One of the major reasons people strive for a fully paid off house is the dream of living rent-free. The idea that homeowners don't pay rent is somewhat true, like golf being a sport.
Rent is money exchanged to use something without receiving residual value. A familiar example is paying your landlord to use their property. You get a place to live, but when your lease is over, you don't own anything. This is explicit rent, it's obvious and easy to calculate.
Another, less obvious type of rent is implicit rent. Implicit rent is not directly paid to anyone. It's expressed and paid in the form of opportunity cost.
Opportunity cost is the cost of choosing one option and forgoing another. Like when the Portland Trailblazers decided to draft Sam Bowie (choice) ahead of Michael Jordan (opportunity cost).
As a homeowner, you have a lot of capital tied up. Your capital could've instead be invested in the stock market. The growth you could have experienced is your opportunity cost.
The opportunity cost is essentially rent you're paying to yourself, hence implicit rent.
Below is a simple formula to calculate your implicit rent:
Implicit Rent = After-Costs Home Equity (Home Equity - Transaction Costs) x Expected Portfolio Return
Example
- House valued at $500K
- Average realtor transaction costs are 5%
- Expected return of stocks is 7%
Annual Implicit Rent would work out to be:
$500K - ($500K * 5%) x 7%
= $33,250
Leading to a Monthly Implicit Rent of:
$33,250/12 Months
= $2,771
You end up paying a monthly rent of $2,771 to yourself. If you can find a comparable home to rent for less or even slightly more (given all the costs associated with homeownership), you'll want to consider renting. There are many benefits that come with renting that could make it a better choice for you.
Homeownership can be great option for the right person. It all depends on your goals. Just be aware, if your goal is rent-free living, homeownership is not your huckleberry.
Awesome write up!
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