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Many young adults consider homeownership to be the next step in life. While there are many potential benefits to buying a home, there are also lots of reasons that you shouldn’t buy a home. In this deep dive on homeownership, I am going to walk through the pros & cons of renting vs. buying so that you can make the best decision for your financial life.
The Math: Renting vs. Buying Pros & Cons
While I will get to some of the qualitative considerations a bit later, let’s first consider the math of renting vs. buying.
Let me start by making a bold statement: a home is not an investment. Let me repeat that. A home is not an investment.
Before the Global Financial Crisis, many believed they should buy a home because it will always go up in value. If the GFC taught us anything, it’s that this simply isn’t the case.
You might argue that home prices in many areas have recovered since the financial crisis. And that’s a fair point. But I can assure you that home prices have not returned to 2008 levels in some places. How do I know? Because I live in one such area (lucky me).
That said, when evaluating the purchase of a home, you must do some math to determine whether renting or buying makes the most sense.
How to Do the Math
If you want to do the complete math yourself, here are some things to think about as you compare renting vs. buying pros & cons.
Costs of Buying a House:
- Down Payment
- Closing Costs at Purchase
- Closing Costs at Sale
- Mortgage Payment (minus tax deductions)
- Property Taxes (minus tax deductions)
- Homeowner’s Insurance
- Capital Expenditures (appliances, heating/cooling systems, etc.)
- HOA Dues (if applicable)
- Special Assessments (if applicable)
Costs of Renting a House:
- Security Deposits
- Parking/Amenity Fees
- Pet Rent (if applicable)
- Renter’s Insurance
Of course, because I am a finance guru, I use an Excel model I built to evaluate these two alternatives (and customized it for things like my tax situation, etc.). However, for most of you, a simple rent vs. buy calculator should do the trick. Nerdwallet has a great calculator you can use for this purpose.
How Much Does It Cost to Own a Home?
Next, make sure you understand what it truly costs to own a home. Let’s quickly walk through each of the homeownership costs identified above, starting with acquisition/sale costs.
The first step in buying a home is to save for the down payment. Aim to put aside 20% of the purchase price towards the down payment.
Closing Costs at Purchase
In addition to the down payment, expect to pay ~ 3% of the home value in closing costs. So, on a $200,000 house, closing costs are likely in the $6,000 range. Of course, this varies by region, lender, etc.
Closing Costs at Sale
In most areas, it is customary that the seller pays both the buyer’s and seller’s realtor when a property is sold. While this varies by region, you can typically bank on about a 6% total commission when you sell a property.
So, if, for example, you buy a $200,000 house and sell it five years from now (assuming no appreciation), you’ll have to pay $12,000 in closing costs when you sell.
Before I get to the ongoing maintenance costs, pause here, and make sure you understand this. The math is not as simple as “is the mortgage payment less or more than I’d pay in rent.” You can expect to pay 9% of the home’s value (or more) just in transaction costs at the front and back end. On a $200,000 house, this is $18,000 down the drain. I cannot overemphasize this – transaction costs add up.
Next, let’s get into the ongoing costs of homeownership.
Mortgage Payment (minus tax deductions)
To calculate the mortgage payment on a prospective property, use a simple calculator.
Now, while I am by no means a tax expert, there are typically tax deductions for mortgage interest. However, it is also possible that you will not be able to benefit from these deductions. One reason is that the standard deduction was recently increased. So, if you do not itemize on your taxes (or plan to after purchasing a home), you will not benefit from the mortgage interest deduction.
Talk to your tax professional about the mortgage interest deduction and how much it might save you.
Property Taxes (minus tax deductions)
As part of your due diligence process in assessing a home purchase, be sure to evaluate what property taxes will cost. Property tax estimates are generally available online through Zillow. Still, it may not hurt to check with the local tax assessor’s office, as that’s going to be the most up-to-date information.
Again, you may be able to deduct property taxes (as it falls in the state and local tax bucket), but new caps on state and local tax deductions may limit your deduction. Again, check with your tax professional on this particular point.
Next, know that homeowner’s insurance costs more than renter’s insurance. A lot more.
Call your insurance agent to find out what this might cost.
Maintenance & Capital Expenditures
One high cost most people underestimate is the cost of maintenance on a home. Yes, there is the basic stuff like having your air conditioner serviced, but there are also costs associated with longer-term components of the house. You must replace the roof every so often. Furnaces only last so long. Ovens don’t work forever.
Most major mechanical systems in a house have a limited life. While it depends on many factors (the age of your home, how recently mechanical systems were replaced, etc.), a good rule of thumb is to plan for 1% of the home’s value per year for repairs, maintenance, and capital expenditures.
