Renting Versus Buying: Are There Situations Where Renting Clearly Wins?

Recently, several readers have contacted me arguing quite forcefully that renting gets a bad reputation and that in many cases renting is actually a better deal than buying a home.

In order to break down this argument, I defined three distinct cases: rent exceeds total monthly mortgage payments, rent exceeds the interest portion of total monthly mortgage payments, and rent is lower than the interest portion of total monthly mortgage payments.

Of course, I am defining a “mortgage payment” as the payment one would make on an acceptable home given whatever amount one currently has saved for a down payment.

Let’s look at each case.

Rent exceeds monthly mortgage payment. You’re actively choosing to throw away equity here, so this is pretty clearly a poor deal. If you are paying more in rent each month than you would be paying in a house payment, there’s pretty much no reason for you not to buy immediately, as you clearly are in a financial state where you can afford to buy. Many people are in this area, but their idea of an “acceptable” house is higher than it needs to be in order to justify not making a move.

Rent exceeds interest portion of a monthly mortgage payment. I usually define the “interest portion” as being what you will be paying for interest five years after the start of the mortgage rather than simply looking at the first payment, because with each on-time payment, you pay less interest and more principal. This is the gray area, in my opinion, where you have to look at several additional factors: are there any utilities covered in your rent? How much will utilities go up when you move? Will there be a large increase in maintenance time at a home versus an apartment? If the total cost of ownership of a home added to the interest exceeds the rent you’re paying, then it is justifiable to rent instead of owning if you’re putting some away each month for a large down payment or into a strong investment.

Rent is less than the interest portion of a monthly mortgage payment. In most areas, this is only true if you have almost nothing saved for a down payment, in which case you should be renting and putting a significant amount away each month towards a down payment. Once you have a large enough down payment to bump you up into the “rent exceeds interest portion,” you should recalculate things.

The biggest key here is understanding what you plan to buy and knowing what it will cost. This involves learning about the housing market in your area, defining what you want to move into as a first home (remember, once that is paid off, you can definitely upgrade), and knowing what that will cost and what the payments will be. Once you know these things, it’s easy to compare the payments and figure out exactly where you are and where you want to be.

It is also vitally important to note that all arguments in favor of renting assume that you’re investing the extra money and not merely spending it. If you’re racking up credit card bills and have a stellar wardrobe, but live in a tiny apartment and have no real hope of owning a home any time soon even though it is a dream of yours, it may be time to reevaluate your life situation.

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  1. Sarah says:

    If you are paying more in rent each month than you would be paying in a house payment, there’s pretty much no reason for you not to buy immediately, as you clearly are in a financial state where you can afford to buy.

    Well, there is a very good reason for people who live in large urban areas: down payment.

    A small 1-bedroom just about anywhere in Manhattan will easily run you $500K. Co-ops generally require 20% down payment (no financing). As you can see, that’s $100K you need up front just in down payment, which is not exactly an easy sum to accumulate. It’s an insane market.

  2. eR0CK says:

    “Many people are in this area, but their idea of an “acceptable” house is higher than it needs to be in order to justify not making a move.”

    I’m in this camp. My rent is in-line with the cheapest condo’s in my area. The problem is that many of these condo’s that are in my price range aren’t in the best area and don’t have much space … leaves much to be desired.

    I’ve decided to wait and see what the future brings.

  3. Amy says:

    I think my situation is an example of when renting is a better option than buying. We live in coastal southern California. We rent a modest 800 square foot house from my uncle; it’s is in a relatively inexpensive neighborhood.

    If we purchased this (not extravagant) house, or a similar one, our mortgage payment and property taxes would be *triple* our current rent. (Plus, we would need a very large down payment.) In addition, the houses here are old and need a lot of maintenance (like re-wiring).

    This rent/mortage imbalance is pretty typical in this area. We know there’s a risk of rents increasing, but for now that isn’t likely.

    We moved here knowing exactly what the real estate market is like, but to us it’s worth it to gain the lifestyle we wanted. We hope we’ll someday own a house, but we just don’t see real estate as a good investment for us right now. I think we’re probably better off funding our retirement plans.

