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Comment by jdietrich | Hacker News Reader

It's a very simple mathematical error - people compare the cost of a mortgage payment with the cost of a month's rent, failing to take into account that only a tiny fraction of the mortgage payment actually becomes equity.

If they actually sit down and work it out, most people are astonished at how much flexibility they sacrifice for that small slice of equity.

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It comes down to compounding interest. Same as with credit cards or really any similar debt (or investment).

People are: shown the total amount they have to pay to the bank over the life of the loan. It is hundreds of thousands of dollars over 30 years. And most can see in their statement what gets applied to principle and what gets applied to interest.

If they didn't screw themselves and get a loan with early payment penalties they are always free to pay extra anytime they see fit to reduce principle (and if it is early enough it could end up dramatically reducing the total interest paid).

TL;DR: people need to know more math

Here's a fun calculator (not by me) that takes all these things into account. It's great fun!

http://michaelbluejay.com/house/rentvsbuy.html

The author offers a reward if you find an error.

love how those calculators start with 200~300k houses prices.

in most areas where i want to live, this is the going price for a buying an extra parking spot at the building garage. when you get a good price.

That mathematical error corrects itself over time. I now own my house. Rent is forever.

That's an excellent point, but a mortgage is not the only route to true home ownership. You could work and rent in a city with high salaries and low rent vs. purchase prices, then retire in a very cheap area where you can just buy a house with cash saved up, thereby paying no interest whatsoever on the house and keeping maximum mobility during your career.

> a city with high salaries and low rent vs. purchase prices

This is not easy to find and the market typically corrects itself over the course of a few months to a year, unless there is rent control.

Property tax is forever too.

This is an excellent point I think people often forget about. How does property tax in a house (whose valuation you often have no control over) compare to rent?

Renters pay property taxes as well, it's just hidden from them because the landlord is a middleman. If property taxes go up, so will rents.

That's not even it; in most towns with a 20% down traditional 30 year mortgage, you do very well versus renting if all you count are taxes+interest as expenses, particularly as interest is tax-deductible but rent isn't.

However, you also have to pay maintenance. And had you not put all that equity in your home, then it could be earning above inflation, whereas real-estate in aggregate earns approximately at inflation (if you do better or worse, then you were a winner or a loser versus the average).

Precisely. If its more expensive to rent the money than rent the house, there is no gain.

Of course, the tax deduction is worth something, inducing people to do things they would not otherwise do. And no capital gains tax on profits. And first time assistance. And whatever else there is running up government deficits.

Its a big ponzi scheme. It blew up once and I guess they know how to profit on the way up and on the way down. Its Mr. and Mrs. Joe Average who get skewered.

But the interest is tax-deductible. So you should also include tax savings in your cost-benefit analysis.

Only to the extent that its over your standard deduction. In my case,about 1/3 of the interest I pay is deductible.

>failing to take into account that only a tiny fraction of the mortgage payment actually becomes equity.

What percentage of a mortgage payment actually gets converted into equity?

(coming from a genuinely curious person who has never owned a house)

It depends. The interest portion is very high in the beginning of the mortgage and very low at the end.

In a typical 30yr mortgage, you will make 360 monthly (roughly equal) payments. If your mortgage payment is $1000/mo, payment #1 will be approximately $950 interest and $50 principal. Payment #360 will be ~ $50 interest and $950 principal.

Most people move every five or six years (historical, might not be true with current RE market), so they complete about 20% of their total mortgage schedule. However, because of this ramped apportionment, most people still owe the lender much more than 80% of their initial purchase price.

The first time I did the math on this, I thought I had discovered a huge consumer-hostile scam. But actually it's quite reasonable -- mortgages are designed to keep payments equal over the term of the loan, so there's really no other way to do it.

I just bought a home and 40% of my payments are principal from day 1. That's at 3.5% interest. If you get a conventional loan instead of a jumbo, you can do even better than that. Mortgage interest deductions make the calculus even better. Plus tax-free capital gains.

It was quite the slam-dunk easy decision to make where I live (San Francisco), considering how hot the rental market is. My house rents for $1k more than the monthly mortgage!

Interesting. If I understand the math correctly, that means that you have an effectively variable interest rate over the life of the loan (though presumably it will average out to the 3.5%). Is there a special name for that kind of loan?

The reason mortgages front load the interest is not to victimize borrowers (that's just a pleasant side effect) but because in the early days of the loan, you are using more of the lender's money. You pay it back slowly, but you pay interest in each payment on the amount that you're using at that point in the term.

