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Should I buy or rent a house? Buy vs. Rent HouseFor many people, especially during a housing boom, the decision to buy a home or rent can be a challenging one. Over time, most real estate does appreciate, but buying at the peak of a bubble can easily cost you 10-25% of your home's value, and it could take you a decade to make up that lost ground. Of course missing out and watching home prices go up by 15-25% per year while you are renting can potentially lock you out of the real estate market permanently, as housing costs outpace your ability to earn and save. Many times, new home buyers feel compelled to buy, fearing just this getting left behind. Other times, they simple cannot afford to buy a home since they don't have a down payment or can't qualify for a mortgage. But for those who do have the option, buy vs. rent is a big decision. In this guide, we will take a look at the question of whether it is better to rent or buy a home, when renting makes more sense, and what the pros and cons of home ownership vs. renting are.
Home Ownership Costs - Should you buy or rent?As a general rule, if you can afford a home, you should probably buy one instead of renting. But "afford" means more than just saving up a 5% down payment. It also means having the funds necessary for maintenance and upkeep on the house, and money for property taxes. Before buying a home, make sure you know what these expenses are and that you can afford them. Depending on where you live and how much your house is worth, property taxes can easily consume $1000-$10,000 per year -- that's a lot of money on top of mortgage expenses if you could have rented a home for $1000 per month instead. And if you've ever had to replace a roof, you know the kind of dent a $15,000 repair can put in your savings account. The standard arguments in favor of buying a home are:
To be fair, lets take a look at some of the disadvantages of home ownership:
Advantages and Disadvantages to Renting vs. Owning a HomeSo given market value vagaries and realtor fees, your first question to ask when considering whether to buy or rent is how long you plan on living there. If you want to stay in one area for less than 2-3 years, consider renting. While property values in general go up over time, you could buy at the wrong time (especially if there is talk of a real estate bubble in your area) and not have enough time to recover any drop in value. Plus factoring in property taxes, loan interest, and realtor fees, even if your home goes up 20%, you might not see any gain (realtor fees = 6%, mortgage interest = 6% PER YEAR on 90% of the property value, property taxes eat up another percent or two per year). Stop and think about that for a moment. If you borrow $200K at 6% per year interest, you are paying $12,000 per year in interest alone, plus another $2000 or so in property taxes. So after 3 years, your $220K home (you put 10% down) has appreciated by 20%, to $264K. Ahhh -- that's $44K in equity, right? But over 3 years, you have also paid $36K in interest, $6K in property taxes, probably $3K in home repairs and maintenance, and you also get socked with 6% realtor fees on the sale price, which sets you back another $16K. So you have gained $28K in equity (plus your original down payment of $20K). Of course the interest you paid would also have been paid in the form of rent if you had decided to rent for those three years, but if you could have rented a comparable apartment, home, or condo for say $200 less per month ($7.2K over 3 years) that the mortgage cost you, and avoided the home owners insurance, property taxes, and repairs ($10K), you would be looking at about a $10K advantage from having purchased vs. renting over those 3 years. But remember the assumption here was a 20% property value increase over those 3 years -- it could also turn out to be 10%, 0%, or minus 10%. If values had just held steady those few years, you'd pay out $13K to a realtor our of your $25K in equity, leaving you with $12K instead of the original $20K you started with, not to mention the fact that you had $10K in additional expenses paid out in taxes, insurance, maintenance, etc. So by owning a home for 3 years instead of renting, you essentially turned your $20K down payment into $2K.Is it better to buy or rent?So as we saw in the examples above, a couple of key factors affect whether you should rent or buy. The main one that is out of your control is whether, and how much, your home will appreciate during the time you own it. If you are planning on buying and staying put more a decade or more, you are probably pretty safe here, although consider your market. Many properties in Texas and other states barely increase year after year -- if you buy somewhere like that, you may end up with little or no appreciation, especially after taking into account inflation. Plus, if areas are around you are appreciating faster than your area, it is highly likely that you will never be able to move to a more expensive state. Secondly, you need to compare how much rentals go for compared to mortgage payments on a similar property. If interest rates are low and you have money for a down payment, you might find that buying a house is actually cheaper than renting. Alternatively, if home prices have skyrocketed, you might find rental prices that are only 70% of how much a mortgage would be. And thirdly your time horizon is a critical part of the equation. Short term, it is often safer to rent than buy. However, to restate our general rule, if you can afford to buy a home, you are almost always better off buying than renting. Buying locks in your monthly home expense for decades (avoid interest only loans and adjustable mortgages -- again, if you can barely afford a home and need these kind of loans, maybe you shouldn't be buying...). Studies by the Federal Reserve Board show that for every income level, home owners as a group have a net worth that is 6 to 25 times higher than renters. So do the math, figure out if you can afford owning a home in the first place, consider what your local real estate market is like, consider how long you will be staying there -- then make the right decision, leaning towards home ownership whenever possible.
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