  4. Lana says:

    I think you’re overlooking a few simple points.

    One, as a single woman in her early 20s, I’m one year into my first “real” job and getting my finances in order for my adult life. My rent includes all utilities, and if something breaks, I don’t have to pay out of pocket to have it fixed. Paying a flat rate every months allows me to work with my budget as I set aside an emergency fund and pay down debts.

    Two, for the same reason as above, renting affords me flexibility — if I decide to move, if I get married, if I lose my job, all I have to worry about is the terms of my lease rather than a mortgage and a house on a shaky market.

  5. John says:

    I have begun looking and have decided to make the leap up to 2 family or 3 family and use the rental units to help with the mortgage.

    Not sure if it is the best call but if one is either going to rent or live in a condo 2/rds the size of what they are renting is it really worth it?

  6. John says:

    Sorry and as to region I am in Boston and the pricing is almost as nuts here as in Manhattan. And I have a requirement to live within a close walking distance of the mass transit system (the T) so I don’t have to add on car payments and what not.

  7. Tony Corwin says:

    Don’t forget about property taxes, which are high in New Hampshire. I don’t have to deal with the additional cost when I am renting.

  8. Amy says:

    Yeah…I live in Manhattan with my boyfriend, and frankly this post was pretty funny. Assuming we could scrape together a 20% down payment, the mortgage plus the maintenance on our current apartment would be just about double what we currently pay in rent. And that down payment? About the size of our combined yearly income.

  9. Jerry says:

    You’re forgetting the intangibles as well, which will have different values to different people. These are things like not hearing your neighbors procreating every night, not having the people upstairs sound like they have a bowling alley, and not having to deal with bass notes from the party next door.

    You also didn’t mention the rent to own scenario.

  10. Matt says:

    Another factor to think about is how long you plan to be living there. If there is a probablility of some relocation in the next 2-3 years, then it can be risky to purchase due to fluctuations in housing prices..

  11. Nathan says:

    I think renting generally gets the short end because when people try to estimate numbers, they don’t actually include everything necessarily involved in purchasing a house. Much like the some above, I live in a major metropolitan area (Chicago) and the prices to buy are outrageous. I am a renter, and my rental of about $900 a month would cost almost $230,000 to buy. I was interested in researching the market a few months ago, so I ran the numbers.

    For the condo numbers, I included the average association dues and property tax per year. And then I also added rental/property insurance and standard utilities for both the rental and condo monthly payments. The monthly numbers ended at roughly $2100 a month for the condo and 1200 a month for the rental. The first thing I noticed was that there is no way I can afford $2100 a month. It was out of the question, and for comparable properties, the difference was outrageous. But I went along with the experiment assuming I could afford it, and would invest the difference.

    I ran with the assumption that I’d also be living in each property for only 5 years, and after that I would sell the property/end my rental lease. I assumed that the $20,000 down payment and closing costs were invested, and then the $890 difference I saved every month was added to that. I didn’t go overly ambitious assuming an 8% return, so at the end of my 5 years I’ve got almost $105,000 that I would not have had if I bought. My total cost of housing (rent, utilities, insurance) for the 5 years was also about $70,000. So bottom line was, I paid $70k to live, and I’ve got $105k in liquid assets.

    The condo on the other hand, including closing costs and down payment, I had put about $150k into during the same 5 years. I also still had about $195k left on the mortgage to pay off. That’s telling me that I’d need to sell the place for about $445,000 to end up with the same amount of liquid asset at the end of the 5 year mark. With the housing market forecast, and the general feeling I get, I highly doubt I’m going to be able to sell a $230,000 condo today for $445,000 in just 5 years time.

    Obviously I’m operating under some pretty strict assumptions, but I believe my case is not that uncommon. The market conditions aren’t entirely specific to my area, and the 5 year move is probably not uncommon either. Everyone has a different situation and would need to run the numbers themselves, but with some give in both directions, it’s pretty clear that renting can be much more of an investment opportunity than home equity is, and that isn’t commonly discussed.

