About half of U.S. homeowners would have been better off renting and investing rather than buying a home, but location is key, says Matt Fellowes of Morningstar subsidiary HelloWallet.
Adam Zoll: For Morningstar, I'm Adam Zoll. Buying a home rather than renting has long been seen as a great way to build personal wealth, but is that still true today? Here with some answers is HelloWallet's CEO and founder, Matt Fellowes.
Matt, thanks for being with me today.
Matt Fellowes: Nice to be with you.
Zoll: HelloWallet has just come out with some new research looking at this question of whether it makes more sense to buy or to rent. Can you tell us a little bit about the study?
Fellowes: So, HelloWallet is hired by employers to help boost savings rates and retirement programs and health programs through health savings accounts. Given that one of our research agendas is to figure out how to grow savings and where those dollars are being allocated today outside of the retirement and health programs. So, we've written a number of papers. This paper that just came out looked at all the dollars that are flowing to homeownership, which is quite a few dollars, about 62% or 63% of U.S. workers currently own a home. About half of those currently have a mortgage.
And what we were interested in asking is how many of those people are really better off renting a home and investing versus what they're doing today, which is homeownership? And what we found is that a good share of them, about half, would've been better off at the time that they bought their home renting and investing instead of buying their home.
Zoll: Did your research look at this phenomenon over decades or is it looking at it more recently? We're currently in the midst of a great bull market in stocks, while real estate hasn't fully recovered in many areas from the collapse during the financial downturn.
Fellowes: That's a great question. Our primary data set was the Federal Reserve's Survey of Consumer Finances, which is a randomized sample of the entire U.S. household population. So, in that population, we were able to look at all of the 10-year rates that exist out there in the marketplace from people who just bought one or two years ago to people who bought about 40 or 50 years ago.
And what we found in our research is that there have been periods of time where it's made sense to buy a home instead of renting and investing; however, for most of the history that we've looked at, people would've been better off renting and investing instead of buying a home. However, it's very important to point out that homeownership is all about location, location, location, and where you live makes a big difference to whether it's a good investment or not.
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Zoll: Another point brought up in the paper, I believe, is the benefit of tax breaks associated with homeownership and that not all homeowners are getting the full benefit there. What can you tell us about that?
Fellowes: The mortgage interest deduction is just one of the most popularly cited tax deductions. Tax deductions are not something that gets a lot of press coverage and is part of the American dialogue in this country. However, if there is one deduction people talk about, it's the mortgage interest deduction. We looked at the Survey of Consumer Finances, asking renters why they were interested in buying their home. And the majority said because of the tax deduction, if you can believe it.
However, it's just not the case that most people receive that interest deduction because they don't itemize other taxes. And so, for that reason, the great majority of middle-income America does not benefit from this interest deduction at all. In fact, we found, in the majority of cities in our sample, there would be zero benefit to middle-income families.
Where all that spending on the deduction is going is toward higher-income households that do itemize their taxes and can benefit from that deduction. But by no means is it a supporter of general homeownership, at least financially. However, it certainly serves as an incentive--a false incentive--for people to be buying their homes today instead of renting and investing.
Zoll: So, for someone who is watching this right now who maybe is on the fence between renting and buying a home, what are some of the questions they should be asking in order to make this cost-benefit analysis?
Fellowes: The most important question that they should be asking is how much would it cost to rent my home compared to buying my home? My colleague, Aron Szapiro, who wrote this study, found that in general if the annual rent of the home is greater than 5% of the purchase price of the home, then you're going to want to go ahead and buy the home. If it's less than 5% of the cost of the home, then you're probably going to be better off renting and investing; however, importantly, it's all about location.
So, the prospective homeowner is going to want to look ultimately at the local property taxes, income taxes if they exist--some municipalities have income taxes. The state income tax, which exists I think in all but maybe nine states. So, these are the types of additional variables that you're going to want to look at. But we found in our research that the most important variable you want to look at is what's call the rent/price ratio. How much does it cost to rent my home as opposed to buy the home?
Zoll: And do you have to have a certain sort of investor profile in order for this to work for you? For example, if you are a very conservative investor where you may not be getting market-level returns, could that potentially impact your decision-making?
Fellowes: It does. Though, about a third of the prospective buying market out there has access to a 401(k) and a match at their 401(k). So, even if you're a conservative investor and putting that money into a money market account, you're going to be getting a 100% return on the match contribution into that account. So, in addition, everybody has access to an IRA and so on. So, it's not purely the case that if you're investing in cash and bonds that you're going to be better off buying a home instead of investing.
Zoll: Well, Matt, that's great food for thought for people who are trying to make this decision right now. Thanks so much for sharing your thoughts with us today.
Fellowes: Pleasure to be with you.
Zoll: For Morningstar, I'm Adam Zoll. Thanks for watching.
