Start With The Basics: Rent Or Buy?
For most of us who are invested in real estate; the question is more appropriately, “do you intend to be wealthy?” But everyone must decide and everyone must start from where they are standing.
This is a primer for you if you have just discovered real estate.
Now ... for many Americans, the two biggest personal expenses that exist are housing and taxes.
In terms of controlling your housing expenses, one of the biggest decisions you’ll need to make is whether to rent or buy your home. There are pros and cons to each, and the best choice for you may not be as obvious as you think.
So, let’s talk about that renting vs buying question...
"Real World" Personal Strategy Note
Your Home: Renting vs Buying
"The greatest glory in living lies not in never falling, but in rising every time we fall." - Nelson Mandela
No matter what the economy is doing, a debate that’ll never be effectively settled is whether to buy or rent your home. We’re not going to decisively settle it here either, but the fact is there are countless ways to be “right” in your approach to where you lay your head at night.
In fact, if you ask ten different financial gurus, podcasters, or personal finance bloggers about this, they’ll probably give you ten answers -- all of which are correct to a certain degree. Ultimately, it comes down to what you are most comfortable with and getting very clear about what your needs and wants actually are.
Knowing Your Financial Options
Let’s start with the obvious: Your finances largely dictate your housing options.
Carefully consider financial factors like your income, the amount of cash you have in savings, and your credit score. These three items in particular will tell you a lot about your available housing options.
- This is perhaps an overly broad generalization, but a basic rule of thumb is to spend one-third or less of your pre-tax income on housing. In high cost of living areas, this may not be practical, but again, it’s a rule of thumb.
- Cash on hand is important because you’ll need money for deposits if you’re renting or down payment and closing costs if you buy. If you’re short on cash but have a good income, don’t automatically assume you can’t buy a home. There are programs available for getting into a home with very little money down -- perhaps even zero.
- Your credit score is important, also. Far more so if you plan to purchase a home, as your credit score can open or close the doors to certain mortgage products. But landlords and property managers are going to check your credit, also. While seemingly less important when you rent, a credit report riddled with missed payments and collection accounts can definitely prevent you from renting a home.
These three financial factors are important to consider together in determining what type of housing options are going to be available to you.
If you’re thinking about buying a home, be fully aware of all the costs.
Buying a home comes with costs you might not have foreseen. It can be simple things, such as buying a lawnmower to cut the grass. But you may also have HOA dues, higher utilities than a smaller apartment, appliance repairs, etc.
If you’re buying a newly built or remodeled home, what’s covered under the warranty and how long is it? Buying a previously owned home, especially one with a few years on it, will inevitably call into play Murphy’s Law, and you may end up needing to spring for a new roof, furnace, or air conditioner (and maybe even all three!) within the first few years of ownership. Is this something you’re financially prepared for?
One of the other costs that can quickly add up (with seemingly little benefit to you) is PMI, or Private Mortgage Insurance, which is generally required if you didn’t put at least 20% down on the home. While it may not sound like much – usually less than $100/month -- it’s painful to know you’re paying for insurance on your home loan to, well… make sure you pay your home loan. It would be far more satisfying to put that money towards the loan principal each month…
One last thing to consider is the time it will take to grow equity in your home. Remember, mortgage interest is “front-loaded,” so while you’ll likely have a moderate increase in property values over the first few years, you really don’t begin to build a lot of equity in your home until about the second decade. If you have plans to move in just a few years, you must understand that the actual value you’ve built up in your home (the equity) isn’t going to be substantial in most cases (yes, I’m intentionally ignoring the rapid short-term appreciation we’re seeing right now).
This same rationale extends to your career – if transferring or going to work at a new company is a likely scenario, then understanding the cost of homeownership in real dollars over the likely period of your stay in the area is some math that you’ll need to work out (which we’d be happy to help you with, of course).
The Math of Renting
You may have heard the old adage that “renting is throwing away money every month.” For some people, this is absolutely true. For others, it’s absolutely false.
When you rent, a lot of potentially expensive liabilities go out the window for you, as those expenses become somebody else’s problem to deal with and pay for.
If the water heater goes out on Saturday night, you’ll be inconvenienced for a couple of days probably, but you’re not going to have to pull out of your own pocket to get it fixed. That’s tremendous peace of mind for many people, and that alone can be an argument in favor of renting instead of buying.
Most people also tend to rent smaller homes or apartments than what they would purchase. This will lower utility costs. You’ll also find that renter’s insurance is far more affordable than homeowner’s insurance. In most situations, you’ll be required to come up with less cash upfront to get into a home as a renter, as well.
Renting also comes with much greater flexibility.
Got a dream job offer across the country? It’s usually cheaper to buy-out of a lease than it is to sell a home.
Don’t like your neighborhood? At the end of your lease, it’s easy to give notice and move elsewhere.
Of course, with renting, you lose out on some tax deductions, such as property taxes and mortgage interest -- even though you’re still paying them via your rent. You’re also not building equity in your own home from paying down a mortgage, and you’re missing out on that sweet, sweet appreciation -- both of which are huge factors in how Americans typically build personal wealth.
The rent vs buy question is one that is deeply personal to you and your family. From the financial aspects to the lifestyle factors, there is no one-size-fits-all answer.
BE THE ROAR not the echo®