  12. Gabe says:

    Not all of us are in the most ideal situation to buy a home – hence we rent.

    You’re apparently not accounting for those who live in expensive urban and suburban areas where putting together a decent down payment is a challenge. Not to mention the fact that the mortage and property tax payments will likely be higher than what we’re paying in rent.

    Oh and I didn’t mention a scenario where you’re trying to rebuild your credit just so you could maybe have the hope of qualifying for a home loan that won’t blow your budget to smithereens.

    It’s not always as easy as you make it seem, Trent. I’m sure if I lived in Iowa I might have an easier time getting my act together to buy a home. But my career and family obligations keep me renting in the big city for the time being.

  13. Jim Lippard says:

    Einzige did some similar calculations, with specifics for the current Phoenix market, here. At the moment, you’re much better off renting in Phoenix.

  14. Ian says:

    “In most areas, this is only true if you have almost nothing saved for a down payment”

    That might be true, if you don’t bother to consider population. To anyone who lives in New York, California, Florida, and any big city along a coast (you know, where 70% of Americans live), the suggestion is laughable.

    I notice that the basic assumptions of the article are biased toward home ownership: No mention of property tax, home maintenance, transaction costs, etc. All of that can make a difference that you might not see just by looking at the mortgage payment.

  15. Trent Trent says:

    Actually, I am accounting for the situation where you’re living in an expensive situation. I’m not sure what you’re saying, to tell the truth; the same rules apply no matter how much homes cost in your area. If you have a rent that’s lower than the interest on your prospective home loan, you shouldn’t be buying yet, but if you have a rent that’s higher than the total monthly payment, then you should look seriously at buying. It does not matter what the amounts are.

  16. !wanda says:

    Trent, the point that you’re asserting, that your post covered the situation in large, expensive cities, is true. However, the posters are objecting to your statement one should be saving a lot each month *for a down payment*. In cities with prohibitively large down payments, perhaps it would be better just to invest the money for the long term to fulfill other goals.

  17. I can make a solid case for renting in Silicon Valley (where I am). My two-bedroom, 1.5 bath, 1100 sq. foot place is $1900 a month to rent. I’ve looked through a lot of real estate magazines and the equivalent is around $700K.

    That means that I have to come up with $140K. Assuming that’s not a problem, it looks like my payment (with great credit and that 20% down) would be $3448.02 a month. Interest is around $2916.67 to start and $2766.19 in year 5 according to the amort. charts. It’s hard for me to make an argument for buying in my area.

    Typically, I’m right there with buying, but in some markets it just doesn’t seem to add up.

  18. Trent Trent says:

    That’s a different subject entirely, though. I would agree that if you’re paying rent that’s WAY below any sort of cost, then a down payment in your current area may not be a realistic goal, but that’s also true here, with people working low-wage jobs and living in apartments that are about $150 a month (yes, in rural Iowa, these exist). It’s the same situation, just about 8x lower in every regard.

  19. js says:

    I think bottom line is some people just can’t afford to buy period. Rent in Los Angeles takes 29% of my income already and housing would be significantly more. There comes a certain point where you just can’t afford it.

    Although there are those that would say that anyone can afford housing: just get your ARM, negative amortization, no money down loan here. And frankly that is the only way many people are buying the houses out there. But I think that jig is just about up.

    Also most people I know that own housing are driving an hour and often more to and from work each day. I’m not.

  20. plonkee says:

    Trent:
    I think you’re right. If renting is cheaper that is the better option financially and if buying is cheaper that is the better option financially. It all depends on a good definition of cheaper (which you’ve probably got).

    I’m going to run through my figures later.

  21. Citoahc says:

    Trent,

    While this applies if you are going to be in the house for the long term things can change dramatically if you are only going to be there short term. If you are going to be in an area for less than two years and don’t intend to turn the place into an investment property you have to add all the associated costs (closing, higher insurance…) and the extra time you will have to spend selling the place. 2k in closing costs spread over two years is and extra 80 a month. Home owners insurance would cost about a hundred dollars a month more than my current renters. That is almost 200 more per month.

