Should you buy your home?
Or rent forever?
For some of you, it might be obvious to buy a home because that’s what your parents did, or you might think that renting is just throwing away money.
For others, you might think that renting is better because you have more flexibility in where you live.
Or the peace of mind knowing when something breaks, all you have to do is call the landlord and everything magically gets fixed.
Both sides have really good arguments, but this has been a long-standing debate, and ultimately, you have to do what’s best for you and your family.
Because whatever you decide, it will impact your life and financial wealth. It is literally one of, if not, the biggest financial decisions you’ll make.
So in this post, we will explain the difference between buying a home and renting.
And by the end of it, you will understand the financial impacts of both.
If that sounds good to you, let’s dive in!
Buying a Home Advantages
Oftentimes, people associate homeownership with living the “American dream”, and there are a few reasons why, such as:
- The ability to accumulate wealth.
- The average net worth of homeowners is 80 times larger than renters according to the U.S. Census Bureau.
If you own a home, this is likely your largest asset and it is directly tied to your net worth.
And owning a home encourages intergenerational homeownership and wealth.
Children of homeowners tend to transition to homeownership sooner which extends the time period they can accumulate their wealth and pass down even more to their children.
All of that sounds good but let us give you solid financial advantages of owning a home.
1. It is usually a good investment.
In general, real estate appreciates in value over time. About 3-4% annually is the average. So if you buy a home for $400,000, it should be worth about $475,000 in 5 years.
And if you choose to sell your home at that point, you would not have to pay any capital gains tax on the sale, up to $500,000 for married couples.
2. Hedges your risk against inflation
Right now, we see that inflation is at an all-time high. And if you don’t know, inflation is a decrease in purchasing power.
Basically, a dollar doesn’t buy you as much as it used to a few years ago. And this is shown in the increase in the price of things like interest rates.
When you own a home, you can lock in a fixed interest rate. So as inflation and interest rates increase, you can avoid paying higher interest rates later on.
And as with any good or service that increases in price with inflation, rent is included. In fact, rent tends to increase on average 3 to 5 percent annually.
When you own a home, you are not exposed to rising rent. Your cost of living is fixed, regardless of the market and inflation.
If you want to learn more about inflation tax, then read this post next.
3. Building equity
Equity is the portion of the home that you have already paid off. So if you had a 20% down payment, your starting equity would be 20% of the home value.
As you make your monthly mortgage payments, your home equity grows and gives you more borrowing power.
So this means as a homeowner, you have the flexibility to take money out of your home in the form of a home equity loan.
These loans can be used to fund:
- home improvements projects,
- your kid’s education,
- an emergency fund,
- a new car,
…or anything else for that matter.
You essentially have more access to cash when you own a home.
4. There are tax incentives for homeownership.
You are able to deduct your mortgage interest and property taxes on your annual tax return.
During the first several years of paying a mortgage, most of your monthly payments are going toward interest.
This means at the end of the year, there is a large tax deduction you can take.
You’re also able to deduct what you paid in property taxes as well.
Check out this post next to know more about how you can pay less in property taxes.
*These tax incentives are dependent on if you take the standard deduction or itemize your deductions so do keep that in mind.
Buying a Home Disadvantages
So you have the financial advantages of owning a home but what are the disadvantages?
1. There are higher upfront costs to homeownership.
When you buy a home, you typically need 20% of the purchase price as a down payment. This could easily mean at least $30,000.
Not to mention the costs of an appraisal (which is required to secure a mortgage), mortgage underwriting fees, and home inspection costs.
Probably one of the biggest financial disadvantages to owning a home is the maintenance costs.
It doesn’t matter if the AC goes out, the sink is leaking, or if you stumbled across a pest issue in the basement. You are solely responsible.
There isn’t a landlord to call, in fact, you can think of yourself as the landlord when you own a home.
And if you think you won’t have much to fix or those problems are far and few between…
…we can tell you that 99% of the time, there is usually always something that needs to be fixed, updated, or routinely maintained in a home.
Besides just repairs, there are also potential costs like lawn maintenance, shoveling snow, and cleaning the gutters.
The 1% rule says you’ll pay about 1 percent of the home’s purchase price in maintenance annually.
2. Long term commitment
Life happens and maybe you change jobs or go through a divorce and your household income is just not as high as it was when you first bought a home.
Those facts would not change your mortgage payment or property tax obligations.
You could sell your house or refinance your mortgage in these circumstances, but doing so would come at a cost as well in form of refinancing fees and the selling costs to sell a home.
So there’s another disadvantage to owning we want to talk about.
