TL;DR
There are several financial and non-financial considerations when deciding to rent or buy a home. Renting is often associated with flexibility, lack of maintenance responsibilities, building amenities, urban locations, and lower upfront capital requirements. Buying a home is typically associated with large upfront costs, stability, and building equity in the property over time. Weighing all of the factors together is very important when considering this big decision! It comes down to your current financial situation, desired lifestyle, and personal goals.
RENT OR BUY? YOU MAKE THE CALL
This can be a very emotional decision, but if you're smart about your personal situation and lay out your financial and non-financial goals then you'll find yourself in the best possible position!
Regardless of which option to choose, a general rule of thumb is to keep your monthly housing costs to approximately 30% or less of your gross income. While renting may seem like throwing away cash without building equity, this missed opportunity can be offset with the flexibility of 1-year lease commitments, lower monthly payments, the ability to tackle other financial goals during rental years, and lifestyle perks such as urban convenience and amenities.
If you believe you can financially afford a home in your desired area, you are likely to remain in the home for 5 or more years, and you can reasonably afford the monthly cost of owning the home in question, then buying is often the correct decision from a long-term financial standpoint. The monthly costs of owning a home typically include a mortgage payment (principal, interest, taxes, insurance), maintenance, repairs, utilities, homeowner’s association dues, and general upkeep.
Renting or buying a home is a big decision! It will likely have lasting effects on your life and financial picture, so you'll want to make sure you're approaching it with all of the factors in mind. In this section, we'll discuss the different factors involved in deciding whether it makes sense for your situation to rent or buy.
KEY FACTORS INVOLVED
What are the key factors to consider when deciding whether to rent or buy? It’s important to consider multiple decision points. This calculator from the New York Times does a nice job of laying out all of the financial factors for purchasing a property while comparing the result to rent prices for a similar home.
The macroeconomic landscape can also have a large impact, such as rising interest rates or highly competitive housing markets with rising prices and low inventory of homes for sale.
Let’s consider the main factors:
Lifestyle
Do you want to live downtown in a big city with access to bars, restaurants, fitness options, and other urban amenities? Then renting may be right for you. Many rental properties also have built-in features like gyms, rooftops, dog wash stations, pools, and package management. But they often come at a cost!
Personal preferences in terms of lifestyle and level of flexibility will always be a big determinant as to whether renting or buying is right for you. When deciding to rent, consider researching all of the considerations including everything from splitting the rental with roommates, parking situation, and which floor to live on.
If you're looking for more stability and don't necessarily need the freedom to move around as frequently, then buying a home may be right for you. Many people prefer buying a home due to the larger space necessary to raise a family, or simply to be in a quieter, more rural area. Of course, people can buy condos, townhomes, and other properties right downtown in their favorite city as well - but that often comes with a larger price tag!
Financial goals
Your current financial situation has an impact on whether renting vs buying makes sense as well. If things aren't going so well financially right now then making extra payments towards debt rather than paying off mortgage interest over time might help alleviate some stress while still providing benefits like tax deductions from mortgage interest payments made during those same years.
Is buying a house within your financial reach? Do you have other competing financial goals like paying off debt, buying a car, or saving for children’s college? Do you have enough money saved up for a down payment and enough monthly income for a larger mortgage payment? If not, then renting may make more sense for now. If you do have those things taken care of, it could make sense to take on the responsibilities of homeownership to reap future benefits like building equity in your real estate property while the property appreciates over time.
Renting a home can be an excellent way to save money, but it can also be extremely expensive depending on your area. Many apartments require the first month’s rent plus a security deposit upfront, and some properties require the last month’s rent upfront as well!
Renting a home can be an excellent way to save money, but it can also be extremely expensive depending on your area.
Many apartments require the first month’s rent plus a security deposit upfront, and some properties require the last month’s rent upfront as well!
Flexibility
Do you want your home to be a short-term commitment where you may only have to live there for 1 year? There are other reasons why renting might be more attractive, such as not having to worry about maintenance work, repairs, property taxes, or HOA fees.
Stability is, on the other hand, one of the big benefits of owning a home. You know exactly what your monthly costs will be and how long it will take for that mortgage to pay off. This can make things easier when planning for retirement or deciding where your children should attend high school (or college!).
