Where to live is one of the biggest decisions retirees face. For many people approaching retirement, the decision to keep the family home, downsize to a smaller house or condo, or rid themselves of the stress and expense that can come with homeownership altogether is a difficult one. Here, we'll provide you with the points you should weigh to make this decision for yourself.
Things to Think About When Deciding Between Renting and Homeownership
Although this is an important choice for any retiree, it is best to avoid the details of specific homeownership and rental opportunities and examine this question from a big-picture point of view. Keep the following points in mind as you consider this decision:
- What is your budget for renting or owning, net of taxes?
- Do you view a home or condo as a potential investment opportunity or just another cost of living?
- Have you thought about the risks associated with homeownership in terms of unexpected costs, and can your budget tolerate them?
The first step in analyzing homeownership versus renting is to determine how much money you want to spend net of taxes. Since mortgage interest and property taxes on a primary residence are tax deductible, knowing after-tax cost is essential. Fortunately, the math is very simple and is explained in Figure 1, which arbitrarily assumes an after-tax monthly budget of $2,000 for the mortgage payment, taxes and insurance for homeownership, or for rental costs. (For more, read: Tax Deductions on Mortgage Interest.)
Because rental costs are not tax deductible, no calculations are required. However, being able to deduct the mortgage interest and property taxes on a home you own means your monthly budget will go further because you will get some of your money back in the form of a deduction come tax time. To calculate how much your pre-tax budget is worth when you buy a home, determine your marginal tax bracket, deduct that percentage from Figure 1, and divide your budget by that amount.
Risks to Consider
In theory, you can get more for your money if you buy instead of renting. However, there is no such thing as a free lunch—homeownership also entails substantial financial risks. Issues such as fluctuations in market value, unexpected maintenance expenses and insurance deductibles can increase costs over and above renting. And whether you buy or rent, don't forget to plan for inflation—rents, taxes and insurance costs all go up over time.
Another major issue to examine is the maintenance risk associated with ownership. Renting is like buying an insurance policy against maintenance because renters have no liability for regular maintenance costs, equipment failures or catastrophic occurrences, such as a tree falling on your home or being hit by a storm. The landlord has to worry about the unexpected financial costs. When you own your own home, you are responsible for these costs. (For related reading, see: 4 Reasons Why Renting a Home Is a Wise Decision.)
An Investment Opportunity?
Even though homes and condominiums can be good investment opportunities, these assets shouldn't be purchased only for that reason. The fact of the matter is housing is an unavoidable cost of living. And liquidating an investment asset shouldn't involve finding another place to live. Therefore, from a retiree's standpoint, it would be best not to factor in the investment upside of ownership when planning for your retirement housing costs.
“One of the biggest myths of homeownership is that it is an investment. It isn’t,” says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, Mass. “Owning a home that you live in is an expense, not an investment. An investment is one which generates cash flow. Sure, there are some benefits of owning a home, but when you factor in the costs, tying up large amounts of capital, illiquidity of the home and the fact that house prices don’t always go up, it makes for a much less attractive ‘investment.’”
To truly use your home as an investment, you have to buy low and sell high. This means buying and selling homes opportunistically. However, by selling your home to make a profit when prices are high, you take the chance of becoming priced out of the market if prices continue to increase after you sell instead of going down. If you are on a fixed budget, as most retirees are, you may not be able to purchase another home or condo and will find yourself dealing with a landlord instead.
In some ways, renting can be considered the economic equivalent of shorting a stock. For example, if you believe housing prices are headed lower, you would rent a home, wait for prices to fall and buy a home later. If you're wrong about the direction of housing prices and you end up paying a higher cost when you do buy, this is similar to paying a higher price for a stock to cover your short position.
Cashing Out and Liquidity
Other financial benefits of being a tenant are you don't have to worry about market conditions in case you move, and there is no possibility of an investment loss. Moreover, as a tenant you don't need to worry about liquidity. Selling a home can take a long time; it also involves lots of paperwork, and most real estate agencies charge a commission, reducing the return on your investment. Sidestepping this mess when it's time to move can definitely be worth it.
Some retirees live solely on pensions, such as Social Security or a corporate plan, so they don't always have large sums of liquid cash. If you don't have sufficient assets on the sidelines to pay for unexpected expenses, the regular costs of owning a home could be ruinous. On the other hand, if you have enough assets set aside to cover the unexpected costs of ownership, then maintenance risks aren't as much of a factor in your deliberations. (For related reading, see: Why You Should Have an Emergency Fund.)
The Bottom Line
To summarize, the decision whether or not to own a home in retirement can be made by examining several key points:
- Decide whether you are looking to make an investment or budget a cost of living.
- Figure out what you want to spend after taxes, and do the math to determine your budget for renting vs. ownership.
- Seriously consider how much risk you're willing to undertake. Do you want to worry about market prices? Can you afford the financial risks of maintaining the property?
- Keep in mind there is a direct relationship between the size of your liquid assets and your ability to tolerate the financial risks associated with ownership.
Unfortunately, these sorts of decisions have little to do with hard facts and more to do with soul searching. Retirement is supposed to be carefree and enjoyable; examine your situation and only undertake the costs and risks that will allow you to sleep well at night.
(For more, see: Should You Really Sell Your House to Retire?)