Is it better to rent or buy going into the new year? Easy formula breaks it down

The most significant financial decision most adults will make in their life is whether to buy or rent a home.

When purchasing a home, buyers must navigate various expenses, such as down payments, closing costs, maintenance, property taxes, and insurance, all of which can add up quickly.

In contrast, renting typically involves a more straightforward monthly payment along with a security deposit but may lack the long-term investment benefits of ownership. The complexity and diversity of these costs can make it difficult for individuals to determine which option — buying or renting — best suits their financial situation and lifestyle goals.

A recent analysis from the real estate services firm CBRE found that, on average in the U.S., buying a house is 38% more expensive than renting when it comes to the cost of a monthly payment.

Pros and cons on renting vs. buying

On average, a new apartment lease will cost $2,165 monthly, while a mortgage payment on a new house is nearly $3,000.

When deciding whether to rent or buy a home, Americans should note location plays a big part. Renting in New York City is different than renting in Cleveland, Ohio. According to Apartments.com, the average rent in New York City is $3,871 per month, versus in Cleveland, where it's $1,262 per month.

New York City is just one example, and some may say it's an outlier since it is one of the world's most expensive places to live.

Generally, renting is typically more affordable if you plan to stay somewhere for less than five years. This is because buying a home comes with many upfront costs. You may have to pay thousands of dollars in closing costs, including fees for title insurance, brokerage, and taxes. Unfortunately, these costs are nonrefundable.

When you make a mortgage payment in the first few years, most of your money goes toward interest. Interest is the fee you pay to the bank or lender for borrowing money. It's important to note that this is money you won't get back.

The longer you live in your home, the more your monthly payment goes toward paying down the principal instead of interest. This is important because the principal is how you build equity. Equity is the money you would receive if you decided to sell your house.

When you buy a house, you can make it your own — whether that means painting, tearing down walls, or adding a pool — you're not accountable to a landlord. However, this also means that if something breaks, you're responsible for covering the repair and maintenance costs yourself.

So what's the better overall deal between renting and buying?

One simplified way to compare the cost of renting versus buying is by calculating a "rent ratio." Here’s how it works.

Imagine you're interested in purchasing a $400,000 house. Determine the annual cost of renting a similarly priced house. If the monthly rent is $2,000, that totals $24,000 per year.

To determine the rent ratio, divide $400,000 by $24,000. This calculation results in a rent ratio of 16.7.

A rent ratio below 20 indicates that buying is advantageous. A ratio above 20 suggests that renting may be a better option.

In this example, purchasing could be the better financial option in the long term.

ABC's Lindsey Griswold contributed to the report.