When someone is renting, they really only have one cost - the rental cost. Unfortunately, when they try to compare the rental cost to the cost of owning the home, they often make inaccurate comparisons. One thing to do is to unpack the "cost of owning a home" into its three main segments: Ownership Costs, Financing Costs, and Equity Costs so that we can more easily compare the cost of owning a home with rental costs. We will discuss Ownership Costs below - Equity Costs and Financing Costs will be discussed in Part 3.
For renting, the rental cost is easy to see - it's the rent! However, Ownership costs can be more difficult to see and people don't always note them. Let's take a look at the Ownership costs - let's ignore the mortgage for now, we will take a look at it in Part 3.
- Real Estate Taxes - If you own a house, your local community assesses yearly real estate taxes based on the value of the house. The actual amount of taxes varies widely - and I mean really widely! First, the taxes are usually expressed as a percentage of the home value - and home values themselves vary widely - from about 600K in San Fran to about $150K in TX. Second, different communities may assess a greater or lesser percentage. This is in part because the communities may also be relying on a sales tax as well - and a higher sales tax in general means a lower property tax. Also, different communities vary in how much "government" their property tax supports. Communities that are run more efficiently and with minimal benefits and numbers of governemnt workers, are generally much cheaper to run and require less tax - for example, NY = lots, TX = not much.
- Homeowner's Assessment/Maintenance - If you live in a condo or townhome association, you have to pay an assessment - usually monthly. This covers cleaning, landscaping, maintenance, janitorial, etc. If you live in a home that is not part of an association, you still have to perform the work or have it performed - someone has to mow the lawn! If you live in an association, the association payment is a convenient way to have all of these costs added up. If you don't live in an association and want to figure out how much this cost you, add up everything you spent on materials and charge a reasonable hourly rate $10-$15/hour for each hour you spent and add up the number of hours. The actual charge for the homeowner's accociation may also vary widely - in Chicago, for 2-bedroom condo in a nice area downtown, the cost may be anywhere from $300/month to $800/month depending on the specific arrangement.
- Utilities - When you own, you pay them all - but when you rent you typically don't pay them all and may not pay any. Again, the cost for utilities varies widely across the country. Heat can be expensive in the New England area, especially for places that are still using heating oil (Seriously! There are still places still using heating oil!). On the other hand, your air conditioning costs may be very expensive in hot areas. If you are attempting to make a direct comparison with a rental apartment, remember to only count the utilities that are included in the rent.
- Homeowner's Insurance - Cost varies widely. Can be cheap in the Midwest and New England, but often expensive in California (earthquakes) and Florida (hurricanes). Some renters use renter's insurace, so perhaps the most accurate number to use in this category would be the differential between renter's and homeowner's insurance for a specific property.
- Breakage/repairs - If you are renting and the fridge breaks, the landlord replaces it. Conversely, if you own, then that cost is all yours. Also, you are going to have to replace the roof or carpet some time - and the occasional broken window. The repairs figure can vary widely depending on the type and age of housing. However, a reasonable estimate is 0.5-1 percent of the house's value per year.
However, the real estate tax deduction should only be taken into account to reduce the ownership price when it is actually providing a financial advantage to the buyer. For example, if the buyer does not itemize before the purchase and still does not itemize after the purchase, then there is no real tax deduction for the payment of real estate taxes. Further, anything that limits the total deduction, such as the AMT, should also be taken into account.
Also, recongnize that you need to compare the cost of utilities in your home to just the utilities that you would pay for in the rental. That is, if you are comparing to a rental that makes you pay electricity, then don't include electricity in your total cost of ownership or else you won't get a straight comparison.
Also, I think that now it is easy to see that the phrase "my house is paid off" is kind of misleading. Although the mortgage might be paid off, owning the house is still going to cost you thousands of dollars a year for the Ownership costs identified above.
Now that we have a way to determine our ownership costs, in Part 3, we will discuss Equity Costs and Financing Costs