A recurring theme among letters from "Moneywise" readers is "What can I do about rent increases?" Generally, these letters tell how a single person or couple sold their house, took the $100,000 once-in-a-lifetime exemption to avoid paying income tax on the capital gain, and invested the funds in a long-term certificate of deposit paying 7 1/2 or 8 percent. Two errors compound these readers' problems in keeping up with or ahead of inflation.
First, renting takes an increasing bite out of what is generally a minimum, mostly fixed income. I strongly recommend owning one's housing to control this expense. A house returns a substantial benefit in living value with no tax assessed. Here's how:
Suppose you own a house with a net market value of $60,000 (sales price less settlement expenses). Invested at 15 percent, the $60,000 would yield $750 each month. Assume a 24 percent marginal tax rate, and the net falls to $570 per month. You could easily afford to rent an apartment for less than $570 -- say,
Looking ahead, consider that rents will likely increase by 12 percent each year. Using the rule of 72 (divide the inflation rate into 72), that means rent could double in six years -- to $900 per month. To pay $900 would actually cost With $60,000 still invested at 15 percent, there would be a shortfall of before-tax money equal to $1,184 less $750, or $434.
If instead of selling, you keep the $60,000 house, your cost in terms of income lost amounts to $750 a month. You would likely break even on rent vs. income lost sometime around the third year.
Obviously, the comparison is more complicated. You might not be able to invest the $60,000 from your house at 15 percent forever. You can expect expenses for owning the house to continue -- taxes, insurance, and maintenance. Utilities would likely be similar in your house or a rental. However, you have inflation working with you instead of against you when you own the house.
Second, considering the $60,000 base price and escalating its value at 10 percent each year, you could expect the value to reach $106,000 after six years. When you could no longer keep the house, you would have $106,000 to invest rather than the $60,000.
Not all of the inflation increase could be considered profit. If maintenance , taxes, and insurance totaled $1,200 the first year, this would reduce the inflation increase from $6,000 (10 percent of $60,000 net market value) to $4, 800 -- still a substantial cushion.
If you should own a big old house far from public transportation, selling may be tempting. Instead of selling and investing the cash to pay for a rental, consider selling and rebuying a smaller house or a condominium for cash. With the maintenance covered and a smaller space compatible with a retired life style , you would still own your housing. The important thr ead is to recognize the continuing benefits from owning your housing, compared to renting.