Updated: Mar 5, 2022
This week’s topic is around a common question: Is it more advantageous to own or rent a home?
This has some similarities to the discussion we had in Podcast #59, is it better to lease or buy a car? One achieves ownership and the other comes with a consistent never-ending payment.
Whether you choose to rent or buy your home it is a major life decision that affects not only your lifestyle but also your financial health, and if you have the money to afford both, you need to carefully weigh the options for both.
Real estate ownership is often personally celebrated as an investment that is likely to build equity and a source of tax deductions for you. But, renting also has its advantages, including little-to-no responsibility with more flexibility. However, people often believe that buying a home, rather than renting is the more financially sound decision.
With the housing market still so hot and these unprecedented low interest rates, what is the right thing to do? What we do know is as of November 2020, according to Census Bureau data, over 38 percent of owner-occupied housing units are owned free and clear. For homeowners under age 65, the share of paid-off homes is 26.4 percent.
That means out of the 331 million people in the US, only 86 million people under 65 own their home outright. It’s a hard achievement obviously considering the price of housing, and length of loans that you may take out to make housing affordable. In the US people typically lean toward ownership. This is in part due to the fact that we've been bombarded with the message that being a homeowner is the key to happiness and the American dream. Real estate is also big business for everyone, from mortgage lenders to real estate agents to home improvement stores.
However, it's important to remember that owning a home isn’t always better than renting, and renting is not always as simple as it might seem of course. You really need to consider the pros and cons of each to figure out whether renting or owning is best for you.
The Components of Buying a Home
According to the National Association of Realtors, the median price for a home is $303,900 as of January 2021. So let’s call it $304,000
If we took a $20,000 down payment or 6.6%, that would be a mortgage of $284,000. Using a 3.5% interest rate the mortgage payment for a 30-year fixed term comes to $1,257.
As for taxes for home with this price, the national average for taxes is in the range of $3,200. So let’s assume that’s $271 per month.
Then we factor in closing costs that are typically 2 - 6% of the mortgage price. At 3% that comes to $8,520. (We’ll also assume that the prepaid interest is factored in). Hence, when adding that to the down payment, the total investment is $28,520.
Now see that the down payment was less than 20%, there will be PMI applied each month and this typically ranges from .25 to 2%. If we take 1% for this scenario that comes to $2,840 per year or $236 per month. (The cost for PMI is highly dependent on your credit score.)
next, we take that number and divide by 12 and that comes to $473 per month.
And, Oh yeah! Don’t forget about hazard / homeowner’s insurance. The average cost according to PolicyGenius in a January 2021 report, it states that the average is $1,200 per year. So that’s $100 per month.
Average Cost to Live In a Home
Mortgage Payment: $1,257
Homeowner’s Insurance: $100
So this brings the total payment to $1,864 per month.
That’s a lot! And remember, that’s just the base cost to own your home. This doesn’t include your monthly bills, lawn care, and ongoing maintenance costs.
Let’s rundown some of those expenses that you have to pay to own a home vs. renting
Property taxes (may increase over time)
Water and sewer service
Homeowner's insurance (may increase over time as well)
Pool cleaning (if you have one)
Lender-required flood insurance, in some areas
Earthquake insurance, in some areas
What Comes With Renting an Apartment or Home
Renting means you can move without penalty each time your lease ends. You can just pick up and go if you aren’t happy with your surroundings.
However, it also means you could have to move suddenly if your landlord decides to sell the property or turn your apartment complex into condos.
Less of a big deal to that point, is they could just bump up the rent to more than you can afford, and then when your lease is up you could move. That can be a hassle too.
In addition, typically you can’t make any home improvements, paint, or add anything to the aesthetics to the apartment or home you are renting.
Depending on where you rent you may have a multitude of neighbors to contend with.
I remember renting in a huge complex when I first came to Michigan. It was a nice apartment, but I honestly hated that part of it because you could hear so much going on through the walls.
Nothing I wanted to hear, but I could only afford to rent, and so that was not my choice. It was based purely on my financial situation, like so many who do rent.
When you rent, you know exactly how much you’re going to spend each month; you have a fixed monthly cost.
Contrary to popular belief, renting doesn't mean you’re "throwing away money" every month, and owning doesn't always build wealth "in the long run."
With renting, you need a place to live and that always costs money in one way or another.
While you might be inconvenienced by a leaking roof as a renter, it's unlikely you'll ever have to pay to replace your roof when you rent.
Your monthly home-related expenses such as renter's insurance are more predictable and significantly cheaper.
Remember, when we were renting before we bought our house? A couple major things happened. The bathroom started leaking, and needed a major gut. My landlord came in and totally remodeled the bathroom.
I also warned the landlord that a tree in the front yard was going to fall; he denied it and it eventually fell and engulfed our cars; and totaled mine. He had to pick up the cost.
