Given the hefty upfront costs associated with purchasing a home, most young people begin their independent lives renting an apartment. As they build careers, save money, and start families, many choose to buy a home. On the other end of the age spectrum, homeowners nearing retirement may choose to sell their family homes, downsize, and become renters once more.
Since the middle of the 20th century, the U.S. homeownership rate has fluctuated between 62% and 70%. According to the U.S. Census Bureau, it sat at 63.7% in the second quarter of 2017, near lows not seen since the mid-1960s. By contrast, the rental vacancy rate was 7.3% in Q2 2017, near a 20-year low.
The homeownership rate has been in the doldrums for years. The decline is largely due to economic and demographic factors, such as the downsizing efforts of aging Baby Boomers, elevated housing prices in some high-population markets, and high student debt loads that prevent many younger buyers from saving enough to make down payments.
Regardless of the big-picture socioeconomic forces that affect homeownership rates, determining whether and when to purchase a home is a personal choice that demands careful deliberation. This decision varies from market to market – what makes sense in Peoria might not work in San Francisco, and vice versa. Also, because American culture idealizes homeownership to a certain extent, emotional and social pressures can affect the decision almost as much as financial concerns.
Are you a renter interested in buying a home, or a homeowner wondering whether renting makes more sense at this point in your life? It’s time to evaluate the relative costs, benefits, and drawbacks of owning versus renting your home.
Costs of Buying & Owning Your Home
Upfront & Closing Costs
Buying a home entails numerous upfront costs. Some are paid out-of-pocket after the seller accepts your purchase offer, while others are paid at closing.
- Earnest Money. To show the seller you’re serious about buying the property, it’s customary to accompany your purchase offer with an “earnest money” check. Earnest money generally ranges from 1% to 3% of the home’s purchase price, depending on local market conditions and the seller’s preference. After accepting the offer, the seller deposits the earnest money funds into an escrow account, and the amount is credited against your closing costs.
- Down Payment. Your down payment is the percentage of the home’s purchase price that you pay upfront, typically at closing. You need to specify a down payment amount in your purchase offer, though you can change it prior to closing if the seller agrees. Your down payment amount varies widely based on your credit profile, local market conditions, and the type of mortgage loan you’re approved for, but typically ranges from 3.5% (chiefly for FHA loans) to more than 20% of the purchase price.
- Home Appraisal. To ensure that the offer price matches the actual value of the home, lenders require a home appraisal prior to approving the loan. Appraisal costs, typically $300 to $500, are paid during or before the appraisal.
- Home Inspection. Licensed home inspectors are trained to find potential problems and defects that might not be apparent to an inexperienced buyer doing a casual walk-through. For this reason, buyers are strongly encouraged to get one, even though private lenders rarely make loan approval conditional on a completed home inspection. The cost is similar to the appraisal and is usually paid at the inspection.
- Property Taxes. Since property owners pay property taxes upfront, usually in six-month increments, you need to compensate the seller for taxes paid on the period between the closing date and the end of the current tax period. This expense varies widely based on your local tax rate and the closing date. You could be responsible for nearly six months of property taxes, or practically none at all.
- First Year’s Homeowners Insurance. Lenders require proof of homeowners insurance prior to closing. You almost always need to pay the first year’s premium upfront, either on the date you purchase the policy or at closing. Homeowners insurance costs vary based on the value, style, location, and contents of the home, as well as your credit score, policy deductible, and coverage limits.
- Other Closing Costs. Appraisal, inspection, taxes, and insurance are just a few of the many line items bundled into your closing. Other closing costs include loan origination charges, credit report fee, flood certification fee, lender’s and owner’s title insurance, recording taxes, state and local transfer taxes, first month’s mortgage interest, and closing fee. As a rule of thumb, you can expect your total closing costs to range from 2% to 4% of the purchase price, with the ratio falling as the purchase price increases.
Depending on local real estate market conditions, general economic climate, and negotiations, the seller may agree to pay some or all of your closing costs. Before making an offer, ask your agent whether it’s realistic to expect the seller to share or cover closing costs in your current market.
Homeownership also involves many recurring costs. Some are included in the monthly escrow payment you make to your lender or mortgage servicer, while others are paid separately.
- Loan Payments. You need to make monthly principal and interest payments for the life of your mortgage loan, usually 15 or 30 years. If you have a fixed-rate mortgage, your loan payment remains constant for the full term. If you have an adjustable-rate mortgage, your rate gets tied to a benchmark and your payment varies as the benchmark changes. Your loan payment is part of your monthly escrow payment.