  22. Gabe says:

    “I’m not sure what you’re saying, to tell the truth;”

    Now that I’m re-reading my comment, I’m not sure what I’m trying to say either. I think I was just venting my frustrations over my current situation. Sorry about that.

  23. Ian says:

    “Actually, I am accounting for the situation where you’re living in an expensive situation. I’m not sure what you’re saying, to tell the truth; the same rules apply no matter how much homes cost in your area.”

    If this was directed at my first comment, I meant to point out that your three categories are misleading. Rent is cheaper than a mortgage payment for the vast majority of people. In many high population areas, renting is cheaper by a factor of 2 or more.

    The claim that renting is generally only cheaper than buying “if you have almost nothing saved for a down payment” (which I quoted in the first comment) is simply false for the majority of people right now. Furthermore, it doesn’t consider the lost opportunity cost of the down payment. Even if I had $200K saved up for a down payment (I actually only have about $30K), I might not get as good a return in a house as I do in other investments.

  24. Trent Trent says:

    In areas where housing costs are really high, “not much saved for a down payment” can mean a seemingly big pile of money.

  25. Jesse says:

    Hi. Good stuff.
    Looks like I might be a bit late to the party, but here goes…

    This question taps into some strongly held cultural currents in the U.S., and the truth often has difficulty emerging. This is due in large part to the complexity that surrounds home purchase decisions. By comparison renting is the height of simplicity: it costs you “X” per month. End of analysis.

    It can be worth keeping in mind that there are many interested voices in our economy arguing the benefits of ownership, while very few stand to profit from your decision not to buy. The only person I’ve been able to find – in my whole life (36 years) – to argue against me buying a home is my fee-only financial planner, who is paid strictly on an hourly basis for his advice. You’re unlikely to get a fully-informed, balanced view from anyone even remotely connected to the real estate economy, nor from current homeowners, who obviously have their own reasons for believing certain things. Just something to think about, along the way.

    There was a feature in the Wall Street Journal lately by David Crook (who wrote the “Complete Real-Estate Investing Guidebook” – recommended) titled “Your Home Isn’t the Investment You Think It Is” – published 3/12/07
    Here’s just a small excerpt:

    “…houses have become substitute credit cards, as profligate owners borrow their equity to finance everything from cars to vacations. Among thriftier owners, the equity they have built up in the family home has become a vital part of retirement planning — a “fourth leg” of the now-unstable “company pension/personal savings/Social Security” stool that was long the model for a financially secure old age.

    “Unfortunately for both groups, however, houses are not very good investments. For the grasshoppers, there’s nothing quite as stupid as paying off your 2002 trip to Orlando in 2032, when you finally settle up your refinanced “cash out” 30-year mortgage. And for the ants, economic studies have demonstrated over and over that houses (1) cost more than most people make when they sell and (2) rarely match the long-term returns of stocks or other investments.

    “And that’s doubly true today, with much of the U.S. well into a real-estate recession. It’s unlikely that homeowners in once-booming areas will see a return of skyrocketing prices anytime soon.”

    I’ve done a large amount of financial analysis on the rent v. buy question, because I’ve been wanting to buy for over a decade, and am finally just barely in a position to do so. I’ve found that the typical “Buy vs. Rent” calculators are overly simplistic and limited. And since I’ve gone through the pain of getting an MBA, and currently work as an investment analyst (full disclosure: not in real estate), I’ve got some tools to bring to the problem. So I made an elaborate spreadsheet model and asked it: am I better off buying or renting? I defined “better off” in terms of the Net Present Value of my total wealth, and considered various holding periods for the purchased home.

    (Re: Net Present Value: Trent points out that most arguments that challenge the benefits of buying rely on the assumption that the extra cash available when renting will be invested somehow. This is true, and must be true if we are going to compare the “wealth effect” of buying to that of renting. We must look at it this way if we are to judge to what degree buying the home is a good investment. The analysis is not comparing how wealthy we’d be if we bought a home vs. how wealthy we’d be if we took a bunch of vacations. That’s a different question, and a much easier one to answer. Our assumption here is that we are trying to determine what choices we can make to give us the greatest total wealth, an assumption that requires us to also assume that if we rent we will make good choices with the extra money. If we find that we are talking ourselves into buying a home because “we’d just waste the extra money anyhow,” then we have a deeper set of issues to address when it comes to our personal financial management practices.)

