When it comes to buying vs. renting a house, there is always a passionate debate about which makes the most financial sense. Both sides have valid points, so it can be a bit confusing. For example, in the US, recent changes in the tax law have also made owning a home less financially advantageous, so the buy vs. rent dispute continues to evolve.
A common argument for buying is, ‘Why would you pay monthly rent to a landlord instead of building equity in a home for yourself?’ In reality, there are many financial reasons why renting may be more compelling. You also need to make sure you understand whether you are even in a good position to buy a house. Your finances are not your only consideration either. If your social, professional AND financial lives aren’t in order, now is probably not the right time to be buying.
Now, let’s break down this buying vs. renting decision and some of the important factors.
1. The true cost of homeownership is higher than many anticipate. There seems to be a widely held belief that buying a home always makes more sense than renting. That it’s a foregone conclusion. You often hear that ‘every dollar you pay in rent is a dollar you’ll never see again,’ while buying a house is a ‘great investment.’ This is misguided for a few reasons.
Paying rent isn’t a waste of money. Yes, you won’t see your money again, but you are getting something in return: shelter for yourself and your loved ones. Even when you buy, you’ll be spending a lot of money on interest payments, taxes and other fees — money you will never see again. These payments are not helping you build equity. Owning a house isn’t just sunshine and rainbows.
When it comes to thinking about the true cost of homeownership, you need to have a holistic view of all of the related expenses. At first glance, a mortgage payment might be less than your current monthly rent, but that mortgage is just the tip of the iceberg. For many people, the associated costs of homeownership might run as high as 50%+ of their mortgage payment. Ouch.
Below is a list of homeownership expenses to get you started as you begin to think about buying a house. This doesn’t even take into account the additional cost of new furniture, upgrades or equipment (like lawn mowers) that new home owners will find themselves buying.
One Time (Non-Equity) Homeownership Costs (6-12% of home value):
- Mortgage Origination Fees (upfront fee charged by lenders for processing a new loan)
- Closing Costs (usually include escrow fees, property taxes, interest)
- Realtor / Lawyer Fees When Selling
Annual Ongoing (Non-Equity) Homeownership Costs:
- Mortgage Interest Payments
- Homeowner’s Insurance (HOI)
- Property Taxes
- Utilities (e.g. electricity, gas, water, etc.)
- Flood Insurance
- Mortgage Insurance (if downpayment < 20%)
- Maintenance & Repairs
- Condo or HOA Fees
- Investment Opportunity Cost (the cost of foregoing investments due to having your money tied up in a down-payment or other expenses you wouldn’t have if you were still renting)
2. Renting might cost less, even over the long term. After seeing that long list of expenses, it might start to sink in that the cost to rent can certainly be lower than the cost of homeownership. A common rule of thumb is to not purchase a home if you know you won’t live there for at least five years. Why is this the case? For example, if you buy and own a home for 30 years, chances are the closing costs will be more than offset by the growth in the home’s value. On the flip side, if you only own the home for four years, there is a much higher chance that the home’s value won’t have increased (and potentially have decreased) and thus, the closing costs and fees will mean you’ll likely lose money on your investment. Additionally, the payments at the beginning of the term of a mortgage go disproportionately to interest and not to paying down the principal balance (building equity). This is the perfect recipe for a bad investment.
In order to determine whether it makes more financial sense to rent or buy, you’ll need to compare the total cost you’ll pay when renting to the total cost of homeownership. In addition to the costs, you’ll want to take into account the benefits accrued if you were to sell the home, as well as any tax deductions you’d receive via homeownership. This seems kind of complicated, right? Not exactly.
3. Calculating whether it makes more sense to rent or buy is easier than most people realize. In 2014, the NYTimes published an incredibly helpful calculator that made it easy to calculate whether you’d be better off renting or buying a home. The more accurate your assumptions, the more accurate your results will be. Keep in mind, as noted above, that the laws have changed significantly since the calculator was published, and not all taxpayers will be able to claim related tax deductions – that can change your overall savings. Also, it’s tough to predict how long you’ll own a house, or whether it’ll go up in value, but just use your best judgement.
For most people, this calculation will make it painfully obvious whether renting or buying a house makes the most financial sense. Once you’ve evaluated the finances and the other non-financial factors (e.g. social, professional), you’ll be on your way to making the best decision regarding whether to rent or own your home.