One of the biggest debates in the world of personal finance is whether it’s best to rent vs. buy a home.
For a long time, homeownership has been widely considered as a mark of adulthood and a major financial milestone.
In recent years, though, the conventional wisdom has been challenged. Millennials saddled with student loan debt are reluctant to take on a commitment as large as a mortgage. On top of that, some of us wonder if buying a home really makes sense with modern lifestyle choices.
I bought a house once. I discovered I like renting better.
But as with all things personal finance, the decision to rent or buy a home depends on your individual situation. If you’re pondering whether or not buying a home is the next natural step in your financial progression, here are some things to think about.
Rent vs. buy: A look at the numbers
We’re told that buying a home is an investment. The common line of thinking goes like this: You purchase a house with a mortgage. Over the years, you pay it off and the home builds equity. Your home will also appreciate in value over time.
Eventually, you’re supposed to have an asset that is worth more than you paid for it — even after you factor in the mortgage interest and other costs associated with homeownership.
Before you get too excited about buying a home as your primary residence, it’s important to consider the factors that go into whether or not you’ll really come out ahead financially.
True costs of homeownership
It’s great to imagine that you could buy a home for $200,000 and sell it in a few decades for $450,000. But are the returns really so amazing?
If you borrow $200,000 today at 3.92% APR, in 30 years you’ll end up paying $140,427 in interest alone. Instead of a $250,000 profit, you’re already down to a profit of $109,573.
But that’s not all. You also have to factor in property taxes and homeowner insurance over the course of 30 years. Don’t forget about costs related to utilities, maintenance, and repairs. What if you decide to remodel or upgrade?
Add all that up over 30 years and that $109,573 profit pretty much disappears. Even if you end up taking a tax deduction for some of the eligible expenses, it’s probably not enough to offset the costs.
We hear stories of amazing appreciation, but that’s mostly in larger, hotter markets. Most of us live in markets that are much less sexy. You’ll be lucky to see home appreciation big enough to overcome 30 years’ worth of costs related to buying and living in your home.
What could you do with the money instead?
When deciding to rent or buy, consider what you could be doing with your money instead. In some cases, the total costs you incur for homeownership annually are larger than what you would pay renting.
What if, instead of buying, you take the money you save each month and invest it?
Whether it’s adding more to your retirement account or paying off high-interest credit card debt faster, you might find a more effective use for your money. I compared the results of owning a home for seven years to my investment portfolio performance after I sold my house.
Owning cost me $300 more per month than renting. Investing that amount for seven years at 6% annualized growth would have resulted in an extra $31,222. Instead, due to market conditions and other life-related factors, I paid $10,000 out of my own pocket to unload that house.
One of the benefits of buying is that your home payment amount to forced savings. Each month, you build equity. The longer you’re in the home, the more equity you build.
For some, this amounts to a good forced savings plan. Later, you can draw on your equity to help pay for large costs. My parents tapped into their home’s equity for a remodeling project. They also used their equity to help manage the costs of helping five kids go to college.
If you stay in your home long enough to pay off the mortgage, you end up with a low-cost place to live. You might need to pay utilities, insurance, and property taxes still, but a big cost — monthly rent — can be avoided. My grandmother derived great comfort and financial stability from the fact that she had nearly two decades to live in a home that was paid off.
You can also benefit if you decide to downsize during retirement. If your home is paid off, when you sell you end up with a nice chunk of capital. You can buy something smaller outright, or do something else with the money.
Just make sure you have other savings mechanisms in place. You can use your home as a forced savings plan in conjunction with tax-advantaged retirement savings and other strategies.
Housing market considerations
Every housing market is different. Conditions in one area might be such that it does make financial sense to buy a home instead of rent. Even with all the costs associated with homeownership, you might still come out ahead.
One handy tool you can use to check your rent vs. buy considerations is from the New York Times. Their calculator takes into account various factors like:
- Cost of your home
- Length of stay
- Mortgage details
- Home price growth rate
- Rent growth rate
- Investment return rate (potential)
- Inflation rate
- Property tax rate
- Your marginal tax rate
- Closing costs
- Maintenance and fees
- Additional renting costs
You can make adjustments to reflect your local area, based on your own data.
After putting all of my information in, I found that I could actually do better buying where I live, assuming my plans to move in five years. The calculator estimates that if I can rent a house similar to what I live in now for $910 or less, I should avoid buying.
My current rent is $995 per month — not a big difference, but the bare numbers say I could gain an edge by buying instead of renting. However, the rent vs. buy conversation isn’t just about the sheer numbers.
I like renting because someone else is responsible for maintenance and repairs, and I can avoid yard work and snow removal. Plus, I like the idea of being able to break a lease and leave whenever I like, rather than dealing with selling the home.
Basically, it’s all about convenience, flexibility, and freedom for me. It’s worth the lost value because my lifestyle trumps the small difference.
However, even if renting makes more sense financially, it can still be worth it to buy.
The security of owning your home can be a major comfort. On top of that, the ability to alter your home however you want can be attractive. Plus, if you know you will stay a long time, owning a home can help you put down roots in the community.
As part of your decision, make sure to consider your lifestyle preferences and what you hope to accomplish with your home. This will help you with the rent vs. buy decision.
What about buying as an investment?
The decision to buy a home as an investment is a completely different animal. When you live in your home, you’re paying all the costs — the asset (your home) isn’t actively providing you with income. That changes when you buy with the intent to rent to someone else.
If you buy a home and plan to live in it for a couple of years before deciding to rent it out, that changes the equation to some degree. As long as you have someone who lives in the house and pays you rent, your costs are covered.
Someone else pays the mortgage and you get the equity. Plus, once the mortgage is paid off, it becomes pure income, minus the costs of keeping up the property. Later, if the home has appreciated enough and you no longer want to maintain it, you can sell at a larger profit.
Should I buy a house or rent?
In the end, only you know whether or not it makes sense to rent or buy a home. Before you move forward, weigh the pros and cons associated with buying and renting.
Think about your financial situation and your lifestyle preferences. Be realistic about your expectations, then do what feels like the right thing for you.