Housing

Buying vs Renting a House

The decision to buy your first home or continue renting is a complex decision that many households face and the answer depends on a number of factors that are unique to each situation. In this article, we explore several of these factors both internal and external and hopefully help our readers make an informed decision with a better understanding of the drivers of this decision.

1. Interest rates:

It may seem odd that we ranked interest rates as the first factor to consider when buying a home but the interest rate can have a huge impact on how much your home will eventually cost you. Even with interest rates close to a generational low right now, a 30 year mortgage at a 4% rate could end up costing as much in interest as the price of the home. By the time you are done paying off a $500,000 home 30 years later, you may have paid as much as $1 million after including the interest you paid on the loan. Our Mortgage Calculator can show you the fully amortized cost of a loan along with a break down by month of who much you will pay in interest and how much of your monthly payment will go towards the principle.

Your choice of a loan product (30 years, 15 years, interest only, adjustable rate mortgage, etc.), the timing of your purchase and your ability to refinance if and when interest rates drop can have a large impact on your total cost. We discussed interest rates in more detail in our articles “Why are mortgage rates pegged to the 10 year treasury note” and “Should you refinance your mortgage”.

2. Rent = Buy?

Does it cost the same amount to rent a property as it does to buy a similar property in the same area? This is not often the case but can and does happen either because of area specific factors or on account of a downturn in the economy like we saw during the great recession from 2007 through 2009. Area specific factors could include high property taxes, lack of job mobility, lack of good schools, etc.

The kind of loan you take, 30 year fixed, 15 year fixed, an adjustable rate mortgage, a mortgage that moves with you or an interest only loan, can all significantly impact the rent vs. buy equation. For a conservative estimate, use the mortgage payment for a 30 year fixed loan to determine your monthly morgage cost and add property taxes and insurance to it to come up with your monthly outlay for a home.

In some cases it may actually make sense to pay a whole lot more than what it costs to rent a property to buy one. This could be on account of local factors like prop ? in California that caps the rate at which property taxes can increase each year. This and a fixed interest rate can protect you from the inflation in housing costs most renters face where their rents keep going up but homeowners pay the same mortgage payment year after year. This can make a huge difference if you stay in the home over a long period of time. A $2,500 monthly mortgage payment that may seem large today, may not look quite that large 10 years hence after inflation has caused rents to go up a lot and wage increases and/or career growth has caused your income to rise over the course of a decade.

3. Hidden costs of ownership.

When budgeting to buy a home, first time home buyers are usually just focused on the down payment, the monthly mortgage payment and property taxes. They should open the aperture a little and also think about regular maintenance (gardening, trees, gutter cleanup, etc.) as well more capital intensive deferred maintenance project like a new roof, a new fence, painting, etc. As the word implies, you can only defer deferred maintenance for a while and it is probably best to save towards these projects that will eventually show up. While some folks may have anticipated maintenance costs as well, most don’t realize that moving from an apartment to a house can lead to an increase in utility costs as water, sewage, heating and cooling bills are all likely to go up substantially. One additional hidden cost could be assessements that condo or townhome owners associations could charge to undertake large projects such as retrofitting the property to meet new earthquake standards or a large roofing project. The Home Owners Association (HOA) fees that condo and townhome owners pay also often increases at a rate that far exceeds inflation.

4. Insurance:

Expensive and vary based on your location. Homeowners required. Based on where you live, you may also need flood or earthquake insurance. If you have a young family and not a lot of savings after you put down a down payment for the house, then you may also want to consider term life insurance. This will allow the family to continue to afford the house if something untoward were to happen to the primary breadwinner and will insure them against having to sell the home at an inopportune moment that is likely to be one of the worst moments of their life.

5. Benefits:

The benefits side of the equation includes both tangible and intangible benefits including a larger space to raise a family, a sense of permanence and belonging. Tangible benefits include being heavily invested in an asset class (real estate) that has the best long-term returns after stocks with much less volatility. Considering the nature of the asset class, it is also tax efficient both from the fact that if and when you eventually sell, the gains are at the lower capital gains rate and the first $500,000 (?) of gains on a primary resicence are tax free as long as you lived in that residence for at least ? years.

6. Buying would make sense if you plan to live in the same area for more than 5 years as the cost of buying and selling a home are significant and if you use a mortgage, the amortized nature of mortgages would mean you will pay mostly interest in the first few years of a mortgage and very little towards the principle. One common fallacy is that people assume they will move in a few years but more likely than not end up staying in the same place for an extended period of time. Inertia is a powerful force.

7. Opportunity cost of the money that was put down as a down payment and opportunity cost of paying more each month compared to renting.

8. Flexibility to pick up and move, providing chances to improve job prospects or experience new places and cultures. Cost of sellign a home (6%) has come down if an online brokerage like Redfin is used but there are other ancillary costs such as staging the home, taxes on capital gains, etc.

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