People usually get emotional when the topic of rent versus buy is brought up. One group swears by owning a home, and believes that it is a good decision. The second group believes in renting for life, and brings a lot of arguments to support their decision. I have personally stayed in the “undecided” camp, right in the middle of it all.
We are rational people however, so we want to avoid emotions, and make the best decisions for our own situations. Owning a home is one part a lifestyle decision, and another part a financial decision.
There are pros and cons to buying and renting a home.
I believe that some people who rent may be wasting their money away if house prices in their areas are low. If home prices are high however, people who buy a home may be the ones wasting their money away. Home prices are low, if they are selling at a low multiple of home cost divided by annual rent expense. Home prices are high, if they are selling at a high multiple of home cost dividend by annual rent expense. I find a ratio about 15 or lower to be attractive. If that ratio is over 20, it may be a little bit too high.
Based on my research, if you manage to purchase a comparable unit to what you are currently renting, and you are mindful of costs, you may do better than renting over long periods of time ( exceeding ten years). On the other hand, if you pay a high price to rent multiple, and your monthly payment absorbs most of the funds you would have otherwise used to save to retirement, you may not do as well with buying a home.
You should rent if you:
1) Cannot afford the 20% downpayment for a home
2) Move every 5 – 10 years due to personal or work reasons
3) Simply do not like being tied down to a single location for an extended periods of time
4) Do not want to/cannot afford to spend time maintaining a home
5) Realize that the price to buy is too high
6) May end up buying too much house,
7) Are not ready to settle
8) Are not very handy, and do not want to learn new skills
If you plan to stay at a place for at least a decade, buying might be cheaper, assuming that home cost values are not outrageous. The focus on valuation is similar to the evaluation we use when considering dividend stocks for long-term investment.
For someone staying at a place for a decade, owning could turn out to be cheaper than renting. When you rent you pay the landlords:
– Property Taxes
– Administrative Costs
– Depreciation on the property
But most importantly, you pay a profit to the landlord, who risked their capital and wants to earn an attractive rate of return on it.
The government has provided certain advantages for owning a home. For example, you can get a 30 year fixed rate mortgage in the US, which is at something like 3% – 4%. This is very low. You are essentially purchasing an asset with 20% down (and in some instances as low as 3% – 5% down). This is a large amount of leverage. If you put 20% down in an asset, and the asset increases in value by 20%, you have essentially doubled your original investment. If the home price declines however, you can lose money on paper. If you can afford the monthly payments however, any short-term fluctuations in home prices should not matter to you.
You also get to deduct that mortgage interest on your taxes. However, if you didn’t have the mortgage interest deduction, you would have been using the standard deduction, so this is a moot point in my opinion ( unless of course you are buying too much house).
If you live in a home for 2 out of 5 years, and you sell that home, any gains up to $250,000/individual or $500,000/couple are exempt from federal income taxes. This is a pretty neat advantage to consider. On the other hand, houses usually appreciate at the rate of inflation, according to research by Prof Schiller.
Source: Robert Schiller
Perhaps the property markets of San Francisco and New York are an exception to the rule. I would think that prices in the Midwest would likely follow the rate of inflation. So in other words, if you buy a house in Kansas City for $250,000, and you hold for 24 years at a time when inflation is at 3%/year, your house may be worth $500,000 later. If you decide to sell the house, you would have a “gain” of $250,000. However, in real dollars, you would not be any better off than before. At least you won’t have to pay a tax on capital gains, which could make you poorer at a rate of 23.80%. (plus state tax)
All of this of course assumes comparable units of buying versus renting comparisons. I have often seen someone in the pro-rent camp compare the costs of renting a 1,000 square feet house/apartment to the costs of owning a 2,000 square foot house in an effort to justify their opinion. If you do not compare apples to apples, your decision will not be the most optimal one.
It also assumes that you do not fit one of the criteria I listed at the beginning of the article, which would make renting more advisable. If you overpay for a home, and your expenses are higher than what you would get by renting this equivalent unit, then you are not making a smart choice.
There is the argument is that the real prices of homes in the US have remained pretty flat/stable over the past 120 years. This means that the price of a home barely goes up to match inflation. This is a reason why home ownership is viewed as a bad idea. However, those statistics usually ignore what I call the “housing dividend”. If you own your home, you can essentially live in it rent-free (minus maintenance costs, property taxes, and insurance). Therefore, the benefit of owning a home is the shelter it provides. I view this shelter as a home dividend. You can call it a house dividend as well. As a homeowner, you are essentially paying rent to yourself, building equity.
On a side note, people regularly forget about the impact of dividends on returns when they look at stock charts. This is why I find stock charts to be misleading.
As a hidden bonus, owning may be better than renting, because as an owner, you are more likely to care about choosing energy efficient appliances, energy efficient heating and cooling, as well as making sure that insulation is good. If you are handy like my friend Carl however, you may also manage to increase the value of your home by renovating it completely.
Owning is not a slam dunk decision however. There are many risks associated with it.
In general, you need