Extremely low mortgage rates and rising apartment rents in many cities have led some people to dive into homeownership more quickly than they’d originally planned. However, others are choosing to wait until the housing market recovers, in spite of the incentives to buy. The truth is, there’s no one right answer when it comes to determining whether to rent or buy a house.
There are a number of considerations you must make when making this decision. Renting and buying both present a number of pros and cons, and your own financial situation may be the biggest factor of all.
Pros & Cons of Renting
Despite the fact that you can’t build equity, renting offers you the most freedom and flexibility, especially if you are on a month-to-month lease.
- No Maintenance Is Required. If the garbage disposal breaks or you need a plumber, getting maintenance is as easy as calling the superintendent.
- It’s Easier to Move. If you are not settled into your career or could have an opportunity to relocate in the near future, it is much easier to switch to a month-to-month lease or sublet than it is to sell your home.
- You Can Avoid Owning a Depreciating Asset. While home prices have stabilized and are rising in most housing markets, there’s no guarantee that your home will increase in value over time.
- Your Monthly Payment Can Increase. Rents have been rising in many cities, so you may be facing an increase in your monthly housing payment as soon as your current lease ends.
- You Don’t Build Equity. When you rent, your housing payment provides you with a place to live, but will not provide you with an asset to sell when you are ready to move.
- You Don’t Receive Tax Benefits. Homeowners can deduct their mortgage interest payments and their property taxes from their federal income tax, which reduces the final cost of homeownership. Renters cannot deduct any of their housing expenses.
- You Can’t Paint or Remodel Without the Owner’s Approval. While some landlords are kind enough to let you paint your apartment, you’ll have to get their permission and consult on the color. If you want to make other changes or upgrade an appliance you’ll have to put in a request with your landlord or apartment manager.
Pros & Cons of Buying a Home
Homeownership is not for everyone, but there are some financial and emotional advantages that can be enticing.
- You Can Build Equity. Historically, homes rise in value anywhere from 4% to 6% per year. Even if your home doesn’t increase in value, though, you’ll be building equity as you pay down your mortgage as long as your home maintains its value.
- You Can Take Advantage of Tax Breaks for Homeowners. Homeowners can deduct their mortgage interest payments and property taxes when they itemize their federal income taxes. These deductions offset the cost of your housing.
- Your Housing Payments Will Stay Stable. If you choose a fixed-rate mortgage, your principal and interest payments remain the same for the duration of the loan. However, your homeowners’ insurance and property taxes can change.
- You May Be Able to Use Your Home as an Investment. If you buy a home and choose to leave it, you can rent it out rather than sell and generate income. This works best if you can cover your mortgage (or more) with rental payments. With this in mind, it pays to choose a home that will make a good rental property in the future.
- You Can Settle in a Community. Once you commit to owning a home, you are more likely to become more involved in your community because you know you’ll be there for years. You can get to know your neighbors, perhaps join a homeowners’ association, or volunteer for projects that benefit the community or the local school.
- You Have the Freedom to Decorate as You Please. One of the joys of homeownership is the ability to change your environment to suit your tastes. Of course, if you live within a development with a homeowners’ association you may have a little less freedom with your home’s exterior, but you can still paint your kitchen purple if you like.
- You Have to Pay for Your Own Maintenance. As a homeowner, you must spend time and money keeping your home in good repair. You need to set aside funds for unexpected expenses, such as appliances that break, a service contract on your furnace, or the need to replace your windows.
- Your Home Is an Illiquid Asset. If you would need to sell because of a job relocation or change in your circumstances, you may not be able to sell your home as quickly as you would like or for as much money as you want.
- You Must Pay Property Taxes. Property taxes can go up, making your home less affordable.
- Your Home Could Lose Value. As many people have learned the hard way, there’s no guarantee that your home will increase in value over time.
- Buying a Home Requires a Cash Investment. You need to use up your savings for a down payment and closing costs and for other expenses of homeownership. That cash won’t be available for other investments.
- Homeowners’ Insurance Is Mandatory If You Have a Mortgage. As a renter, renter’s insurance is recommended but not required. Your lender requires you to insure your residence, and typically you have to pay those insurance premiums along with your mortgage payment.