- Property Taxes. Your city or county sets your property taxes, which pay for local schools, infrastructure, and other critical services. Rates vary widely by location and often change from year to year. Property taxes are part of your monthly escrow payment – you pay one-twelfth of your annual tax burden each month.
- Homeowners Insurance. According to the Insurance Information Institute, the average annual U.S. homeowners insurance premium was $1,132 in 2014. However, homeowners insurance premiums can vary from year to year based on changes in your home’s appraised value, your policy’s deductible and coverage amounts, your claim history, and your credit score. As with property taxes, you pay one-twelfth of your annual homeowners premium with your monthly escrow payment.
- Private Mortgage Insurance. If your mortgage lender is a private company and your down payment is less than 20% of the purchase price of your home, your monthly escrow payment initially includes a private mortgage insurance (PMI) premium payment. PMI protects your lender from financial loss if your home is foreclosed upon and sold at a discount relative to your purchase price. If you have good credit, your lender may assess PMI premiums until your loan-to-value (LTV) ratio – the ratio of your current mortgage balance to your home’s total value – reaches 78%. However, lenders generally honor borrowers’ PMI cancellation requests once LTV reaches 80%. If you pose a higher credit risk, your lender may require you to carry PMI until your LTV is lower. Monthly PMI payments typically range from $50 to $200, depending on your loan’s balance and PMI rate.
- Utilities. As a homeowner, you’re responsible for paying all utilities and local services on your property: water, gas, electric, garbage and recycling, cable and Internet, and perhaps more. These costs vary widely by location and usage.
- Maintenance. You’re also responsible for all home maintenance and upkeep costs, such as replacing worn-out fixtures and appliances, exterior painting and finishing, interior cleaning, and mechanical maintenance (such as HVAC cleaning and inspection). As a general rule of thumb, you can expect to pay 1% of your home’s value per year on maintenance and wear-related replacements and repairs.
Special or One-Time Costs
Homeownership also comes with somewhat less-predictable costs that occur only once or at irregular intervals.
- Furnishing. If you’re a first-time homebuyer, your new home is probably larger than your previous space. That means you need to buy furniture and fixtures, even if you owned some or all of the furnishings in your rental. If you’re a repeat buyer, furnishing isn’t quite so costly. Regardless, your furnishing expenses are likely to vary in accordance with your budget. Purchasing secondhand furniture and fixtures is a great way to reduce this expense.
- Moving Costs. Whether you hire a team of movers or rent a truck and take a DIY approach, moving can range in cost from around $100 or $200 to more than $1,000, depending on how much you have to move and what you can accomplish on your own.
- Repairs. You’re responsible for paying to repair any damage that isn’t covered by insurance. For instance, if your basement sustains water damage due to exterior flooding and you don’t carry a flood insurance policy, any mold remediation costs are yours to pay out-of-pocket. Even less costly repairs and replacements can add up. For instance, a child or pet denting a wall, knocking over and breaking a lamp, or soiling a carpet beyond repair can get expensive.
- Improvements and Renovation Projects. If you want to take on a home improvement or renovation project, you either need to pay for it out-of-pocket or take out a home improvement loan, which can come with onerous stipulations. Project costs vary widely. A full kitchen renovation or bonus room addition can easily soar past the $20,000 mark, while fencing in the yard or updating your porch furniture might only cost a few hundred dollars. Though improvement and renovation projects can boost your home’s appraised value, that’s not guaranteed to be reflected in its eventual sale price.
Costs of Renting Your Home
Renting doesn’t involve a costly purchase process, so it has fewer upfront expenses. Still, you may encounter the following costs before or shortly after moving into a new apartment.
- Security Deposit. Landlords require a security deposit to insure against property damage requiring repairs, delinquent rent, broken leases, and other incidentals. Many states limit security deposits to 1.5 times monthly rent.
- First Month’s Rent. Most landlords require the first month’s rent upfront. If you move in the middle of the month, your landlord may accept a prorated rent payment.
- Nonrefundable Deposits. Depending on the rental property laws in your state, your living situation, and your landlord’s preferences, you may be charged nonrefundable deposits in addition to your security deposit. For instance, pet deposits are commonplace. They typically range from $100 to $500, depending on the type of animal and base rent.
- Moving Costs. Like homebuyers, renters have to pay to move their belongings, whether by hiring movers, renting a truck and driving it themselves, or relying on friends.
- Monthly Rent. Unless you live in a rent-controlled neighborhood or a city with strict renter protection laws, your rent can increase whenever you sign a new lease. Rent payments vary widely based on local market conditions, number of occupants, and the size, condition, and location of the rental.