    By assuming that we would invest the extra money that renting might provide each month, and by picking a rate of return that we think is most likely for this money (our “discount rate”), we are focusing on the question: is buying a house a good investment? We can’t answer that question without first answering the question: “…compared to what?” (Answer: the annual rate of return of the next-best use of your money. Other debt you could pay down, which costs X% to carry?; long-run stock market returns of Y%? Other? Your choice.)

    The answer to the rent v. buy question is, sorry to say but maybe not a surprise: “it depends.” And it depends on a lot of things, because a complex set of factors come to bear on determining how well we’ll make out on our decision to buy a home.

    The starting point is to get clear about what we are comparing the home to, since it’s not an option to go without shelter. Our current apartment may or may not be the relevant point of reference. If we did not end up buying a home, would we stay in this apartment or move across town to the nicer one that’s closer to work? Some of the previous comments address this issue. To compare apples to apples, we’d need to get a pretty good idea of what rent we’d need to pay in order to get an apartment that is equally (approximately) satisfactory to us as the homes we are considering.

    Once we’ve established this, we can find the home that is equivalently satisfactory (how ever we define this), and run the numbers on the two choices.

    At that point, the analysis becomes dominated by a few critical assumptions that we need to make. Key among these:

    What is our relevant discount rate?

    What will our interest rate be on the mortgage?

    At what rate will the value of the home increase?

    For how long are we most likely to hold the house?

    At what rate will the Assessor’s office increase the assessment, and therefore the taxes?

    At what yearly rate would the rent increase, in the comparative apartment?

    What Standard Deduction will we get from the IRS, if we do not buy a home and itemize, and at what rate will the Standard Deduction increase?

    What is our Federal Income Tax rate?

    How big will the closing costs be?

    What will maintenance costs on the home be, and how will they grow, year by year?

    When we sell, what percentage will go to transaction costs (sales taxes, realtor fees, sprucing-up costs)?

    How much will we pay for insurance?

    Will we be paying PMI?

    The size of down payment may or may not be an important factor, and Ian gets at this with his last post. The relationship between the mortgage interest rate, the appreciation rate of property, and our relevant discount rate all play a role in determining how good a use of money it is to have a larger down payment. (There are other good reasons to have a large down payment, though… better rates; avoid PMI; a credit cushion, etc.)

    What we find when we account for all of these elements together is that most rule-of-thumb type of guidelines are too limited given the variety that exists in personal circumstances and local real estate markets (and as previous contributors have pointed out, the relationship between the local rental market and local purchase market is very important). It’s possible, for instance, to be better off buying even if our current rent is less than the interest portion of our mortgage would be, if property values are rising at an abnormally high clip (for just one example).

    If you’ve read this far, I’ll go on to mention that I’ve also given my analytical spreadsheet model the ability to consider owner-occupancy situations for multi-unit properties. Doing so made the math quite a bit more complex, but was very interesting. Although there are plenty of details there that we could talk about, the key “take away” was that just because it can be very good financially to be a landlord does not necessarily mean that it is financially bad to be a renter. The wealth-transfer dynamics are not a zero-sum game. The tax environment for landlords has a lot to do with this.

    If anyone out there would like me to run their numbers for them or otherwise talk about these issues, please feel free to contact me.

    All the best.
    – Jesse
    haifley@gmail.com

  26. karin says:

    my questions is this: i’m paying about 3100 in rent right now for a 1 br. i can put together a down payment for a 1br in my area, but with taxes, and association fee’s I’ll be paying about 3800. i’ve been told by my accountant however that since i have no other tax deductions buying is a good move for me. given the current market condiditons does this make sense? Also, should I wait until I can afford a 2 br to maximize resale value?