Important Questions to Consider
1. How Long Do You Expect to Live There?
While buying a home may be one of the most expensive investments you’ll ever make, it also requires a major emotional investment. The days of buying a home and selling it for a profit within a short period of time are pretty much over except for the most savvy house flippers. If you are considering buying a home, be prepared to stay in it for five to seven years or longer in order to recoup the cost of buying, to survive a questionable market, and to build equity. If you can’t make that long-term commitment, you’re probably not ready for the responsibility of homeownership.
2. What Are the Costs of Buying?
A big factor in the decision to buy or own is your local housing market. Check online to get an estimate of rental costs and purchase costs for your area, and check with a realtor to learn about neighborhoods and homes you might want to purchase. Most mortgage lenders are happy to work with first-time buyers to explain the mortgage process and pre-qualify you so you know how much you can borrow. But be careful to consider how much you want to spend on your housing and whether you are ready to make the long-term commitment.
How to Calculate Your Costs
When you rent a home, you typically need to make a security deposit and pay a month or two of rent. As long as you take care of your home, you’ll get your security deposit back when you move. But buying a home costs considerably more money upfront, which is why you need to stay in the home for a few years to build equity and earn a return on your investment.
To start, you need cash for an earnest money deposit when you make an offer on a home, usually anywhere from $500 to $1,000, or as much as 5% of the sales price. You also need to make a down payment of at least 3.5% of the home price with an FHA-insured mortgage, or 5% to 20% with a conventional loan. On a $100,000 home, this will be at least $3,500.
In addition to your down payment, you have to pay closing costs – usually 2% to 5% of the home price depending on your local real estate market. Other costs of homeownership include moving costs, paying for inspections (such as a home inspection and a termite inspection), repairing or replacing appliances if necessary, and furnishing your new home. It’s essential that you consider all these costs within the context of the cash you have available to you. The last thing you want, for example, is to live in an unfurnished home or one in need of repair or remodeling because you spent everything you had funding the home purchase.
3. What Are Your Future Plans?
While no one really knows exactly where they will be in five years, you should think carefully about your goals for your career and for your personal life. If you hope to climb your career ladder – but may need to relocate to do so – then renting may be the best option, unless you are certain you want to own an investment property.
If you are single and hope to be married, you need to think about your home purchase in terms of whether it will be comfortable for two people or a small family, or whether you will want to sell it or rent it out in a few years. If you are married and hope to start a family, and thereby intend for one spouse to work less or stop working altogether, make sure your housing budget can accommodate a reduction in income. Lastly, if you have an avocation that you love but costs money, such as golfing or skiing, make sure you keep that in mind when you create your housing budget.
4. Do You Have the Ability to Finance a Home Purchase?
If you’re considering buying a home, your first step should be to meet with a lender to determine whether you qualify for a mortgage and, if so, how much you can borrow. Your ability to qualify depends on several major factors:
- Credit Score. You typically need a credit score of at least 620 or higher to qualify for a mortgage. The lowest interest rates are available to borrowers with a credit score of 740 and above.
- Income. You must prove that you have a steady income and can afford to repay your mortgage.
- Debt-to-Income Ratio. Your lender compares the minimum payments on all outstanding debt to your gross monthly income. While the maximum allowable ratio varies by lender, most will not go above 41% to 45% for an overall debt-to-income ratio.
- Assets. You need to prove you have the savings to pay for a down payment and closings costs, as well as have some cash reserves in the bank.
If you fall short on any of the above criteria, you may be better off renting until you can improve your credit score and save more money.
Buying a home is a major decision that shouldn’t be taken lightly, but when faced with rising rent and low mortgage interest rates that make purchasing more affordable, you should take the time to consider the pros and cons of both renting and buying. Long-term homeowners, even those whose homes lost value during the recession, can build wealth that can be used to fund their retirement or pay for college. As long as you can comfortably afford your housing payments and are emotionally prepared to commit to homeownership, buying a home can be a smart financial move.
Do you own your own home, or do you rent? What was the biggest factor in your decision?