So payment #1, you pay interest on ~100% of the loan. Plus a little extra to reduce your principal. Next payment is interest on ~99.8% (100% minus 1/360th), plus a little extra (more than last time) for principal reduction so that the payments total the same amount. On and on til payment #360.

If you're paying 40% principal on payment #1, by my math, either your effective interest rate is variable over the term, or you're choosing to overpay the invoice (applying the excess to principal -- which makes a huge difference in the early years).

I'm surprised the economics of buying work out so well in SF these days. When I left, it was the other way around. Interest rates help a lot. Congrats on the house!

It's not variable, it's fixed at 3.5% for 30 years. A "jumbo" loan has a higher interest rate than a conventional simply because of its high initial principal, making it a riskier proposition for the bank. What calculator are you using to calculate principal vs interest for a fixed rate loan? Remember, the lower the fixed interest rate, the higher % of principal you are paying at day 0.

The economics of buying vs renting has changed a great deal since I moved here. 5 years ago, buying was rather questionable. I took advantage of "cheap" rents to save up for buying a house when it finally became a buyer's market. Now rents have nearly doubled, but housing prices haven't gone up proportionately.

25%

However, blindly following advice on renter-ship is as bad as blindly following advices on homeownership. Every situation is different, and you should do your math per your specific situation.

True. However, in the majority of cases the math is overwhelmingly on the side of renters. Whereas conventional wisdom goes the other way. This is one of the reasons we had the housing crash. The house of cards can only stand for so long.

At the beginning of a mortgage, the overwhelming majority of your payment will be interest; a very small slice is applied to the principal. Over the term of the loan, those small cuts whittle away the principal owed, which in turn lowers the amount of interested charged each payment (a percentage of the principal owed), until at the end of the mortgage your payment is mostly principal.

If you do the math, a typical 30-year mortgage will cost you twice the actual cost of paying cash for a home, so roughly 50% of your payment actually gets converted into equity, assuming your home value was static over the term. This is why people often advise new homeowners to make an extra principal-only payment as often as possible at the beginning of the loan: to cut down the eventual amount of interest you'll end up paying.

That's what I've done with my mortgage. I've been lucky to be in a position to make frequent principal-only payments and should be able to cut a 30-year mortgage to 15-ish or so, saving a metric grundle of cash in the process. Given the nature of the conversation happening around this thread, I suppose I should state my reasons for trading away job-seeking flexibility: I LOVE that eventually, I'll have a roof and four walls independent of my employment situation.

As someone who just bought a home -- I can also assure others in this thread, there is a lot of emotional value in owning your own place (reality check -- yes I know the bank owns it for a while) -- but for me and my wife, the value comes from being able to do whatever we want with the house.

Expand the basement? Sure! Get a bunch of dogs? Why not! Commit to getting to know the neighbors? Sounds great. All while not having to worry about a landlord doing whatever they want at the end of a lease.

It's a very rewarding thing. Is it for everyone? Absolutely not, much in the same way having kids or getting married isn't for everyone either. But for me, there is a lot of value in the actual ownership.

>>Expand the basement? Sure! Get a bunch of dogs? Why not! Commit to getting to know the neighbors? Sounds great. All while not having to worry about a landlord doing whatever they want at the end of a lease.

It's funny that two out of the three things you said are additional expenses that the house enables.

Of course, we aren't disputing the emotional value of owning a home. We're just saying that it's a poor financial decision most of the time.

>>It's funny that two out of the three things you said are additional expenses that the house enables.

Those same two things may also be valuable to the owner, regardless of expense. Expand my basement so I have room to continue working on the hobby I love? Sounds good.

You obviously don't live where I do; nearly all changes to the house require a permit which takes 6-12 months to get and is quite expensive, and for anything that changes the # square feet (like expanding the basement) will be denied.

People often pay double the cost of the house, so on average (for the life of the loan), half of your mortgage payment is equity. In the beginning the vast majority (90%+) is interest.

Here's a calculator I whipped up: http://instacalc.com/1737 (adjust the numbers as you need; this is a side project of mine).

There are lots of calculators that will show you, but for a $100,000 loan at 5% you only get about $1450 in equity the first year and only another 1550 the second year, but you pay about $4950 in interest the first year and $4900 in interest the second.

Unless you make lots of extra payments you gather equity very slowly. The break even interest vs equity per year point is at the half way point.

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