Kelly writes in:
“Sometimes you encourage people to rent instead of buying a home ASAP. This seems like a giant waste of money to me. Renting doesn’t build equity or help with taxes.”
When it comes to housing, I do not believe that either renting or buying living space is the right answer for people all of the time. I know that there are a few zealots on both sides of the coin (and perhaps a few more zealots in favor of homebuying than renting), but neither is an absolute winner.
There are a lot of factors to consider when making housing decisions. Some of those factors favor homebuying. Some favor renting. Some factors depend entirely on the situation you’re currently in as well. Let’s run through some of these factors.
Rent versus mortgage payments Assuming you’re getting a mortgage that’s worth somewhere around 80% (or more) of your home’s value, it’s likely that your monthly mortgage payment will be significantly higher than what your monthly rent would be in an equivalent home. The exact amounts vary wildly depending on your location, which is one big reason why I can never absolutely be in favor of one side or another.
When you make a mortgage payment, you’re actually paying two separate things: one portion goes toward the interest on your mortgage (which essentially means it disappears), while the other part goes toward paying down the balance of your mortgage. When you pay rent, all of it disappears into the pocket of the landlord.
So, the real comparison here is between the interest paid on the mortgage versus the rent paid. In both cases, that money essentially vanishes. Typically, throughout most of a large mortgage, the amount of interest paid exceeds the amount that would have been used for rent.
However, mortgage interest is tax deductible, but that requires you to forego the standard deduction on your taxes, meaning that, in general, you’re only recouping a small fraction of that mortgage interest.
Insurance Rental insurance is significantly less expensive than homeowners insurance. Both provide similar protections – they make sure that in the event of catastrophe, you retain the value of your possessions – but homeowners insurance also insures the value of the home and many other things.
Other expenses Again, renters have a significant advantage here as many of the expenses of home ownership are foisted on the landlord. If you’re a home owner, for example, and an appliance breaks, it’s up to you to repair it. Often, in rental situations, if an appliance breaks, you simply call the landlord.
Property taxes Homeowners have to pay these. Renters do not.
Equity Here’s where home ownership does something that renting cannot do. When you purchase a home, you’re purchasing an asset that will either go up or down in value. Generally, it will go up in value, provided you take care of the home and you’re not in an unstable area.
Taking all of these factors together, it’s easy to see how there’s not a simple answer to this question.
If you’re in a situation where housing prices aren’t rising much at all, you don’t have a down payment saved, and rental rates are far lower than monthly mortgage payments, it makes sense to rent.
If you’re in a situation where the housing market is relatively hot, you have enough in the bank to make a down payment, and rental rates are inflated due to an influx of workers in recent times, it makes sense to buy.
Most situations are somewhere in between these two extremes and figuring out whether renting or home ownership is right for you isn’t always easy.
Here are five questions I’d ask before considering buying a home.
What is the recent history of property values in the area I’m looking at? Has the area been rising in value? Holding steady? Dropping? To make home ownership worth it, your home will need to at least retain its value.
Do I have a down payment adequate enough to get the lowest possible mortgage interest? Home ownership becomes a failing proposition if you borrow more than the usual 80% and are locked into a higher-interest mortgage or a high interest second mortgage.
Do I have a strong enough credit history to get the lowest possible mortgage interest? A quick check of your credit history will give you a good idea here. If you see late payments and delinquincies, then you need to clean things up before pursuing home ownership.
Do I already have an emergency fund? If you buy a house without an emergency fund in hand, you’re almost begging for disaster when a major appliance fails or something else happens to your home. Homes aren’t invincible.
Am I actually spending significantly less than what I bring in? If you’re barely keeping your head above water, owning a home won’t magically make you more responsible. It just raises the water level and gives you more room to drown. Get your own monthly financial routine in order first.
If you find yourself saying “no” more than once to these questions, then renting is the better option for you.
Renting isn’t a throwaway. For many people in many situations, it’s a better financial choice than owning a home.