There is growing sentiment that it is better to rent than to buy a home. People argue that owning a house is much more expensive than renting, because you have to pay taxes, and maintain the house. You also have to spend more money on down payments than you would to rent a house. I believe that in a perfect world, sometimes it makes sense to rent, but for most people buying a house is a better financial decision than renting. If you look at the numbers, the majority of most peoples net worth comes from their home. Home owners have 44 times the net worth of renters and owning a home can also be less risky than renting.
When deciding whether to buy or rent, consider your plans
The first step when deciding whether to rent or buy is deciding what you want a house for. Do you want a rental property, a place to live, or a place to live that you turn into a rental property later on. If you want a rental property then you obviously want to buy a house, but that doesn’t mean you have to buy the house you live in. You could rent the house you live in and buy the rental property. Or you could live in a house for a year and then turn the home into a rental property.
When deciding whether it is better to rent or buy a house, you have to consider where you want to be in one, five or even ten years. The longer you stay in a location the more sense it makes to buy a home. Real estate prices have historically always gone up, but they can also decline in the short-term. The longer you live in a home, the better chance it will go up in value. If you plan to move in one year or two years it may be smarter to rent. Here are some other considerations when buying or selling a house.
- It costs money to sell a house. If you have to sell you need to sell the home for six to ten percent more than you bought it for to break even.
- It can take time to sell a house. In today’s market houses are selling very quickly, but in a down market it can take months to sell a home. If you want to move quickly buying a home can be a hindrance.
- Can you qualify for a loan to buy a home? If you can’t get a loan to buy a house, than renting is the obvious choice. To qualify for a loan buyers need to have good credit, a steady job and enough income to cover their current debt and a new mortgage. Many people don’t realize that a large car payment or two can greatly affect their ability to qualify for a loan. Credit card debt and any payments that you make for appliances, furniture or student loans all affect your ability to qualify for a mortgage.
Qualifying for investment property
Another consideration for those that want to invest in real estate is qualifying for a loan. If you buy the most expensive house you can qualify for, you won’t be able to qualify for a loan on an investment property. This is one reason I don’t think it is always a bad thing to rent a home if you want to buy a rental property. If you want to buy rental properties and invest in real estate, buying a personal house may slow you down. If you are willing to live in a house that can be turned into a rental property, this can be a great way to get started investing with little money down.
How much is rent compared to the costs of buying a home
If you don’t want to invest in rental properties, but just want to know if it is smarter to rent or buy, you have to look at your market. Some markets are better to rent in and some markets are better to buy in. Again, you have to consider how long you want to live in a house as well. In my market, rental rates are extremely high compared to what you can buy a house for. I think this makes my area great for landlords that want to make money with rental properties, but it makes it hard on people who want to rent houses. Here are some numbers on renting versus buying in my area.
Buy a house for $200,000
- Mortgage payment with 5 percent down: $962
- Taxes and insurance: $200
- Mortgage insurance: $200 (required on most loans with less than 20% down)
- Total payment: $1,362
- Total cash needed: $10,000 (assuming seller will pay for buyers’ closing costs)
Rent a house worth $200,000
- Rental payment: $1,600
- Total cash needed: $3,200 (for first month’s rent and deposit)
There are a lot of things to consider when deciding whether to rent or buy in this situation. The monthly payments are more when you rent, but there is more cash needed to buy the home. Now, if you can use a VA or FHA loan you may be able to put less money down, which might make buying a better option. When you buy a home you do not have to make a payment until the second month you own the house. That would save you another $1,362 over renting the home. Even though you are paying more cash with buying a house, that cash is going towards the house. If you sell the house you will get that money back, but you have selling costs like paying a real estate agent.
When you buy a house, part of your mortgage payment also goes towards paying off your loan. About $200 of your $1,362 mortgage payment will go towards equity pay down. After one year you could be paying off $2,000 or more of your loan if you buy a house. This is why it is important to know how long you think you will live in a house or an area. The longer you live in a house the more equity you will gain through mortgage pay down and possible appreciation. When you buy a house your interest part of the mortgage payment is also tax-deductible. The savings from the tax deductions will vary based on your tax bracket, but for the average person this may save $2,500 a year.
Looking at the numbers more closely; buying a house saves $238 in lower payments, $200 in equity pay down, $196 in tax savings, and $500 a month if a house appreciates three percent a year. That totals over $1,100 a month in savings if you buy a home instead of renting one. That savings more than makes up for the extra cash you have to spend buying the home to begin with. There are however more things to consider.
What about the maintenance and repairs a house requires?
When you rent a house, you do not have to pay for maintenance and repairs. The landlord will pay to make repairs for things that break or wear out. When you own a house, you are responsible to pay for the maintenance and repairs that are needed. When an investor owns a rental property, a good rule of thumb is that 10 to 20 percent of the monthly rents will be used for maintenance. When you own a home I think that same figure can be used to determine how much maintenance a home will need. If your house payments are $1,300 a month, then you can count on at least $1,300 a year in maintenance and repairs that will be needed. $1,300 is not a lot of money to spend on maintenance, but many times we want to improve a house or make updates to houses we own. Improvements are a hard thing to value, but in most cases they add value to a home. In some cases they will add more value than they cost and in other cases they will add less. I will assume the improvements made in houses will equal the value added.
Why buying a house will always beat renting a house if you buy right
Up to this point it looks like buying a house beats renting a house, but there are many factors we did not consider. In many areas, rental prices are not as high compared to mortgage payments as they are in Northern Colorado. In some areas house prices are extremely high and they have rent control which keeps rent low. Even in those areas, there is one thing that will always make buying a better option. If you can buy below market value you can make thousands as soon as you sign the paperwork. When I buy houses I want to buy them at 20 percent or less of what they are worth. For me I would want that $200,000 house for $160,000 and that would make me a lot of money as soon as I bought the home. To get a deal like that, I would have to make repairs and it would take a lot of work and patience. If you are willing to do the work and find those deals, buying beats renting every time.
For more information on investing in real estate, check out my book Build a Rental Property Empire: the no-nonsense book on finding deals, financing the right way, and managing wisely.
Buying versus renting may seem like an easy decision, but many people do not want to take the time to get a great deal. Many people also want to move in a year or two and in these cases it may make more sense to rent. If you can take the time to buy houses below market value and you consider the other advantages, buying is the clear winner. If you want to invest in rental properties, buying a house as an owner occupant that can be turned into a rental property is a great way to get started. If you can’t bring yourself to live in a future rental property, renting may not be the worst thing you can do if it helps you qualify for a rental property.