So, for example, if you are buying a $200,000 house, plan for $2,000 per year in maintenance.
The cost of the major mechanical systems, even if they only need to be replaced every 10-15 years, is high.
Finally, be sure you check out any other potential costs associated with owning a home. Additional costs could be HOA dues, special community assessments, etc.
When I decided on whether I was going to rent or buy, I ran this analysis with the best assumptions I could develop at the time. And in retrospect, while my assumptions were sound, the world hasn’t played out as I’ve expected, and I candidly probably would have been better off renting.
Doing the financial analysis of renting vs. buying is great, but it isn’t the only consideration. You must also consider the qualitative factors associated with buying a house.
Are You Ready to Buy a House?
One primary consideration in deciding whether to buy a house is whether you are financially and emotionally ready. A few things to think about include:
- Do you have a substantial emergency fund? If not, build one before you consider buying a house. Be prepared for expenses like an air conditioner breaking down and spending $5,000 for a new one.
- Do you have any other high-interest rate debt? If you do, pay it down before considering buying a house.
- Can you commit to staying in one place long enough to justify a purchase? I’ll talk more about this in a minute.
Also, think about the emotional benefits of wanting to buy a house. A few of them include settling down, having a place to call your own, etc.
Do the math and see if that works out – if it doesn’t favor buying, consider if the emotional benefits of buying and decide for yourself if that outweighs the added cost.
How Long Do You Need to Stay if you Buy?
One common question that comes up is how long you need to stay in a house for it to make sense to buy instead of rent. While this depends on the numbers, a good rule of thumb is that if you don’t plan to stay at least five years, you should probably rent instead of buy.
If you stay less than that, you’ll be throwing away a ton of money on closing costs and other expenses.
Finally, many people say that if they decide to move earlier, they’ll just turn the property into a rental. I know, because this is what I said. While I still live in the home I purchased, there is something I’ve learned in the time since I bought it: it would make a terrible rental property. The numbers just wouldn’t justify keeping it. If this is your game plan, make sure your property would work as both a primary residence or a rental, because most properties simply won’t.
Is Buying Cheaper than Renting?
Some people ask whether buying a home is cheaper than renting.
In a nutshell, my answer is sometimes. But not always.
The only way to know for sure is to do the math (as outlined above).
Is Renting a Waste of Money?
Another common question is whether renting is a waste of money. Many argue that you could be building equity in your own home rather than building someone else’s equity.
While that is true, there are also plenty of ways to throw away money when owning a home, such as buying then selling two years later, paying thousands of dollars in closing costs along the way.
Also, bear in mind that “owning” actually comes with quite a few costs that aren’t equity. Out of my total housing costs (mortgage, tax, HOA dues, maintenance), only about 20-25% of what I pay is building equity. In other words, 80% of my monthly payments go to banks (mortgage interest), the government (property taxes), HOA dues, and maintenance.
I’ve gone through a lot of detail and hopefully given you a lot to think about in deciding to rent vs. buy. Here is a quick recap of what I’ve covered and a few other considerations when seeking to understand renting vs. buying pros & cons.
Renting vs. Buying Pros & Cons: Renting
- Ability to move on relatively short notice (i.e., not tied to one location)
- Maintenance costs are fully covered as part of your rent and often easy to address quickly
- No risk that property value may decline
- Lower insurance costs
- Rent is likely to increase, while a mortgage payment (typically) stays constant (though other expenses like property taxes are subject to inflation)
- Can’t make the place your own
- No tax benefits
Renting vs. Buying Pros & Cons: Buying
- Potential appreciation
- Potential tax benefits
- Can renovate the home and make it your own
- Predictability of housing costs (at least your mortgage payment, usually)
- Pride of ownership
- A significant number of potential expenses (including those which are “unexpected”)
- High transaction costs at purchase and sale
- Higher insurance costs
- You are responsible for dealing with all maintenance issues
Renting vs. Buying Pros & Cons: The Right Answer for You
Summing up these renting vs. buying pros & cons, there is a lot to consider. The right answer is ultimately different for everybody.
There are quantitative as well as qualitative considerations when trying to decide whether to rent or purchase your next home. While I usually live by the numbers, the emotional factors cannot be ignored.
Just because many people choose to buy a home doesn’t mean you need to. I own my home, and I am glad I do, but I fully accept it may not be the “economic optimum.”
If you’ve decided that buying a house is the right choice for you, be sure to check out our guide on How to Buy a House.
Is there anything else I missed in considering renting vs. buying pros & cons? Let me know in the post comments below.