"All of which is to say: take another look at that rent vs buy calculator"

Felix Salmon with an important post:

"Rent vs Buy: Buying Becomes More Attractive

I've been playing around with mortgage calculators this morning, after getting an email from a renter in Long Island who wants to buy but isn't happy with falling mortgage rates:

I have saved enough for a substantial down payment - and was looking forward to taking advantage of my savings and higher mortgage rates by buying a home for a lot less then current asking prices.
Lowering rates will only keep these d_mn home prices artificially high. Prices need to come down. Why shouldn't renters have a chance to build equity over time in a home (with 4.5% mortgage rates - you'll never build equity, you'll just really be renting again!)

This is actually the wrong way round. The lower your mortgage rate, the faster you build equity in your home, and the less money you waste in interest payments to the bank( YOU ALSO HAVE TO FIGURE IN THE HIGHER PRICE OF THE HOUSE IN YOUR CALCULATIONS, AND THE EFFECTS OF LOWER PRICES VERSUS LOWER INTEREST RATES ON THE HOUSING MARKET GOING FORWARD. ).

Let's say our friend in Long Island is currently paying $1,000 a month in rent, and would rather spend that $1,000 a month on a mortgage payment instead( THIS IS IMPORTANT ). If he got a 30-year fixed-rate mortgage at 7%, that would cover a $150,000 loan. Since $1,000 a month for 360 months works out at a total of $360,000 in mortgage repayments, on average about 42 cents of his mortgage-payment dollar will go towards building equity. What's more, most of that is back-ended: after five years, he will have paid down his principal amount outstanding by just $8,820.64, or less than 15% of his total payments.

On the other hand, a $1,000 payment on a 30-year fixed-rate mortgage at 4.5% would cover a $200,000 loan -- which means that 56 cents of every dollar you spend on your mortgage goes towards equity. And after five years, he will have paid down his principal amount outstanding by $17,450.82, which is 29% of his first five years' payments.

So yes, the house is $50,000 more expensive, but it's just as affordable, and you're building up more equity, not less, with the lower mortgage rate( THAT'S WHY YOU HAVE TO CONSIDER ALL OF THE VARIABLES ).

Of course, there's always the risk that a house bought with a 4.5% mortgage could fall in price more than a house bought when interest rates are higher -- or that the cheaper house has more room for price appreciation. So the calculation isn't really this simple( TRUE ). But if you look at an amortization curve for a high-interest-rate mortgage, it starts off pretty flat: most of your mortgage payments are going to interest( TRUE ). The lower that mortgage rates fall, the more equity you build up in the early years.

All of which is to say: take another look at that rent vs buy calculator. Even at 0% house price appreciation, buying looks much more attractive when mortgage rates plunge, as they have done recently. ( PLEASE DO )

The best part about this post is that it isn't discouraging home buying even for people who can afford it. It was an investment that worked well for me. A person should generally buy rather than rent, unless that you believe that with the money that you have left over after you pay the rent, you can invest in ways that make up for the total loss of the rent. I simply doubt most people's ability to do so.

So posts like this on Start Making Sense, don't make sense to me:

"The cult of home ownership

Good article in today's Times about how the Bush Administraton helped light the fuse under the current economic meltdown by pushing universal home ownership and hence encouraging( THIS IS PURE MECHANICAL THINKING. THE ONLY THING THAT ENCOURAGES BAD LOANS IS BELIEVING THAT YOU'RE GOING TO GET AWAY WITH IT ) bad mortgage loans.

Needless to say, there's plenty of blame to go around. Just look at the tax code, both its decades-old features and the Clinton Administration-directed changes thereto that I noted in a recent entry here. The only thing distinctive about the Bush Administration's adding a bit more gas to the fire is the lack of fit with its ostensibly pro-market attitudes( THE TAX CODE WAS A DISINCENTIVE ).

But I must say, I've never gotten this political cult of homeownership. True, there is some at least slight evidence of positive externalities from home ownership in some settings because people are more committed to the location. (This can have nasty playouts as well, however, e.g., more assiduous racial exclusion.) But on the other hand, investment in more economically productive assets, e.g., via stock ownership, might have positive social externalities as well( YOU BELIEVE THE AVERAGE PERSON CAN BEAT THE LOSS OF THE RENT PAID ? ). Plus, home ownership is often (usually?) a really lousy investment choice from a personal standpoint ( THAT'S PREPOSTEROUS ). It's wildly under-diversified( COMPARED TO WHAT? ), if you're not rich enough to have a home plus lots of other assets, and leveraging it creates huge downside economic risk (as we've seen)( ONLY IF YOU CAN'T AFFORD IT ).( BUT YOU'RE NOT PAYING RENT, WHICH MEANS THAT YOU'VE TURNED A LOSS INTO AN INVESTMENT)

Once the dust settles, perhaps the government should seek from now on to discourage home ownership( WHY ? ), encouraging those who aren't enormously investment-savvy( YOU BELIEVE THAT THESE PEOPLE'S INVESTEMENTS CAN BEAT THE LOSS OF MONEY IN RENT. THEY WOULD HAVE TO BE VERY SAVVY ) to hold more diversified asset portfolios that are much less leveraged."

There is no way to make an a priori decision about whether to rent or buy, but, for God's sake, if you can't beat the loss of the money in rent by investing, you should consider a house. Otherwise, there's no other way to look at it, you're losing money.