://www.nolo.com/legal-encyclopedia/taxes- when-landlords-sell-rental-real-estate.html.
13. http://homeguides.sfgate.com/landlords-insur- ance-vs-homeowners-insurance-49557.html.
14. http://homeguides.sfgate.com/much-should-land- lord-allocate-monthly-maintenance-repairs-80019. html.
15. https://www.zillow.com/blog/investing-101-esti- mating-rental-property-expenses-94824/.
16. https://www.nytimes.com/interactive/2014/up- shot/buy-rent-calculator.html?abt=0002&abg=1.
17. https://www.millennial-revolution.com/rent/ renting-will-make-you-rich.
18. Id.