— -- Which is the better financial move: Owning a home or renting one?
To a large extent, the answer depends on your location, the market environment, your family situation and your lifestyle preferences. Because paying for a place to live is most people’s biggest lifetime expense, weighing the options is critical to your financial well-being. While buying is undeniably an investment, it’s a far different kind of investment than buying stocks or bonds, which are optional. Everyone needs a place to live.
Perhaps the best financial reason to buy is that it enables you to gradually acquire ownership, or equity. Renting has the serious downside of not acquiring equity, so renters never end up owning and must continue to pay rent, perhaps for their entire lives. Yet, if people rent at low enough costs, they may have money left over to invest and make up for their lack of home equity — if they have the discipline to put money aside.
Also, owners generally qualify for a tax deduction on mortgage interest. As this deduction lowers average monthly costs of ownership, it can enable people to own more house than they could afford to rent. Yet the costs of owning, aside from the down payment and monthly mortgage payments, can mount up from property taxes, insurance premiums and maintenance.
A big potential upside of owning is appreciation — the rise in house’s value over time. Contrary to the common misconception that all homes sell for more than the purchase price after a long period, depending on when you buy and sell and the conditions of your local market, there might not be much real appreciation, even over long time spans. According to the Case-Shiller index of home values, from the mid-1950s to the mid-1990s, average values nationwide didn’t really appreciate at all, when adjusted for inflation. (In between, there were ups and downs that presented advantageous times to buy or sell, but it’s hard to predict when these periods will occur.) And nationwide averages still haven’t come back to their values at the 2006 peak, before the financial crisis of 2008 took its toll.
These are national figures. As values vary widely across the country — there’s an old adage that all real estate value issues are local — Case-Shiller publishes indexes specific to various markets around the country.
Cost comparisons on renting versus buying vary significantly around the country, depending on local real estate values and the supply of rental housing. If the supply is sparse enough, this can push up rents to the point where buying is clearly the better move.
Even if there’s an ample supply of rentals at reasonable prices, home price appreciation can push up rents over time. When you buy, you can lock in a mortgage payment for 15 to 30 years and ultimately benefit from appreciation rather than suffering from it as a renter who must pay escalating monthly costs. Even if you can rent a house now for a substantially lower monthly payment than what you’d pay on a mortgage for a comparable dwelling, gradual appreciation can mean that years down the road, your monthly rent could easily be so much higher than your mortgage payment would have been and you could still have had plenty of money left over to pay taxes, insurance and upkeep if you had bought. And by buying, you’d be acquiring equity to boot.
Another big factor is mortgage interest rates. If you buy during a period of low rates, this means lower monthly payments.
It’s not unusual for people to assume wrongly that they can’t afford to buy. I had a client who had rented her entire adult life — and planned to continue doing so — until she saw that buying was the better choice. She’d let her fear of upkeep — she lacked home-improvement skills — keep her from buying. I did a financial plan for her showing all the costs and accounting for the fact that, with projected rent increases and with interest rates where they were then, it made sense to buy a home with a small down payment to lock in an affordable mortgage payment. Thus, she could gain equity and still afford to maintain a fund for repairs and insurance—far cheaper than paying rent increases. In that location, for her, buying at that time made sense.
Even in brisk local markets with swift appreciation, however, renting may be the best choice for people whose careers require them to relocate frequently. Over a couple years, it takes a lot of appreciation to counter-balance the initial costs of buying and selling, including mortgage lenders’ and realtors’ fees. And because monthly payments tend to consist of mostly interest early in many mortgages, buyers usually acquire little equity in the first several years — except in markets with astronomical appreciation. Though some parts of the country experienced this kind of appreciation in the bubble that popped in 2008, this scenario is historically quite rare nationwide. So unless you can afford to keep your existing home if you were to get a new job hundreds of miles away (which could mean paying a property manager to handle your home as rental property), you’re often better off renting.
Whether you buy or rent, here are some things to keep in mind:
- 1. Don’t get more house than you can afford. High rent punishes people two ways: They don’t get equity and they lack money to make investments. And too high a mortgage payment can severely limit resources for other expenses.
- 2. What are similar homes renting for in the area? If you had to leave your home and couldn’t sell it, could you rent it to cover your payments? Remember, you’ll need to be able to rent it for enough over the mortgage payment to fund a reserve for repairs and vacancies. If you aren’t comfortable handling the rental yourself — or, if you have to move out of town, you might need a property manager to oversee things — which could drain 10 percent of the rental income.
- 3. Resist the all-too American urge to keep trading up. One reason that buying is a good move is that you eventually own the house. But if you keep cashing in for a bigger, more expensive home — and another mortgage — you hinder your ability to acquire equity. Instead, you sustain debt and increase your insurance, upkeep and utility costs. If a rising income prompts you to keep getting bigger and better rentals, perhaps you should consider buying.
Remember that the goal of buying is to eventually own the home. In many markets, people sell their homes when they retire and buy less expensive ones, using the profit to pay retirement expenses while lowering their upkeep costs.
Opinions expressed in this column are solely those of the author.
Byron L. Studdard, a CERTIFIED FINANCIAL PLANNER™ practitioner, is founder and president of Studdard Financial, LLC, a fee-only financial advisory firm in Sarasota, Fla., dedicated to helping clients build wealth, protect it and pass it on to future generations. Studdard has been listed in the Guide to America's Best Financial Planners (published by the Consumers' Research Council of America, an independent research organization). He can be reached at Byron@studdardfinancial.com. If you have a question for him, send him an email and he will try to answer it in an upcoming column.