Time
How long do you expect to live in a given area? If you're planning on staying in an area for longer than 5-6 years it might make sense to buy a place (though this is a very rough generalization).
The first hurdle is your upfront closing costs. Every time you go through closing — buying and selling — you can be on the hook for a significant amount in closing costs! This can be anywhere from 4-8% of the value of the property and includes loan origination fees, discount points, appraisal fees, title searches, title insurance, surveys, taxes, deed recording fees, and credit report charges. Depending on where your house happens to be, the buyers and sellers pay different amounts, but everyone pays something. This can easily add up to thousands of dollars.
The second consideration is the structure of your mortgage. How mortgages are constructed, you pay much more interest in the first few years you own a house. Usually, it isn’t until you’re about five years into paying down the mortgage that you’ve made enough progress on the principal to break even since originating the loan upfront.
On the other hand, if you know that you'll be moving shortly after something like grad school, med school, or law school (or have no idea what your future holds), renting will give you more flexibility.
Cost
What is your current financial situation? Can you afford monthly home ownership costs in addition to making a down payment, paying closing costs, insurance, etc.? This is certainly something to consider....while owning real estate can make sense financially over time, buying too early can do more damage than good, don't let your emotions get the best of you!
- Can you afford the monthly payments? Remember the 30% rule for gross monthly income listed above.
- Can you afford the down payment? The golden rule is 20% of fair market value.
- Can you afford all closing costs associated with purchasing your home? This can be another 4 - 8% of the property’s fair market value.
- What about property taxes and homeowners insurance? In many states, property taxes and insurance can add another 20-30% of your mortgage principal and interest (see example below).
This article shows the Top 10 cities in America ranked by highest median home values, according to research data from Zillow:
- San Jose, CA $1,390,000
- Los Angeles, CA $998,330
- San Francisco, CA $978,478
- Ventura, CA $943,967
- San Diego, CA $921,000
- Stamford, CT $900,000
- Seattle, WA $782,997
- Boston, MA $746,000
- Honolulu, HI $721,667
- New York, NY $692,333
Let’s take an example…
If you want to purchase an $850,000 home today (July 2022), putting down 20% to avoid PMI (private mortgage insurance) would cost you $170,000 upfront. Let’s assume another $51,000 for closing costs (6% of home value). By taking out a 30-year fixed mortgage loan at 6.6% interest with an excellent credit score of 800+, principal and interest would be $4,351, and your monthly property taxes and insurance are estimated at $1,133.
In summary, your $850,000 house will cost you $221,000 upfront and will require a monthly payment of $5,484! Using the 30% rule, this would imply a minimum gross household income of $183,000 per year.
Going further, are you currently paying a high rent payment that you could be putting towards a mortgage instead? This will clearly depend on where you live but if rent prices are high in your area it may be smarter financially to put the money towards a monthly mortgage payment to build equity instead. Many people often think of renting as a cheaper option, but when you consider that the average rent in Manhattan, NY just topped $5,000 (!!) there may be an argument to be made for purchasing a home that comes with a lower mortgage payment.
Another top priority on that list is the ongoing cost of living. The higher your cost of living, the more likely it is that renting will be more expensive than buying a home; this is especially true in urban areas where real estate prices are high. If you live in an area with a low average income, however, it may make more sense for you to rent rather than buy a house (though this can also depend on how quickly your salary can rise).
NEXT STEPS
Hopefully, this post helped you get a better understanding of some of the key things to consider when deciding whether or not to rent or buy. As mentioned, there are many factors that should be considered when making this decision and it can sometimes be overwhelming! This is why we've created a 3-part series on home buying.
In Part II of our home buying series, we'll discuss how to think about home affordability and how to determine a reasonable budget for purchasing a property once you’ve decided you would like to be a homeowner.
After that, Part III will take a look at the complete home buying process. We’ll cover everything from the moment you begin looking at homes in your area, all the way through signing the final closing documents and getting the keys!
Range is here to help.
With Range, you can connect all your finances into a single dashboard to track, monitor and plan the best version of your life. Say goodbye to middlemen and spreadsheets and hello to the new financial you.
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