Renting vs owning a home – this is a debate that apparently used to be pretty simple. I remember the discussion being rather one-sided growing up, but maybe I was just sheltered. Here’s the rule as I remembered it back then…
Owning a home was the answer in just about every situation unless your credit isn’t good enough or you’ll be moving again shortly (very shortly). Renting was for those who couldn’t afford to own. I think that’s why there’s still a bit of a stigma associated with renting in certain communities.
So, why was home ownership the easy answer? The logic was that a home is an investment and you were throwing your money away by renting since you weren’t building any equity. However, the last 7 years has changed the rules a bit. So, we’re going to take an updated look at the renting vs owning a home question in order to determine which one is right for your particular situation.
Renting vs Owning a Home - The 5 questions you need to ask
1. What is the annual cost?
Here are the usual cost formulas for renting vs owning a home.
Rent + Renter’s Insurance (optional) + Utilities (sometimes only partial) = Total cost
Mortgage Payment + Property Taxes + Insurance + Upkeep (like lawn care) + Utilities + Repairs/Renovations - Total Tax Break on interest paid = Total cost
Obviously, owning your own home adds a few extra costs like lawn mowers, snow blowers, garbage service, property taxes, fixing or replacing the dishwasher, reshingling the roof (something I need to do this year), etc. The list is truly endless. However, you may live in an area like mine where homes are really cheap right now and the monthly payments are often cheaper than what you would pay for an apartment. It’s all part of the equation. Add up the costs yourself, so you don’t miss anything.
Fortunately, homeownership isn’t all expenses though. You’ll be able to deduct the mortgage interest you paid during that year, and while that’s a nice bonus, make sure you don’t overestimate how much you’re going to benefit. I’ve had people tell me that the reason they decided to buy instead of rent was to capitalize on the tax deduction. I hope that wasn’t the only reason. You’re not going to get rich off a tax deduction. Remember, a deduction is not a credit. The IRS isn’t giving it all back to you. They’re just helping you out a bit.
2. How long are you planning on living there?
This is a BIG one. Much like refinancing, one of the key questions to ask yourself is how long you plan on living there. If it’s less than 3 – 5 years, you may want to take an extra good look at renting. Renting offers flexibility that homeownership can’t match.
Selling a home
I’m sure you’ve seen the news – houses aren’t selling as easily or quickly as they used to. Though the figures vary widely depending on your location, the average time that it takes to sell a house in the U.S. is 10 months. So, a quick job transfer to another city may mean that you’re paying for two homes for the next year or so. That’s not good news for your budget.
It’s true that renting doesn’t build equity, but I think a lot of folks are confused about exactly how much equity you’re really building for those first few years.
Here’s an example:
A $100,000 30 year mortgage at 4.5% interest
The total annual payment for the 1st year would equal $6,080.28, of which $4,467.00 will be interest paid to your bank or mortgage company as a thank you for loaning you the money. In other words, you will gain a whopping $1613.28 of equity, or about 26% of what you paid in.
By year 3 you’ll have gained about $5,000.
Now, I’m fully aware that $5,000 is significantly better than $0 in equity and that’s why owning a home is a great idea if you’re going to be there awhile. Equity is good. But, that $5,000 will quickly disappear once you decide to sell it.
People often forget that realtors want a cut of the sale when they help you sell your home. The average commission is between 6% – 7%. 6% of a $100,000 home is $6,000, which means your equity is gone…and then some. You could always try selling it on your own, but this could backfire and add to the time it takes you to sell it. Either way, selling a house isn’t as simple as it once was.
During those three years that you own the home, it’s possible your home will have appreciated in value slightly, but it will probably be minimal right now. It’s not like it used to be where you could assume a 4% – 7% increase in the value of your home each year. It will probably be a little while before we see those kinds of numbers across the board again.
You also need to be mindful of the closing costs that you paid when you purchased the home. The normal transaction includes an appraisal, title work, bank fees, etc. often totaling $2,000 – $3,000 or more.
It’s only after year 3 – 5 that building equity starts to add up. If you’re going to be staying put for 5 or 10 years or more, the equity should build quickly enough to provide a good investment.
3. Are you capable/willing to take care of a property?
Some people love the relaxation that comes with a rental, and some people need a home-improvement project to work on. Which one are you?
I can’t imagine my parents living in a rental (even though I know we did when I was younger a couple times). They are the types that need to have 14 different projects going at all times. I can’t remember a time when we lived in a house when everything was done…meaning it was just as they wanted it to be, everyone was content, and the weekends were filled with hammocks. They love to improve. They love to work on their house and make it more and more like them. Therefore, owning a home makes sense for my parents.
However, one of these days their acre of land, complex and beautiful garden, and 100 year old farmhouse is going to be too much for them. That time is still in the distance, but it’s bound to happen. It happens to all of us. At that point it might be time to rent…or live with their son. Oh boy
4. How creative do you want to be with your property?
Do you just need a place to live or do you need to express yourself? Do you need a yard, landscaping, and a large garden? Do you need the freedom to knock down walls, paint your bedroom pink, or turn your dining room into a giant sandbox? If so, your only option may be to own a home that can handle your mood swings. Landlords don’t like that kind of stuff.
5. Are there any special circumstances?
I own a home. I don’t plan on living there more than a total of 5 years. Why did I make that choice?
For my wife and I it was pretty easy. There were three main reasons for buying:
- We needed space to set up a photography studio for some fairly lucrative jobs that were coming up.
- We bought the home for less than market value due to its recent label as a foreclosure.
- Most importantly…The friendly U.S. government gave us nearly $6,000 in order to do so.
At the time, the government was giving out significant sums of money to first-time home buyers (or those who hadn’t owned a home in 3 years or more like myself) in an attempt to rev up the falling real estate market. I decided to take advantage and am glad I did. That extra $6,000 helped us finish paying off our debt, which, in turn, saved us a bunch more in extra interest payments from our loans.
The government giving out free money was a special circumstance that needed to be factored into my decision. You may come across something similar. Keep your eyes open.
Which to choose?
There’s a lot to consider when deciding where you’re going to live. It can be a little overwhelming, but make sure you think it through. Renting and homeownership each have their pros and cons. It’s up to you to sort it out.
By the way…noticed that I said, “right for your particular situation.” in the first paragraph of this article. I’ve heard people on both sides argue vehemently for their choice as the only logical one you can make. Renters list all of the extra expenses that come with home ownership and tell you to simply invest your savings in the stock market to come out ahead. Home owners talk about the equity and appreciation as if they’re get rich quick schemes.
Here’s the thing. Every situation is different. Consider your particular situation, the specific costs in your neighborhood, and make the most informed decision you can. Hopefully the 5 questions above will help.
P.S. If you decide that home ownership is right for you, make sure you read this article before you start shopping.
Why did you decide to rent/own? Comment below.