Hi grantmeaname,
Thanks for responding. Okay, a few short replies from me going through your points:
1) I didn't mean to say only staying put for 30 years works. I just meant that the longer you stay put, the better owning looks
2) On moving frequency, I've been looking for a source and don't have anything good. I think the 7 years number is for homeowners moving, not for everyone. Renters move even more frequently, every 3-4 years. Apparently the NAR is one source of this info. That said, homeowner moving rates vary dramatically by age, with younger owners moving more often than older. So saying people move every seven years is a big simplification. I guess the takeaway is, a mustachian move is to be sure you want to stay for a while or you are willing to become a landlord, and you can reduce total lifetime real estate transaction costs.
3) Agreed, 7-10% transaction costs are high and there are good mustachian ways to reduce them
4) Thank you for running through the math on the old vs. new loan. Very helpful and clear.
5) So, then, combining your points 4 and 5, you talk about inflation. My example left inflation out on purpose. In my example, if there is no inflation and people move regularly, homeowners would find that their "ownership" wasn't helping them relative to renters, and they would be surprised.
I agree that one of the strongest arguments for owning is inflation. You can lock in a fixed housing cost (vs. rent which goes up) and the value of the house should (on average, depends on starting point, etc.) go up with inflation. So, in simplified examples, assuming house price goes up exactly with inflation, the following would be true:
* if you bought with all cash, your benefit would really just be the fact that your payments would be lower each month than the costs of a renter whose payments would go up wth inflation, forever. If the buyer's costs were equal to the renters in in Year 0, they could go below 50% of a renters costs near the end of a 30 year mortgage (with 3% inflation), then even less thereafter (no more mortgage payments, just taxes and maintenance which should be an even smaller % of a renter's cost, going up with inflation)
* if you bought with a mortgage, the nominal gain in house price would translate into a leveraged gain on your equity, for a second benefit of real capital appreciation
(And if the house went up faster than inflation, the buyer would do even better)
However, I think there's one small detail in your explanation that doesn't make sense to me. Let me walk through this. If the buyer is benefitting from inflation, and we're assuming that house prices are going up with inflation, then when the buyer moves to a new house after 7 years, the equivalent house (no trade up), will cost more money. So it's not exactly true that moving is irrelevant to the principal paydown question. I just ran some numbers, and what ends up happening is, at any given level of inflation, both your equity and the overall cost of the house have gone up. And if you want the same level house on the next buy, you have to put in new equity or new mortgage borrowing equal to the transaction cost you paid to move. So here's the example, building on yours: $125,000 house, 20% down, $100,000 mortgage, 3% inflation. At the end of 7 years, house is worth $154,000, assume you pay 7% transaction cost of $11,000, your equity has grown to $57,000 (new higher home price minus $86,000 mortgage principal remaining minus 7% transaction cost to sell and rebuy). Now you want to buy the same quality house, which now costs $154,000. You roll your $57,000 in equity into it, and now you need a larger mortgage of $96,000, not just the $86,000 you owed before.
Now, all this really proves is some obvious stuff that you knew anyway, but I wanted to think it out for myself. It seemed like you were suggesting that a series of mortgages is the exact same thing as one longer 30 year mortgage. That's partly true, but the obvious stuff I proved to myself is: a) the transaction costs are real costs that decrease overall returns vs. buying and holding longer; and b) when you move in a rising market, you end up paying more in nominal terms for the same quality house on the subsequent transactions. You have to feed a bit of new money into the system, either by replacing the amount your equity was reduced by transaction costs or by taking out a slightly bigger mortgage, effectively financing the transaction cost.
So the conclusions for me are:
1) You have to include transaction costs in the up-front analysis of whether to buy or rent
2) The less frequently you move, the better
3) The relative monthly cost of renting vs. buying is an important driver
4) And, all other things being equal, a lot of this is a levered bet on inflation
So, if the monthly costs of renting and buying are equal, then inflation has to be high enough to overcome the expected transaction costs.
If you do buy and hold for 30 years, or get enough inflation to cover any transaction costs along the way, then you do get an amazing benefit vs. renting which is that the payments do end, which they never do with renting.
But if we are just focused on renting vs. buying over a short time-period in a house, e.g. 7 years, the small principal repayment and the transaction costs partially cancel each other out, and ultimately you're just making a bet on inflation. If prices go up, it's great. If they stay flat, it's so-so. But if they go down, the leverage works against you. (I know that this isn't new information.)
But the point I guess I'm still trying to make is that most "equity building" in the early years of owning a house depends on inflation. Without inflation, the principal repayment factor is slow in the early years, and is partly offset by transaction costs.
One other plug for renting--it can give you major flexibility to save costs in other ways. You can shop for good deals on rentals every single year, whereas as a homeowner you need to get a good deal at the outset, because you won't have the same flexibility to bargain hunt along the way. Also, renting gives you more flexibility to change jobs to increase income, and to rent a place close to work and go carless even if your job location changes.
So, given all this, if you knew at the outset that it was unlikely you'd stay somewhere more than 7 years, the two questions that matter most are: 1) what is the cost difference at the outset?; and 2) do you expect house price inflation or not?
I personally don't expect house price inflation in the near term. I think prices are sticky and sellers are stubborn. I think we still have a way to fall in price to income ratios. I think most Americans have less ability to save up a down payment than they did a generation ago. etc.
That said, there is something asymmetric about this. If inflation soars, the levered gains on equity could be 1000%. Whereas you can really only lose 100% of your equity to deflation. So maybe some real-estate is a necessary inflation hedge for everyone. Just to hedge against paying $50,000/month in rent down the line.