- Pet Rent. Instead of a pet deposit, some landlords charge pet rent. Pet rent spreads the expected cost of pet-related wear and tear over the tenant’s entire stay. It usually amounts to $10 to $40 per month, depending on the animal and base rent.
- Renters Insurance. Renters aren’t required to carry renters insurance for their possessions, but it’s highly recommended to protect against loss due to theft, fire, and other perils. Insurance costs are based on the value and nature of insured property, coverage limits, deductibles, and other factors. According to U.S. News, the median monthly cost of renters insurance is about $15.
- Utilities. Utilities vary by landlord and region. In some dwellings, particularly those in larger apartment buildings, all utilities (including things like cable and Internet) may be included in the monthly rent. In others, renters are responsible for most or all utilities.
- Laundry. Many rentals don’t have in-unit laundry machines. Tenants either need to find a nearby laundromat or use coin or card-operated machines onsite. In either case, the process requires direct payment of around $2 to $4 per cycle. Even for tenants who employ strategies to save money on laundry, that adds up to $9 to $18 per person, per month, assuming one load each, per week.
Advantages of Buying
1. Building Equity Over Time
Unlike renters, homeowners build equity over time. On most mortgages, a portion of each monthly payment goes toward the loan’s interest. The remainder pays down its principal. (Your lender’s amortization schedule shows the exact proportions, which change over time, for each month’s payment.) Every dollar you put toward your loan’s principal represents a dollar of equity – actual ownership of the property. Once you reach 20% equity, or 80% LTV, you can tap that equity through a home equity loan or refinance your mortgage to secure a lower interest rate or longer repayment window.
You can also boost your home’s value, and thus lower your LTV, through judicious investments in home improvement. For instance, the home my wife and I recently purchased has only a rutted dirt driveway with a small shed at the end. Paving the driveway and building a proper detached garage in place of the shed would substantially increase the property’s functionality and curb appeal, potentially boosting its value by an amount greater than the project’s total cost.
2. Tax Benefits
Several tax benefits cater exclusively to homeowners, though not all homeowners qualify for all benefits. These are the most notable:
- Homestead Exemption. Many states exempt owner-occupied homes (homesteads) from a portion of the property tax burden that would normally accrue. For instance, Louisiana exempts the first $75,000 of a home’s value from property tax assessments, so a $200,000 home in New Orleans is taxed as if it were worth $125,000.
- Federal Tax Deductions. If you itemize your federal income taxes, you can deduct your property taxes and the interest paid on your mortgage, reducing your overall income tax burden (often substantially). This particularly benefits those in higher tax brackets.
These benefits aren’t available to renters.
3. Potential for Rental Income
Even if you don’t initially think of your home as an investment property, you can turn it into a source of income. This can partially or totally offset your mortgage, tax, and insurance payments on it.
The easiest way to do this is by renting out part or all of the property, provided you follow all local rental property laws. You might rent out a basement bedroom to a friend, live in one unit of a duplex and rent out the other to strangers, or purchase and move into a second home, leaving your entire property free to rent. You can also plunge into the sharing economy and take in short-term renters via Airbnb, VRBO, or another house-sharing platform.
4. More Creative Freedom
As a homeowner, your decorating, DIY project, and home improvement choices answer to no one, provided they don’t break local building codes or violate homeowners’ association rules. You can paint walls, add new bathroom fixtures, update your kitchen, finish your basement, or build a patio or deck to your heart’s content.
Radically changing your living environment to suit your whims is a fun, and even cathartic aspect of homeownership – and generally, it’s not available to renters.
5. Sense of Belonging and Community
Since homeowners tend to stay in their homes for longer than renters, they’re more likely to put down roots in their communities. This manifests in many ways. You might join a local neighborhood association, sponsor block parties or National Nights Out, volunteer at a nearby community center, join a school group, or align with a business improvement district. As a renter, you might not do any of those things, particularly if you know you may be moving in a year or two.
Disadvantages of Buying
1. Potential for Financial Loss
Although homeownership builds equity over time, equity doesn’t equate to automatic profit. If home values in your area decrease or remain flat during your tenure as a homeowner, dragging down the appraised value of your home, you risk a financial loss when you sell. While renting doesn’t build equity, it also doesn’t involve the risk of owning a depreciating asset.
2. Responsibility for Maintenance and Repairs
As a homeowner, you’re responsible for covering the cost of all uninsured maintenance and repair work on your home. Though your exact outlay is likely to vary from one year to the next, you can expect to pay about 1% of the value of your home annually toward these expenses. If you live in a $200,000 home for 10 years, that’s $20,000 over the period, and perhaps more if you have to replace a costly, long-lived mechanical item, such as a furnace.