What Comes With Owning a Home
Homeownership does seem to bring unapparent benefits which can be a sense of stability or belonging to a community, and of course this pride of ownership. Others include tax deductions and equity build up as part of your investment portfolio.
It is true that you aren't building equity with monthly rent payments. On the inverse, not all costs with homeownership lead to building equity.
While homeownership is often hailed as a way to build wealth remember, your home can lose value. Remember the housing bubble of 2008? Some people like me lost everything and took years to get out from under water. I had to walk away and was homeless,
Think about this: the dream neighborhood you moved into could decline. A major employer could leave the area, causing a significant population decline and a surplus of housing. This happened decades in Detroit after the auto boom.
When you own, you might pay nothing more than your mortgage and regular bills in one month, but then but uh oh . . . the next month you might need to spend an additional $12,000 on a new roof (which your homeowners' insurance might not cover).
Alternatively, there could be a residential construction boom, which could also keep prices down (buyer’s market). You might buy a house for $200,000 tomorrow and in 30 years find that it's still worth $200,000, meaning you've lost money after inflation. Right now, we are in a low inventory environment and so it's highly inflating the housing prices.
Ownership is an Emotional Decision
It is important not to take ownership lightly especially for first time buyers. Consider these things: do you like having your evenings and weekends free to do whatever you want? Do you work long hours or travel frequently? If so, then the time commitment that comes with homeownership might be more than you want to take on.
There are always projects around a house that need to be taken care of from finding a plumber or repainting the bedroom to mowing the lawn.
We recently spent 15 hours in our yard to get it ready for the summer on our memorial day weekend. My body was raked. We had to weed the garden, mulch and plant flowers in our one acre yard. There is so much work to do! However, we made the choice.
Rent Vs. Buy Savings Comparison
Let's do a side-by-side look between renting versus buying. In our example, we said the house is $284,000 at $1,864 ($1,257 for the mortgage) which includes $607 for the non-mortgage costs. We also estimate that it costs 50% over and above the mortgage payment to maintain the home each year. Therefore, this comes to $628 and this brings the total to $1,235.
So, let’s take a $1,000 rent payment (including renter’s insurance) and see how that money can be invested. Over the course of 30 years at 7% interest in an S&P ETF 500 type-fund you would accumulate $1,133,529.
So it is a good question to consider: can you save that kind of money when you own? More than likely, the answer is no for most Americans. The only difference is that when you stop working you’ll have a rent payment.
We talked about this in Podcast #9 about making extra payments on the mortgage. Here's what people may not consider: perhaps the biggest throwaway expense is mortgage interest, which can make up nearly all of your monthly payments in the early years of a long-term mortgage.
Take this typical example of how interest is weighted when with amortization: If one borrows $100,000 at 4% for 30 years, your first monthly payment will be $477.42, of which $333.33 is interest and $144.08 is principal. It will be about 13 years before more of the monthly payment goes toward principal.
In total, $71,869.51 will be spent on interest (though, admittedly, some of that can be recouped in tax deductions).
Lastly, renovation projects don't often increase your home's value by more than what you spend on them. Which I think people bank on. On average, you'll get back .66 cents for every dollar you shell out on a home improvement project, according to Remodeling magazine.
Rent Vs. Buy Financial Recap
Consider Renting if:
#1 If you lack the funds for the down payment, that’s just step one. It is one thing to come up with the money, it is another to have the money to maintain it.
#2 Buying a home is typically a long-term investment; therefore, don’t buy if you plan to stay there on a short-term basis. The money that you put into the home to pay for it may not be recouped when you sell it. Plus, if you are in a depressed/stagnant market you may not be able to sell it.
#3 In reference to step #1, maintaining a home, buying involves more than the mortgage payment. It is an additional financial responsibility to cover maintenance and repair costs. With renting it puts that responsibility on the landlord’s shoulders.
Consider buying if: #4 You need to be in a good financial position - truly, a good financial position. This means that you need steady income and you shouldn’t technically move into a home unless you have an emergency fund and a rainy day fund. If you fail to achieve this, it is almost a certainty that you need money due to unforeseen events and you will not have a coffer to pull from. You do not want to be house poor.
#5 For most people, their home is their largest financial asset as it is often a very good investment over the long term. By simple math, the longer you stay in your home the more equity you’re likely to build. This is due to a shrinking mortgage balance coupled with a home value appreciation. In addition, if you run into financial hardship, you can tap equity with a home equity loan. (Avoid this if all possible)
#6 You can receive yearly tax deductions such as state and local income, sales, and property taxes for up to $10,000 ($5,000 if married filing separately).
Other benefits include deductions for necessary home improvements, home office expenses, private mortgage insurance, and capital gains; however, if you live in certain states, there may be no state taxes. That’s why when snowbirds go to warm climates, they stay there for more than six months to get the residency to avoid state tax.
To sum it up home ownership provides a more permanent place to raise children and stake your claim in a community and it provides more flexibility with choices in life. Ultimately, the decision to rent or to own is not just financial. It is also emotional.