  27. Charles says:

    I have to agree with the others here that the author is not looking at the situation many of us face out here in California. My example:

    I live in Monterey, California, and rent a 2 bedroom place (1,110 square feet), with a garage for only $1,175 a month. In addition, it includes the garbage, sewer, water, internet, cable, and all landscaping (total value of all of those is around $400 a month).

    If I was to buy a similar size house in decent shape with the same commute time, I would be looking at $500,000 at an absolute minimum. Assuming I could put 10% down, my mortgage would still be $2,697 a month before any additional costs were tacked on. Apples to apples, the strict monthly comparison is $1,175 vs. around $3,500 (after other costs plus taxes are added). Even with the tax breaks, it doesn’t come out ahead.

    I used to own a house in markets where it made sense. However, around here it does not.

  28. roberto ribas says:

    I have cash to buy a home, and yet your analyis is very very bad: 1. homes are dropping in price, why should I spend more to buy now? they are not dropping for unobservable reasons, they are dropping due to very high supply relative to demand, price/rent ratio being too high for investors, and ridiculously high foreclosure activity, plus job losses. EACH of those can easily be watched, so it is fairly simple to see what will happen: prices will keep dropping. I’ll buy when the market seems to make sense to buy, your analysis on this article is very weak.

  29. robert says:

    What is up with this site? You are giving the reasons for BUYING, NOT RENTING! Housing is a business, so you must keep all of your options on the table including renting. First always assume you will be paying a mortgage for 30 years (because that is what you are agreeeing to). Even though you can sell later buying assumes you want to stay in the same place for a number of years. If you dont plan on staying in the same place for a number of years DONT BUY, RENT! On this same line of thought, If you dont want to stay in the area where you can afford to live for several years then DON’T BUY, RENT. Compare the renting market to the housing market in your area (while related these 2 markets aren’t the same). If renting is significantly cheaper (or housing is significantly more expensive). DON’T BUT, RENT! Finally take a good look at the house you want to buy. Look at the area where you are going to live. Make sure that the house is in good shape. A lot of people are trying to dump their worst place on a sucker. (they hope that sucker is you, and believe me they have some real holes) Remember housing is a business just as renting is. They want to make as much of a profit (if not more) as a landlord does. They want to make that profit at your expense where you dont have the option to terminate your lease after 1 year. And agreeing to buy a 150k house for $250k is a good way to help them. Be ruthless, because this is your livelyhood as much as it is theirs.

  30. Meghan says:

    For me, it’s an easy answer, buy a house. For those of you who live in large cities and are content renting apartments, congrats. However, for me, it’s the intangibles that make buying a house worth it. I actually use the property for something other than to grow grass. The 1/3 acre suburban plot provides about 90% of all fruits and veggies my family consumes plus eggs, poultry meat, honey, and beeswax. Considering that I barter extra honey and beeswax for milk and flour and purchase beef from a local farmer (organic, grass fed at a price cheaper then CAFO beef in the supermarket!) the cost of the property is very low as it provides us with a lot.

    I haven’t run the numbers for what food would cost if purchased in a traditional manner, but right now our food budget (for a family of four) is about 20$/month. You couldn’t match the quality of food that we produce in a supermarket.

    I cannot look at this argument from a purely financial standpoint. By owning property you have the opportunity to provide a healthier life for you (and your family).

  31. Jen says:

    The mill rate in my area puts most homes in the $1000/month range for taxes. Since I pay $800/month for rent, I think I’m making out by not owning a home.

  32. Amanda says:

    Many times there are other considerations to factor in that have not been mentioned. For example, a partially disabled divorced forty-five-year-old woman would not be able to afford or perform the upkeep required on her own house. Being on a fixed income, she would also have fixed housing expenditures every month with renting.

  33. carol says:

    Buying a house is a much better option. I live in southern california where you can buy a 3 bedroom house for less than 100k. My mom has rented a two bed room apt for the past 10 yrs and has paid out more on that then she would on a house. If she would have bought a house it would have been paid off by now. My in laws own a thousand dollar house out right on over 50 acres of land in california their house is worth millions. Rent in california is more expensive then owning a home by hundreds of dollars. Also if you are single you can always rent out rooms for a few hundred and pay your house off faster.

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