Renting vs. Buying a Home

All of us have probably pondered whether it is better to rent or buy a home. Housing is typically the largest expense on a personal budget, so the decision whether to continue renting or become a homeowner is significant. There are a lot of factors that determine whether it is more beneficial to rent or buy, so it is important to consider them all prior to making any life-altering financial decisions. Purchasing a home is a significant investment that you will likely be paying off for the next 15-30 years.

Expenses of Renting

In general, as a renter, you have far fewer expenses, and your responsibilities are minimal. If the air conditioning stops working, you simply call the landlord, so convenience is a huge pro to renting. However, you are also not investing in real-estate, so everything you pay is an expense, rather than an investment. Despite the convenience, renting is not without its expenses. You will still be responsible for several expenses:

• Application fee/background check
• Security deposit: the security deposit will typically be one month’s rent. If you take good care of the property, you can expect to get most, if not all, of your deposit back after you move out.
• First and last month’s rent may be due immediately upon signing the lease
• Monthly rent
• Renter’s insurance
• Pet deposit and fees
• Utilities (determine what is included and what you are responsible for paying)

Expenses of Buying a Home

As a homeowner, you have many more responsibilities, one of the biggest being maintenance. The cost of repairing an air conditioner or fixing a plumbing issue can be significant. Hopefully, the inspection conducted when you purchase the home identifies the majority of the issues, but you can always expect the unexpected. As appliances and fixtures age, repairs are a necessary and recurring expense. Other expenses associated with buying include:

• Closing costs: both the buyer and seller will pay closing costs. Typically, buyer closing costs are about half of what a seller pays. You can expect to pay around 3% in closing costs as a buyer. This figure will differ depending on the market and your negotiations at closing.
• Down payment: the typical down payment is 20%. While some mortgages allow for a down payment lower than 20%, you will be subject to paying private mortgage insurance (PMI). There are some exceptions that allow for less than 20% down without PMI, such as a Veterans Affairs (VA) loan.
• Mortgage (principal and interest): when you first start paying your mortgage, the majority of your payment is going towards interest. As time goes on, each monthly payment pays more towards the principal and less towards the interest. This is important to note if you do not plan to live in the home long-term. Be sure to look at a mortgage amortization schedule to see the breakdown of interest and principal payments.
• Homeowners insurance
• Property tax
• Homeowners association (HOA) fees
• Property maintenance
• Lawncare (if not included in HOA)
• Utilities: some condos or apartments include certain utilities in the HOA, but if this is not the case, you will be responsible for all the utilities.

Homeowners Association (HOA)

An HOA can offer some convenient benefits like lawn care, exterior maintenance on your building, and a community pool or gym, but the fees can add up over time. Additionally, you can expect the fees to increase possibly every year. While an HOA can ensure your property maintains its value by enforcing rules that ensure the appearance of the homes and neighborhood is maintained, carefully consider the long-term costs of an HOA. You must consider the price you are paying and the value received. For example, if your HOA is $300 per month, do you think the value you receive is worth $300? If you estimate that monthly lawn care will be $100 per month, and you are able to save $100 per month in gym membership fees by using the community gym, then $300 may be reasonable. However, if you are in an apartment with no lawn and you do not use the facilities provided by the HOA, there is less value to you. For condos and apartments, the HOA can sometimes include certain utilities like water or trash pick-up. These are expenses you would incur if the HOA did not cover them, so be sure to take that into consideration.

Rent vs. Buy Decision Factors

Mortgage Interest Rates

Interest rates will significantly impact your monthly mortgage payments and the final amount you pay for your home. For example, at a 7% interest rate, a $300,000 home will cost close to $635,000 if you make the scheduled payments for 30 years. That is $335,000 in interest. Alternatively, the same home at 4% interest will cost $413,000 over 30 years. In this case, a three percentage point reduction in interest resulted in a reduction from $635,000 to $413,000. Granted, these figures do not include property taxes and homeowners insurance, but it highlights the importance of the interest rate.

How to get the best mortgage rate?

Shop around. When looking for the best mortgage rate, you need to shop around. While you may be concerned about how getting your credit checked multiple times by different lenders will influence your score, the good news is that if the inquiries are made within the same 45-day period, they will count as one credit check, so just make sure you get all your credit pulls done within a short time period. Even a small change in the interest rate results in significant savings, so do your due diligence and find a good rate. Another option is to utilize a mortgage broker who will shop around for the best rate. However, the added convenience of having a mortgage broker is going to cost you a fee/commission.

How long will you live there?

One of the biggest considerations on whether to buy a home is how long you plan to live there. In general, if you do not plan to be there for 5 years or more, then renting is usually the best choice. This is largely due to closing costs. When you purchase the home, you are likely going to pay around 3% in closing costs, and when you sell the home, that figure will typically be closer to 7%. These figures can vary depending on negotiations at closing, but if you buy and sell within a short period of time, these added costs are substantial. For example, if you purchase a home for $300,000, assuming the buyer closing costs are 3%, you will pay $9,000 in closing costs. If you then sell the home three years later for $337,500 (assuming an annual appreciation rate of 4%), then 7% closing costs equals $23,625. Even though your home value increased $37,500 over 3 years, your combined closing costs from the purchase and sale were $32,625, leaving only $4,875 more than what you initially paid. While that may look like profit, you then have to consider the property taxes and homeowners insurance paid over those 36 months, and you likely lost money. Granted, if you had rented the whole time, you would not have anything to show for that money either.

As you can see, as you near 5 years of ownership, buying starts to become a lot more attractive, so if you plan to stay in your home long-term, then you should definitely run the numbers to determine if buying makes sense for you. One of the biggest pros of buying is that you are investing in real property. Over time, you can expect the land value and home value to appreciate. That being said, do not blindly purchase any home anticipating it to appreciate. You must understand the market.

Is it a renter friendly market?

The 5-year rule will not always hold true. In some cases, if rental rates are continuously increasing, then you may consider buying in order to avoid being subject to the market fluctuations and constant rent hikes. While some states restrict the amount landlords can increase rent through rent control laws, other states have no such restrictions in place, meaning there is no limit to the increase your landlord can impose. Thus, if rent prices are unreasonable, then buying could make sense.

Do you have a pet breed that is prohibited by landlords?

If you own one of the breeds commonly prohibited by landlords, then you are aware of the difficulty with finding a rental property that allows Rottweilers, Pit Bulls, German Shepherds, and other large breeds. These restrictions are more common among apartment and condominium complexes, so you may be able to find a single-family home from an individual that allows these breeds, but that is not always the case. If you cannot find a rental property that allows your dog, then you will be faced with two difficult choices – either get rid of your dog (probably not an option you want to consider) or buy a home. If you choose to keep your pet and buy because it is your only option, then you may end up taking a loss on the home, if you are only there for a short period of time, but at least you went into the decision knowing what to expect.

Location, Location, Location

Another important consideration when renting or purchasing is the location. If you want to ensure your children are enrolled in a particular school district, or you want to be close to work, that may limit your options. It is possible that the area you want to be in is outside of your purchase budget, making renting the only option. Again, the key is to understand your market. Even if you do not have any children, you must consider the school district when purchasing, as it will influence the price you can ask if you sell the property, or it can make the property more appealing if you decide to rent it and become a landlord.

Conclusion

Buying a home is a complicated decision. There is no standardized criteria that can make the decision for you; however, the factors discussed will help you make the most informed decision that is best for your family and coincides with your financial goals. Do your research, shop around, and understand the pros and cons of renting versus buying.