Do You Need to Be a Homeowner to Achieve Financial Independence?
Achieving financial independence is a major life goal that is sought after by millions of people. The challenge is that there is no such thing as a one-size-fits-all solution. We all have different objectives in life or unique situations. When discussing financial independence, homeownership often becomes the center of the discussion.
Most people assume that if you can’t achieve financial independence unless you own a home. This is bullshit. How do I know? Because I’m achieving my goals of reaching financial freedom with an early retirement date while still renting. In fact, I believe that in some situations, renting can actually better positions you to reach your ultimate goal of financial independence if done right. Again, this will depend on your personal situation.
It’s important to understand why homeownership is a controversial topic in the world of personal finance. I agree with the majority of financial coaches who tout the benefits of homeownership (there are many). But, it isn’t as black and white as you might think. My goal here is twofold — provide the pros and cons of homeownership versus renting in the game of financial independence and dispel the myth that renters are destined to be poor forever.
The Argument for Homeownership
Owning a home is a rewarding experience for many people and there are many benefits. Many financial gurus will argue that homeownership is a must-have if you want to reach financial independence. They’ll often point to statistics that show that the majority of people who are wealthy or financial independent do own their primary residence. While this is technically true, I believe its more a matter of correlation versus causation. Owning a home doesn’t guarantee that you will reach financial independence. Sure you could go buy a $2 million home, but you’ll be in debt up to your eyeballs and may never be able to retire. Does that sound like fun to you? Me either.
1. Building Equity
The number one reason why most financial experts swear by homeownership as a path to financial independence is the ability to build equity over time. As homeowners make mortgage payment, they own more and more of their home ultimately increasing their net worth. In addition to this, residential real estate has been reliable source of appreciation with an average growth rate of over 5% over the last 30 years. To make the deal even sweeter, homeowners get the benefit of capturing the appreciation on the total value of the home and not just the portion they invested.
Home equity does provide the ability to build a significant net worth, there’s not doubt about that. But, there is more to the story when it comes to financial independence. Financial independence is all about having enough wealth to sustain your standard of living so you aren’t tied to job.
Let’s look at an example. Most people would assume that someone who has a net worth of $1 million is doing pretty well for themselves. On the surface, this looks great. However, upon closer inspection of their finances, you see that $800,000 of this net worth is tied to the equity in their home. They only have a remaining $200,000 in cash and other investments. Following the standard 4% withdraw methodology, their non-equity net worth would only be able to cover about $8,000 each year of their expenses.
When you look at it from this perspective, this individual is nowhere near financial independence despite being a millionaire. Their only option if they want to stop working would be to sell their home and move somewhere with a significantly cheaper cost of living.
2. Tax Savings
Another benefit of homeownership that is often overstated is annual tax savings. While it is true that our tax code is written to reward homeowners with tax reductions, the benefits aren’t as significant as your loan officer or real estate agent would have you believe. I partial blame these real estate professionals for this confusion. However, the responsibility falls on the prospective homeowner to understand how tax deductions actually work.
Too many people still believe that a tax deduction is a dollar for dollar tax savings. This isn’t true. For example, most mortgage interest can be deducted from your taxable income. Let’s say you pay $10,000 in mortgage interest during the year. This doesn’t mean you are saving $10,000. This only means that you don’t have to pay taxes on $10,000 of the income you earned. If you are currently in the 35% tax bracket, this savings is actually only $3,500, not $10,000. While any savings is great, it isn’t as impressive as most people are led to believe.
3. Predictable and Stable Payments
If you’ve every played around with a online mortgage calculator, you’re well aware that buying a home often comes with a hefty mortgage payment (assuming you don’t have a significant down payment). When you compare this rentals in your area, you may find that a mortgage payment is more than renting. However, over time as rents increase, your mortgage payment will stay exactly the same (assuming you have a fixed interest rate). For renters, this can be very frustrating hearing people brag about their $1,200 mortgage payment on a home they bought 20 years ago while you’re stuck paying $2,000 rent every month.
There are a couple of cons to homeownership in this regard. First, buying a home usually requires a significant cash investment in advance. While this money will grow about 5% per year, there are other (relatively) safe investment options that are more lucrative. For example, an S&P 500 index fund has a historical growth of about 10% over the last 50 years. Compounded over a few decades, this could be significant.
I would also argue that homeownership costs aren’t as stable as you might think. Sure, your mortgage payment might stay the same but other costs will not. The cost of property taxes, home insurance, renovations, repairs, and ongoing maintenance almost always increase over time. Not only that, but large expenses can appear out of nowhere such as a roof leak or burst pipe in the middle of winter. This can cost tens of thousands of dollars. The renter simply needs to call their landlord.
Financial Independence is Still an Option for Renters
As you can see, there are lots of moving parts when it comes to deciding if homeownership or renting is the best option for you. Trust me, it is absolutely possible to achieve financial independence even if you rent. It all boils down to the math and whether you have the discipline to keep pursuing your financial goals no matter what. Here are a few things to keep in mind if you are doubting your ability to become financially free while renting.
Part of the reason homeownership makes building wealth easy is because it works as a “forced” savings plan. You have no choice but to keep making your mortgage payment every single month. For renters, you have to be more intentional and disciplined to make sure you put your budget surplus to work every month.
Building wealth begins and ends with spending less than you make. The recipe for success here is consistency. Unfortunately, homeownership does come with some unknowns. You never know when you are going to face an major unexpected cost like a roof repair. Even with a nice emergency fund, these unpredictable swings in cost can derail your budget and cause you to easily overspend or can wipe out months of savings. Renters have the advantage of having all of their housing costs rolled into one predictable monthly cost which makes budgeting much easier.
Selling a home and moving to a new location is expensive and not easy to accomplish. This gives renters the advantage in growing and building their careers, especially if they are young professionals. Renters can pick up and move quickly if they get a job opportunity in another city or across state lines. Homeowners may be limited to jobs only in their commutable area.
Rental rates, especially in the last decade have increased exponentially, this can be scary and difficult to stay ahead of. Renters can still keep these costs under control, but it may require being more aggressive with career growth or finding alternative ways to earn money like building a side hustle.
I’m very proud of my financial accomplishments as a long time renter. Most financial gurus wouldn’t “approve of my lifestyle”. But hey, most financial coaches and “experts” out there aren’t on track to retire in their mid-40s either. The numbers don’t lie. Don’t let being a renter discourage you from pursuing the financial stability your family deserves.
