RENT OR BUY? - GOOD QUESTION!

If you've ever rented an apartment or a house, you've probably had people tell you that you're making a mistake. Paying rent, they say, is just like throwing money down the drain.

The truth isn't so simple, however. Most American families own their homes--67 percent, a record level. But renting makes sense for lots of people, economists say, especially those who expect to move within three or four years. The notion that renting is universally short-sighted and financially foolish is wrong.

Start with the most common criticism of renting: You don't build any equity. Here's syndicated real estate columnist Ilyce R. Glink in her popular book, "10 Steps to Home Ownership": "Paying rent, the adage goes, is akin to throwing money out of the window. There is no long-term benefit financially. As a renter, you write a check each month to the landlord of your rental unit, and say good-bye to your money as you drop the envelope in the mail."

This sounds sensible. But it misses a key point. When you rent, you pay for use of the house or apartment while you're there. When you buy, you pay not just for use of the property while you're there, but also for the right to sell it when you move out. You can rest assured this right to sell costs you extra.

Another common criticism of renting is that it's a lousy deal because you miss out on the federal tax deduction for mortgage interest. With the deduction, homeowners can subtract the interest they pay on mortgages from their taxable income; doing this can save some people thousands of dollars each year in taxes.

That might seem like a strong argument in favor of buying. But it's not as strong as you might think.

For one, the mortgage interest deduction lowers your tax bill only if your deductions exceed the standard deduction, which is $4,300 for single filers and $7,200 for joint filers. And even if your deductions do exceed the standard amount, you may not save that much.

Assume your deductions total $10,000, all due to buying a house, and that your tax bracket is 28 percent. If you file a joint return, your tax savings will total just $784 a year ($2,800 x 28 percent). Why so little? Because you could have taken the $7,200 standard deduction even if you had not bought a house.

For many lower- and middle-income buyers, the mortgage interest deduction is irrelevant. For buyers with higher incomes, the deduction is relevant but may still provide little reason to buy rather than rent. That's because while the mortgage interest deduction lowers your taxes once you own a house, it raises the price you must pay to buy the house in the first place.

The effect is similar to that when you buy a house in a good school district. You pay extra for the house, because you're getting not just the house but also access to good schools. The mortgage interest deduction works the same way. You pay extra, because you're getting not just a house but the tax breaks that go with it.

In the jargon of economists, the tax benefits of home ownership are "capitalized" into the house's selling price. But to just what extent is a subject of hot debate. "The common wisdom is that some significant part is capitalized, but not all of it is capitalized," said Eric S. Belsky, executive director of Harvard University's Joint Center for Housing Studies.

"It is probably less than fully capitalized but it is probably more than zero," said David Berson, vice president and chief economist at Fannie Mae, the Washington-based mortgage giant. "Most studies show that it's not fully capitalized, so you're getting at least some advantage from having it."

Yet even if there is some tax benefit, it's likely that renters get benefits, too. That's because owners of rental properties also get tax breaks and--in a reasonably competitive market--those savings get passed on to renters.

"Anything that reduces the cost of providing the rental apartments, if it's a competitive market, sure gets through into the rental rate," said David Seiders, chief economist at the National Association of Home Builders. The bottom line? The tax advantages of buying over renting are much less clear than commonly believed.

Does this mean that buying a house never makes sense? Certainly not. For one, buying is often a good investment.

"Go, get yourself a piece of ground, and hold possession," political economist Henry George wrote a century ago. "You need do nothing more. You may sit down and smoke your pipe; you may lie around like the lazzaroni of Naples or the leperos of Mexico; you may go up in a balloon, or down a hole in the ground and without doing one stroke of work, without adding one iota to the wealth of the community, in 10 years you will be rich."

While that's probably a bit too optimistic, investing in real estate can be a smart move. As Princeton University economist Burton Malkiel has explained: "The real estate market is less efficient than the stock market. There may be hundreds of knowledgeable investors who study the worth of every common stock. Perhaps only a handful of prospective buyers assess the worth of a particular real estate property. Hence, individual pieces of property are not always appropriately priced."

Yet investing in a house is hardly a sure-fire winner. "If you look at the average home price appreciation for the '90s versus appreciation of other assets, it's not clear that's the best place to put your money," said Mark Obrinsky, vice president of research and chief economist at the National Multi Housing Council, an apartment industry trade group that has begun a public relations campaign touting the advantages of renting. "It certainly isn't obvious that homes are the best place to get a strong return."