3. Most Homes Aren’t Sold Furnished
The New York Times recently reported on a growing trend in high-end real estate sales: fully furnished new construction homes. While this concept is lovely, it’s far from commonplace, particularly in single-family construction. Unless your previous residence was similarly sized and fully furnished, you need to spend time, money, and energy furnishing your newly purchased home.
By contrast, many rentals come furnished. Even if their decorations don’t quite match your tastes, furnished spaces save resources and sanity on the front end of your tenure.
4. High Upfront Costs
Though upfront home buying costs vary greatly depending on the size of the down payment and the value of the home, you can expect to shell out no less than 5.5% of your home’s value (for an FHA loan and relatively low closing costs) before moving in. You could spend well over 20% of the purchase price.
By contrast, most renters pay relatively low upfront costs. And those who get back part or all of their previous apartment’s security deposit can put it toward the security deposit on their new place.
Advantages of Renting
1. No Responsibility for Maintenance or Repairs
As a renter, you’re not responsible for home maintenance or repair costs. If a toilet backs up, a pipe bursts, or an appliance stops working, you don’t have to call an expensive repair person – you just have to call your landlord or superintendent.
2. Relocating Is Easier
When you rent, relocating for work is easier, less time-consuming, and potentially less costly. That’s why renters who change jobs often (or have steady jobs that require frequent relocation) typically rent until their professional lives stabilize. Though a sudden move may require you to break your rental lease, you can partially or fully offset the cost of doing so by subletting your apartment or negotiating with your landlord.
By contrast, selling a home takes time and effort. If you need to sell your house quickly, you may be forced to accept a lower price and potentially take a loss on your investment.
3. No Exposure to Real Estate Market
Home values fluctuate in response to changing economic conditions, and can decline over time. If you’re a renter, that’s not your problem – it’s your landlord’s.
4. Credit Requirements Generally Less Strict
Although most landlords require prospective renters to undergo a credit check, this is typically a zero-sum proposition. Your application is either approved or denied based on your credit score and credit history. As long as you don’t have a checkered credit report that includes bankruptcies and judgments, you’re likely to find a landlord willing to rent to you.
By contrast, mortgage lenders typically have high credit standards, with credit scores below 680 or 700 considered subprime in many cases. Even small changes to your credit score can significantly affect your mortgage rates, potentially adding thousands of dollars in interest over your loan term.
5. Some Utilities May Be Included
Many multi-unit building owners cover the cost of most or all utilities, including non-essentials such as cable television. The practice is less common, but definitely still possible, in smaller buildings like duplexes and single-family homes. By contrast, homeowners have to pay full utility costs, sometimes several hundred dollars per month, depending on dwelling size and usage.
Disadvantages of Renting
1. No Equity Building
Unless you’re party to a rent-to-own agreement, every dollar you pay in rent is gone forever. No matter how long you remain in your rental unit or how exemplary a tenant you are, you can’t build equity in the property under a standard lease agreement. If you plan on staying in the same location for more than a few years, buying may be a smarter financial choice than renting.
2. No Federal Tax Benefits
While homeowners can deduct property taxes and mortgage interest on their federal income tax returns, renters aren’t eligible for any housing-related federal tax credits or deductions. Depending on your property tax and mortgage interest burden, this shortcoming can raise your federal tax liability by several hundred dollars per year.
3. Limited Control Over Ongoing Housing Costs
Unless you live in a municipality with rent control laws, your landlord has the ability to raise your rent once your current lease expires. Rental property owners raise rents to match rent increases elsewhere in the market, to compel current tenants to vacate the premises rather than sign a new lease, and for many other reasons.
If you maintain a good relationship with your landlord, you’re less likely to face onerous rent increases from year to year. No matter what you do, though, you can’t exercise complete control over your rent. By contrast, homeowners with fixed-rate mortgages make fixed loan payments each month, regardless of what the local real estate market does.
4. Limited Housing Security
While most jurisdictions have generous renter protection laws that prohibit landlords from evicting without cause and require adequate notice (typically 30 or 60 days) that tenants won’t be given an option to renew their leases, no law entitles you to remain in your rental unit indefinitely. Homeowners don’t face such uncertainty. They can remain in their homes as long as they stay current on their mortgage payments.
The New York Times has a handy calculator that weighs the known costs (both financial and time) associated with renting and buying. Although this calculator can help you decide what makes the most financial sense in a particular situation, it can’t help you evaluate all the subjective, non-financial factors that affect your ultimate decision. Only you and your loved ones can make the final choice, so as you work toward an ultimate decision, keep an open mind. Remember that it’s better to wait and make the right call than rush into a choice you come to regret.
Are you deciding whether to rent or buy your home?