Episode 192: October 4, 2010
Debt Loans Credit
by Laura Adams
Has the busted real estate bubble left you feeling confused about whether to rent or buy a home? Maybe there’s something nagging at your subconscious asking, “Am I throwing my money away by renting?” or “Is the American dream of home ownership really so dreamy after all?”
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Well, just like many issues in personal finance, the answer to whether you’re cut out to be a homeowner is “it depends.” It depends because your financial situation, goals, and lifestyle are unique. There’s no right or wrong answer, nor is there a cut-and-dried way to compare the cost of renting to the cost of owning a home. In this article we’ll cover the advantages of renting and buying and I’ll give you some great resources, so you can explore what’s best for you.
Should You Rent a Home?
Homes to rent come in all shapes and sizes, from large single family houses in the country to one bedroom efficiency apartments in the city. No matter where you want to live, there are landlords and management companies that can hook you up. Here are five reasons why signing a lease instead of a mortgage might be a good move for you:
Renting Pro #1: Flexibility
Having flexibility is the best part about being a tenant. Landlords usually want year-long commitments; however, most leases have fairly painless termination terms, such as a 30-day written notice. There’s a lot of freedom—literally and psychologically—to being able to pick up and go. You could take that out-of-state promotion or move back home if your Hollywood career doesn’t work out. On the other hand, if you’re a homeowner and want to pull stakes, you’re usually stuck until you sell the property or find a reliable tenant to help you pay the mortgage.
Renting Pro #2: Low Upfront Cost
The second pro for renting is why most people start out as renters—a low upfront cost. A security deposit plus a month or maybe two months of rent is usually all the money you need. That’s a whole lot cheaper than what it takes to buy a home.
Renting Pro #3: Good Credit Not Necessarily Needed
Some people may have enough cash on hand to purchase real estate, but lack the credit score needed to get approved for a mortgage. I can’t say that credit is irrelevant when you submit a rental application, but some places may not run a credit check if you have impressive references and a steady income.
Renting Pro #4: Less Responsibility
Another benefit to renting is what most homeowners (including me) yearn for as soon as the air conditioner dies in the Florida heat or they hear a trickle from the ceiling after a gully washer downpour—less responsibility. Not only does fixing and maintaining all the appliances and structural parts of a home require money, but it also takes a lot of time. You have to call the professionals, get bids, decide whether to make a homeowner’s insurance claim, and take time off from work to oversee their work. The days of being able to calmly call a landlord to break the bad news about a roof leak or a broken toilet was really nice, I have to say.
Renting Pro #5: Amenities
Not only do you have fewer maintenance and repair hassles as a renter, but some apartments offer additional services to make your life easier. Some communities have on-site restaurants, a salon, or a dry cleaner, for instance, just outside your front door. It’s also not uncommon to have amenities like a clubhouse, pool, gym, theater, or a bowling alley. If you use these types of amenities regularly, think about what you’d have to pay for them if you didn’t rent.
Should You Own a Home?
The challenge in doing an “apples to apples” comparison of the cost of homeownership and renting is that owning has some hidden long-term costs and benefits, and they can vary from year to year.
The challenge in doing an “apples to apples” comparison of the cost of homeownership and renting is that owning has some hidden long-term costs and benefits, and they can vary from year to year. There’s homeowner’s insurance, property taxes, private mortgage insurance (PMI), and maintenance to pay, for instance. But on the other side of the ledger, you may be able to save money with tax advantages and build wealth as a homeowner. Here are five reasons why you might want to make homeownership one of your financial goals:
Homeownership Pro #1: Build Equity
The first major attraction of buying is that you can build equity and wealth for the future. Equity is the difference between a property’s market value and what you owe on it. For instance, if your home is appraised at $200,000 and your mortgage balance is $150,000, then you have $50,000 ($200,000 - $150,000) in equity.
As we know, there’s no guarantee that home values will always go up, but historically real estate has been an excellent long-term investment. Additionally, if you have a fixed-rate mortgage, an increasing portion of each monthly payment goes toward reducing your mortgage balance (which helps builds equity)—whereas rent payments are nothing but a pure out-of-pocket expense. Owning real estate gives you the opportunity to build wealth from price appreciation, by paying down your mortgage, or from both.
Homeownership Pro #2: Tax Incentives
To make homeownership even more attractive and affordable, the government gives you several incentives, such as the mortgage interest tax deduction and the capital gains tax exclusion, which lower the total amount of tax you have to pay.
Homeownership Pro #3: Low Mortgage Rates
An advantage to owning a home right now is that mortgage interest rates are at historic lows and that saves you a bundle! Here’s an example: If you borrow $200,000 at a 7% annual interest rate, your monthly payment for principal and interest would be $1,330. But if you got that same loan at today’s going rate of 4.5%, your payment would be just over $1,000.
Low interest rates can make owning a home cheaper than renting—even with the additional costs of private mortgage insurance, homeowner’s insurance, property taxes, and maintenance. Of course, that won’t be the case in large cities like New York or San Francisco where home prices are notoriously high. Take a look at the index at trulia.com to find out whether you’re better off renting or buying in certain cities.
Homeownership Pro #4: Inflation Hedge
Another advantage of having a fixed-rate mortgage is that you lock in the cost of your home for the term of your loan, such as 15 or 30 years. Rents may increase during periods of inflation, but a fixed mortgage can’t go up. That can make owning a home much more affordable when prices rise.
Homeownership Pro #5: Ownership Pride
The last pro of owning a home is certainly the pride you may feel about having your own patch of land and space to spread out. The sky’s the limit if you want to decorate, remodel, plant a giant pumpkin patch, or raise emus (adhering to local zoning ordinances, of course).
Is It Better to Buy or Rent?
There are some good calculators that can help you with the rent versus buy dilemma at sites like bankrate.com, dinkytown.com, and nolo.com. But none of these calculators are perfect. You have to input key information—like how much a property will appreciate, how much you’ll spend on maintenance, and the inflation rate, for instance—which you can estimate, but are virtually impossible to know.
As usual, I have some final quick and dirty tips. The first is that you should never buy a home unless you’re certain that you’ll stay there for at least five years. You never know how long it could take to sell a house and you have to pay closing costs each time you buy and sell real estate.
And lastly, just because you qualify for a mortgage doesn’t mean that you should get one. It’s a big commitment that has to fit in with all your other financial goals, such as putting enough aside for retirement and paying down your existing debt. If renting will save you money so you can accomplish your financial objectives, then that may be the way to go. But, if buying a home has more advantages and you’re willing to put down some roots, then I’d encourage you to make owning an affordable home one of your goals.
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Dinkytown.com: Rent vs. Buy Calculator
Bankrate.com: How Much House Can You Afford Calculator
NYTimes.com: Is It Better to Buy or Rent Calculator
Nolo.com: Should I Rent or Buy Calculator
SmartMoney.com: Rent or Buy Calculator
MotleyFool.com: Am I Better Off Renting? Calculator