DECIDING TO RENT OR BUY
If your friends are all buying homes these days, you’re probably feeling pressured to do the same. Homeownership is supposed to be a sound investment, your parents are telling you. But, what else should you know before taking the plunge?
Before we talk about the pros and cons of being a homeowner, there are some things to should consider before making such a huge commitment:
Timing: If you are planning on leaving your job or are likely to move in the next 8 – 10 years, now might not be the wisest time for you to buy a home.
Down payment : Lenders usually require a down payment of about 20% of the home’s purchase price before they would consider offering you financing.
Costs in addition to your mortgage: You need to be prepared for additional costs that would include property taxes, upkeep, repairs and general maintenance. In some areas there are Home Owners Associations that require monthly HOA dues. When you rent you are not responsible for these costs, which can certainly add up.
Buying vs. Renting a Home
Whatever advantages or disadvantages there are of buying a home depend a great deal on your values and objectives. There are significant differences between being a homeowner and a tenant. Your age, priorities, goals and lifestyle are all factors in whether you should buy a home or continue renting.
Advantages of Buying
Watching Your Equity Grow
When you make your monthly mortgage payment, part of it goes to paying down the interest on the loan and the rest of it pays down the balance owing on the loan. This means that with each payment, the equity value in your home increases little by little. The value of your home minus the balance owed on your mortgage increases.
If the prices of homes in your area remain stable, building up your equity is like having money in a savings account. Let’s say you pay $300,000 for a home, which would likely cost you $60,000 at the time you close escrow. If you stay in your home for 30 years, making payments, before selling it, you would end up with $300,000 (minus fees). Because home values have historically gone up over time, your equity value is likely to be more.
Fixed Monthly Payment
If you get a fixed-rate home mortgage (will discuss this later), your monthly mortgage payment will never go up. But, rent or monthly lease payments are subject to increases depending on the demand for rental units in your area, inflation and at the whims or your landlord.
Homeowners are allowed to deduct their property taxes and interest paid on their mortgage on their tax returns. Let’s say you pay the bank $15,000 in interest plus pay property taxes of $5,000; your taxable income could be lowered by $20,000! If your tax bracket is 25%, your deductions could mean a savings of $5,000.
Additionally, if you divide the $5,000 you saved in taxes by 12, you get about $417 that you are saving every month. Therefore, if you were choosing between two homes that were identical, one that rents for $2,000 a month and one you could buy for a $2,000 monthly payment on the mortgage, you would be better off buying since doing so would actually save you $417 a month. You would still have to consider whether you had the needed down payment and the cost of upkeep and maintenance for your home.
You Could Always Rent Your Home Out
When you own a home, you can always decide to keep it as rental property in order to make money. This would work best if the rents in the area were higher than your mortgage payment would be. The rent you get should cover not only your mortgage, but also property taxes and maintenance expenses that are likely to come up.
Freedom to Decorate and Remodel
If you own the home you’re living in, you are free to decorate and remodel it to fit your tastes. Local laws and rules set down by homeowners’ associations would have to be complied with, especially on the exterior, but otherwise you can do what you want. You can redecorate or remodel the interiors, apply paint or wallpaper to the walls, landscape the front and backyards, all according to your preferences.
Disadvantages of Buying
Puts Limits on Your Mobility
There is a lot more involved in selling a house than in selling other investments, like stocks and bonds. If you need to relocate to accept a job in another city or state, it might take you some time to sell your home, especially if you want to get a good price.
Whatever You Break, You Pay to Fix
Once you’re a homeowner, you’re the one responsible for paying for maintenance and repairs, unless it’s something covered by your insurance. Therefore, the real cost is a lot more than your mortgage payment. If you need a new refrigerator, it would cost you at least $700. If your water heater goes out, there’s another $2,000. You might need to replace the windows one day, and that could cost you maybe $7,000. Are you getting the picture? These are the types of things that you need to be financially prepared for when buying a home.
Property Taxes Will Rise
In addition to paying your monthly mortgage, you will have to pay your property taxes, and these go up over time. As time goes on these increases could affect how affordable it is for you. The cost of property taxes and their likely increases must be considered when you compare the costs of buying a home vs. renting.
Homes Can Decrease Value
Prior to the financial crises of 2008, it was assumed that home values steadily rise. However, if you purchased a home in 2006 or 2007, you learned a hard lesson very quickly, and the lesson is that no one can guarantee that the value of any home will increase over time.
Coming Up With a Down Payment
The hardest part for first time homebuyers is scraping together the 20% down payment. Whatever money you can save up, if you use it all for your down payment, you won’t have that same financial cushion to help out in an emergency. There are ways of getting around such a large down payment (some only put down 3%), but these options will certainly cost you more in the long run.
Advantages of Continuing to Rent
You are Under No Obligation to Pay for Upkeep
The landlord is responsible for “normal wear and tear” on a rental unit or house. If the plumbing gets clogged up, you are not billed. If a tree falls and damages the roof, the owner has to pay to have it repaired.
You Have the Freedom to Move
If you really don’t see yourself remaining in the same general area for the next five years at least, then you should probably continue to rent. If you are not yet settled in a job or career path, you should try to remain mobile. Trying to sell a house in a hurry is a lot more difficult and expensive than finding someone to sublet a rental.
Moreover, the world is becoming more interconnected every day it seems. This gives people an opportunity to work from home, wherever that might be. Many people love traveling and actually living in different countries so they can experience other cultures. If this is the lifestyle you want to lead, it makes little sense for you to own a home right now.
Disadvantages of Renting
Your Rent Can Go Up
Rents in any given area are driven by supply and demand as well as inflation. Throughout much of the U.S., rents are rising and in some cities, they are at all-time highs. When it’s time to renew your lease, you will likely find that your rent is going up. It is likely that over time your rent could go up so significantly that it would exceed what it would cost for you to own the same property.
You’re Not Building Any Equity
Renters are not in a position to build any equity in the property they’re renting. Whatever money you are paying in rent is gone for good. However, if you buy a home, a portion of your monthly mortgage payment goes towards reducing the principal on the loan. The longer you make your mortgage payments, the more equity you are building up in your home. It’s an investment that grows over time.
Renters Receive No Tax Breaks
When you pay rent you are not allowed to deduct any portion of it from your taxes like homeowners do when they deduct the interest they’ve paid on their mortgage.
You Don’t Have the Freedom to Redecorate or Remodel
If you want to make any changes you would need to get permission from your landlord. Most allow tenants to paint, but you would still have to get it approved. If you want to replace your carpet, any appliances or fixtures, you would definitely have to work it out with your landlord.
How To Calculate Whether to Buy or Rent
Whether you buy or continue renting is not just a financial decision. Of course, this involves a lot of numbers, but it’s hard putting a price on some aspects of homeownership. For example, let’s say you want to live where the have the best schools, a community with beautiful parks and in looking around the homes for rent do not compare at all to the homes for sale. Can you put a value on having your kids attend the best school around? What value can you put on the quality of life possible in a beautiful home when the rentals simply do not measure up?
This is why it is not what you can call an “exact science.” However, there are online tools that can help you compare costs: the potential costs of owning vs. renting a comparable home. You can find a great tool through the New York Times that will go a long way in helping you picture the various components that are relevant to your decision. This tool also provides a monthly price that should be considered in deciding whether to buy or rent. Although, it may not include everything, it has proven to be among the best.