Once you have worked for a few years and saved up some money, you may ask yourself if you’re better off renting or owning a home. I know I have been asking myself this question a lot lately. The answer is, “it depends.”
When determining whether or not to buy a home it’s tempting to just compare your monthly rent to what your monthly mortgage might be, but this is not an accurate comparison. When comparing the cost of renting to owning there are a variety of factors to take into consideration. I will do my best to help guide you through all of these factors. Here is where I would start:
What is the total cost to rent?
Step one would be to determine exactly what you will be paying to rent. This includes monthly rent and renters insurance, which most landlords require.
What is your monthly mortgage payment?
Determining the total cost to buy a home is not as straight forward, as there are a lot more factors to take into consideration. A good place to start is to determine what your monthly mortgage will be. There are a variety of online mortgage calculators available if you want to play around with the numbers.
Your monthly mortgage payment will vary depending on the price of the house, how much money you put down towards the principle, and the current interest rates.
How much money will you put down?
Many real estate professionals recommend you put down 20% on your house if possible. Doing this prevents you from having to pay private mortgage insurance (PMI), which is a type of insurance that protects the lender. For you as the buyer, PMI is just lost money. In addition to avoiding PMI, putting 20% down often gets you a loan with a better interest rate than if you were to put 3.5%.
If you can’t afford to put 20% down on your house don’t sweat it, you won’t have to pay PMI forever. Once you have paid up to 20% you will no longer have to pay PMI each month. If you can pay 20% down by all means pay it, but if this stretches your budget too far just know that many people only pay 3.5% or 5% down.
How much is home owners insurance?
Homeowners insurance is more expensive than renters insurance since it actually covers the entire home structure, whereas renters insurance just covers your belongings. Unlike renters insurance, homeowners insurance is almost always mandatory if you have a loan for your home. That being said, a lot of landlords will likely require you to have renters insurance as well.
How much are property taxes?
Unlike renting, you have to pay property taxes when you own a home. The amount you pay will vary depending on the price and location of your home. It’s hard for me to throw out a number here because it really varies by state, city, and home price.
Is there an HOA fee?
Many communities require owners to pay a monthly home owners association (HOA) fee. This fee can vary greatly by community. From my experience, it can range from $50/mo to as much as $500/mo. The HOA often covers common areas in a community, recreation centers, sometime exterior surfaces of a home if it’s a condo/townhouse.
How long will you live there?
It’s not easy to say with 100% certainly how long you will live at a certain location. Many unpredictable factors may come into play. For example, you could be forced to relocate for a job. However, if you feel like your job is stable or that you can easily find another job commutable from where you live, there is a good chance you will have control over how long you live in your home.
In general, data shows if you purchase a home you should plan to live there at least three years. If you live there less than three years it typically makes more sense financially to rent. The three years time frame is just a generalization. There are many factors that can change this time frame, so it’s really important to crunch the numbers.
What is the monthly maintenance cost?
Maintaining a home you own is more expensive than maintaining a home you rent. When you own you are responsible for maintaining every aspect of your home from the lawn to the structure itself. If you buy an older home, unexpected repairs can rack up bills quickly.
When you rent, you really don’t have to worry about more than keeping the place clean and not destroying anything.
Are any repairs/renovations needed?
Does the home you want to purchase need repairs/renovations? Don’t forget to factor these into your costs. When assessing whether or not repairs need to be made, determine if the repairs will increase the home value by more than you put into it for repairs/renovations if you were to resell it.
For example, let’s say you need to put $20,000 into the home for repairs/renovations. If you were to sell the house the next day, would this $20,000 in repairs/renovations help you to sell your house for $20,000 or more than you initially paid for it? If so, the repairs/renovations may be a good investment. If not, maybe you should look for other homes or assess whether or not these repairs/renovations are really needed.
You don’t want to get yourself in a situation where you have $200,000 in a house and all of the other houses in your neighborhood are selling for $150,000. Before putting more money into your house, be sure to assess what your house can realistically bring on the market.
Owning can be an investment.
When you purchase a home you are investing your money into it and acquiring equity over the course of your loan. This contrasts to renting in which you acquire zero equity. After reading that statement, owning sounds like a no brainer, but remember with each payment you make a lot of the money is going towards interest, not equity.
When looking at your home as an investment, don’t forget to consider realtor fees if you plan to list your house with a real estate company to sell it. The fee is generally around 7% of the price your house sells for. Also remember to factor in the closing costs you paid at the time of purchasing the home.
There are a lot of factors that can come into play that will ultimately decide whether your home is a good or bad investment. Historically, if you keep your home long enough you will more than likely be able to profit on it. How long that is will vary by market conditions. As I mentioned above, 3 years is the general rule of thumb.
Although home prices have historically risen, don’t automatically assume your home will only increase in value for the time you live there. It’s certainly possible your home will decrease in value from the time you purchased it to the time you want to sell it.
For example, you could unknowingly purchase your home at the peak of a real estate bubble and once that bubble bursts your home value could drop dramatically. That being said, if you’re able to hold onto your home during a down market you will likely come out alright in time. It may just take more time to be profitable than you hoped.
Related: Invest Now For Big Returns Later
Is a down payment on a home the best investment?
When looking from a pure investment standpoint at purchasing a home vs renting, you have to consider if putting your down payment money towards a home is really the best investment. Maybe over a 5 year period the down payment money on your home yields a 5% annual return, but if that money were invested in the stock market it may yield a 10% annual return.
This certainly isn’t the easiest factor to consider since there is always some degree of uncertainty regarding how the stock and real estate markets will behave, but it’s definitely something to think about.
Related: Introduction To Stock Investing
Compare the cost of renting to owning.
Once you have all of the information gathered, it’s just a matter of comparing the total cost of renting to the total cost of owning. Don’t just compare one month of owning to one month of renting. Try to compare the cost differences over a variety of time frames to see at what point owning becomes a better financial choice than renting.
To make the calculations easier, check out this rent vs own calculator.
Once you determine how long you have to own a home for it to make more sense to own than rent, ask yourself if you will be able and willing to stay at this location for that period of time. If the answer is yes, owning may be the right choice for you. If the answer is no, you should consider renting for the time being.
It’s not all about the money.
So far I have only been discussing the monetary factors involved in owning vs renting, but there are other non-monetary factors to consider. For example, when own a home you are free to do with it what you please. If you want to have 10 dogs running around the house no one can tell you no. If you want to drill holes in the walls or tear down a wall completely you have the right to do that.
There are non-monetary advantages to renting as well. For example, when rent you are not typically tied down to one location for more than a year. You also don’t have to go through all of the hassles of selling a home when you move. Not having to worry about all of the maintenance associated with owning is nice as well.
It’s ultimately up to you to determine how important these non-monetary factors are in making the decision to rent or own. Maybe having the freedom to do what you want with your home is worth losing a few thousand dollars.