The figures back that up. Over the long run, the value of a house is likely to rise around 5 percent per year, while bonds return about 7 percent and stocks about 8 percent, said Mark Zandi, chief economist at RFA/Dismal Sciences Inc., an economic consulting firm in West Chester, Pa.

Fannie Mae's Berson offers similar estimates. "In the stock market you might have on average gains of, let's say, 8 percent, whereas in the housing market you might have gains of 4 percent. So double, perhaps."

But there are other points to consider. "With a home you get the magic benefits of leverage," writes Gary Eldred in his book, "The 106 Common Mistakes Homebuyers Make (& How to Avoid Them)."

"You invest a relatively small down payment. Yet, you receive returns based on increases in the total value of your home. That's why even a 'lowly' four percent annual rate of appreciation will nearly always outperform the returns you could get from stocks or bonds."

Jane Bryant Quinn, the personal finance columnist for Newsweek, takes a similar view. "You can make splendid profits even in a mediocre market, thanks to the leverage you're allowed," she once wrote. "Leverage is the great advantage that homeowners hold over owners of bank accounts or stocks. You control the property for a down payment of only 5 to 20 percent."

But is the chance to leverage your down payment really a good reason to buy rather than rent? If it's leverage you want, you can get it in the stock market by buying options or by borrowing money to buy stocks. Leverage, meanwhile, carries risks as well as benefits. The reason your expected return is higher when you're leveraged is because you're taking a bigger risk. "Leveraging is great on the way up, but it hurts an awful lot on the way down," said economist Obrinsky.

And house prices can fall. While they tend to rise on average, what matters for you as an individual homeowner is what happens to your house. And the value of your house--unlike that of all the homes in the nation averaged together--could drop substantially.

"House prices do go down," said Harvard's Belsky. "There are many metro areas in which large fractions of people have sustained house price declines."

If the price of your house falls by 20 percent or more--as has happened in recent decades in Texas, California and New England--you've got a serious loss. And while a loss of 20 percent may sound bad, it's actually much worse if you're leveraged. If you put down $10,000 on a $100,000 home--which then drops in value by $20,000-- your return isn't negative 20 percent, but negative 200 percent.

Of course, this nightmare won't arise as long as you buy when the market is about to go up. And that's just what many house-buying guides suggest that you do. "When deciding whether you're better off renting or buying, consider whether the neighborhood in which you're interested is going up in value, or down," recommends real estate writer Glink in "10 Steps to Home Ownership."

But knowing that house prices in a neighborhood have gone up recently is one thing; knowing what they will do in the future is quite another. Most economists say that predicting housing prices is very tough. "Timing the housing market is not that much different from timing the stock market," said Kevin Roth, chief economist at the National Association of Realtors. "It's no different than trying to figure out where the bottom is to Microsoft."

For renters who are considering buying, a more important concern than timing the market is calculating the length of time they are likely to stay in the same place. The longer you stay in one location, the more sense buying makes, because you have a longer period over which to spread the brokers' fees and other costs of buying and then selling.

But many buyers don't end up staying long. According to the National Multi Housing Council's Obrinsky, "About half of people who become homeowners move within five years." Many would have saved money had they rented.

Renters who are thinking about buying also need to consider how much they value the convenience of renting. When you rent, you don't have to worry about keeping up the property or fixing things that break. You also don't have to pay for these repairs.

It is this convenience, as well as the flexibility to move at low cost, that is the big advantage of renting. If you value convenience and flexibility a lot, you probably ought to rent. And forget about the naysayers who claim you're throwing money down the drain.

To Rent or Not to Rent?

Key points to consider when deciding between renting and buying include:

* How long you plan to live in the same place. If you expect to stay there only a couple of years, you'll probably do better renting. That way you avoid the costs of buying and then selling, which can total 10 percent or more of the price of the property.

* How much you value the convenience of renting. When you rent, your landlord takes care of the broken dishwasher and leaky faucet. When you own, these problems are yours. You need to decide whether you want to take on these responsibilities or pay someone else to handle them for you.

* Whether you can afford to buy in the area you want. If you're short of money, you may find it tough to buy in the neighborhood you like best. Yet even if you can't afford to buy there, you may be able to afford to rent there. If so, you may want to rent until you're ready to buy.