Stop 'Dreaming,' America: Why Rent is a Better Deal than a Mortgage

American dream
American dream

Over the past 50 years in America, becoming a homeowner has developed into such a standard rite of passage that millions of people have signed on the dotted line without ever really stopping to consider the alternatives. Perhaps if more them had, we might not have had to watch the roof collapse on the real estate market.

When you look at the way we really live -- how long we stay in one place, what kind of amenities we want -- it turns out that home ownership isn't quite the universally advantageous deal we've all been led to believe.

Jailed in by the White Picket Fence

Let's first take a look at mobility -- our ability to pack up the kids and move for, say, a new job.

Imagine two friends working at the same job in Seattle -- one who owns a home and one who rents. After they both get laid off, a new job becomes available in Dallas. All things being equal, the renter is in a far better position to go after the new job. After all, the mess of selling a house can drag on for months.

In fact, the mobility of America's workforce right now is lower than it's ever been since the Census Bureau started tracking such statistics after World War II. Before 1980, about 20% of the population was mobile in any given year. Here's what has happened since.

American dream
American dream

Source: U.S. Census Bureau.

Being locked into a mortgage severely limits one's potential opportunities in an ever-changing job market.

The mobility conundrum becomes even more dire when you consider that the average age of a first-time homeowner has gone down over the past decade to 30. That means a large percentage of the first-time buyers are younger than 30 -- with their mortgages potentially impeding their career growth.

The Decision to Sell

Of course, the easy answer is to sell your house if you need to move for a job. But take a look at what happens to your dream home/investment.

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In 2011, the National Association of Realtors found that the average home-seller had lived in their house for nine years. That means if you have a 30-year mortgage, about one-third of the house should be paid off, right?

Wrong. In fact, it's usually not until about the 21st year that an owner will have paid off just half of the principal on a mortgage. That's because the nature of an amortization schedule front-loads the interest payments to the bank, and back-loads the equity-producing payments on the house.

In essence, the average homeowner is simply paying rent for nine years to a bank instead of a landlord.

Even if you stay put for a long time, the financial payoff of buying a home is hardly a slam-dunk argument against renting. In fact, Yale economics professor Robert Shiller, who predicted the popping of both the dot-com and real-estate bubbles, has shown that after adjusting for inflation, home prices have remained virtually unchanged since 1890.

The reason is actually quite simple: Homes are "just manufactured goods. Houses in 20 years may have lots of new amenities ... we can't anticipate now. So people won't want these old homes," Shiller argues.

But With Today's Rates, I Can't Lose, Right?

Historically speaking, yes, it's a great time to buy. The 30-year fixed rate on a mortgage is as low as it has ever been.

But even if you own and you pay off your mortgage in 30 years, there's still no guarantee that you'll come out on top of a renter. Using The New York Times nifty calculator -- which takes into account inflation, closing costs, maintenance, and so on -- we see that renting is still a good option.

Imagine two friends live in identical $200,000 houses next to each other.

  • One friend, Spending Sammy, buys his house paying 10% down with a fixed 3.8% mortgage and a property value that increases 3% per year.

  • The other friend, Frugal Fred, pays $900 rent per month (more than Sammy's $840 mortgage), and his rent increases by 3% per year. Fred saves the equivalent of the down payment and any money from not paying for home improvements. Over time, Fred simply invests that money in a fund that matches the stock market's historical 8.8% return.

After 30 years, Sammy sells his house and they both move down to Florida for retirement. When all is said and done, Fred will walk away with roughly $90,000 more than Sammy -- and he didn't have to worry one bit about repairs and upgrades to his house!

Let's Be Clear: There's a Time and Place to Buy a Home

If it sounds like I think buying a home should be reserved for only the foolish, that's not the case. It's just conditional to what you want.

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For some people, there's absolutely no price you can put on the social and emotional benefits of owning a house. If that's you, and you've considered all the alternatives, then by all means: Buy away!

But if you think you're not an adult until you've purchased a house -- or that by doing so you will guarantee the best, most secure returns on your money that you possibly can -- well then it's time for you to re-evaluate this aspect of American dream.

Motley Fool analyst Brian Stoffel currently rents an apartment with his wife. You can follow him on Twitter, where he goes by TMFStoffel.