It’s not really one of your “traditional” disadvantages you hear people talking about, but we think it’s worth bringing up. And that’s the…
3. Opportunity Cost of Owning
Think of opportunity costs as the loss of potential gain from other alternatives when one alternative is chosen.
So what potential gain are you missing out on by owning?
What other opportunities could you take advantage of with money saved that could go to a down payment but instead goes to something else?
Well, for it to be better than buying a house, it would have to be some kind of investment vehicle, like the stock market.
The argument here is that it’s possible that you could earn more from investing in the stock market or other investments than from buying a home.
For example, let’s say you invested $30,000 in the stock market today. Based on the average growth rate of the stock market at 7%, you would have over $55,000 10 years from now.
If that $30,000 went to a down payment, it would be locked in the value of the home. And it certainly would not be worth a penny over $30,000.
The bottom line is, there is an opportunity cost to owning and it is completely possible to earn returns from investing in other vehicles besides your residence.
Renting a Home Advantages
Now let’s move on to the advantages and disadvantages of renting a home, starting first with the advantages.
1. Lower upfront costs
Renting does not require a traditional down payment like owning does. There’s no need to save up $30,000 to rent an apartment
Most landlords do require some kind of security deposit that’s usually first or last month’s rent but that’s normally it.
And if the unit is in good condition at the end of your lease, you can expect to get that deposit back.
2. No maintenance or repair costs
When you rent, your landlord is responsible for all maintenance, repairs, and improvements.
If something breaks or stops working, you call the landlord and they are required to fix it.
Depending on your lease, you might be required to contribute to repairs that are a direct result of your actions. But if you’re taking care of the unit, this shouldn’t be the case.
3. You don’t have to pay property taxes.
Renters don’t pay property taxes. Property taxes can be a huge burden on homeowners.
Property taxes are calculated by estimating property value, the amount of land the property sits on, and location.
And depending on these factors, not paying property taxes is a major cost-saving.
4. Renters typically have lower utility and insurance costs.
Many landlords cover some of the utility costs for tenants like garbage, water, and even internet.
Furthermore, rental units typically have more efficient floor plans which make them cheaper to heat and power than a traditional single-family home.
Insurance costs also tend to be lower with renting than owning. Homeowner’s insurance is required when owning and usually does not cover everything inside the home.
Renters insurance, however, is much cheaper than homeowners insurance and basically covers everything inside your unit.
The average cost of homeowners insurance is around $1300 per year compared to $180 per year for renters insurance.
Renting a Home Disadvantages
1. It isn’t an investment.
You aren’t building any equity in the rental property.
All you take with you when you leave is yourself and your belongings. Basically, it’s your home but it is not your asset.
2. There aren’t any tax incentives for renting.
You can’t write off your rent payments.
And as we know with owning a home, you can write off the interest portion of your mortgage payments.
3. Rent costs are not fixed.
Landlords can increase the rent at any time. You don’t know if they’ll increase by $20 or $200 or more. You’re pretty much at their mercy.
In addition to raising your rent, they can decide to sell the property at any time.
Thus, forcing you to look for a new place to live and incur additional moving costs.
Buying vs Renting: Recap of Both
So, we just gave you a lot of financial information to think about when considering buying or renting a home.
You learned that buying is an investment with real estate generally going up in value over time.
You build equity in a home by making your mortgage payments which allow you to take money out of your home, if needed.
You also hedge against inflation and there are some tax incentives.
Buying also comes at a cost that includes property taxes, maintenance costs, and higher upfront costs.
Renting can also be a good thing since there are no maintenance costs, no property taxes, and lower upfront costs.
The pitfall of renting is the fact that it is not an investment, there aren’t any tax incentives and rent costs are not fixed.
Nonfinancial Considerations of Buying vs Renting
Lastly, we want to mention some of the non-financial, lifestyle pros and cons of buying and renting.
With owning a home, there’s pride associated with that.
It’s your property. It’s your community.
9 times out 10, when you buy a home you are planning on staying in that home for at least 5 to 10 years or more. It’s a more stable environment for you.
You’re also free to re-decorate and renovate your property as you wish.
With all of that, buying does come with its fair share of stress.
Stress when looking for a property, buying a property, renovating a property or even just when something breaks, it is your responsibility and all of that can be stressful for homeowners.
This brings us to renting…
There’s a certain peace of mind you have with renting.
You don’t have to worry about how things are going to get fixed or maintaining a yard.
You’re free to move as often as you’d like. If after living somewhere and you don’t like it, you are not obligated to stay there.
Or maybe you travel a lot and don’t want all of the responsibilities of owning.
Renting will definitely be a lot less stressful.
Also, if you like the amenities that usually come with renting this is also a benefit. Having a gym, pool, or game room might be something you really want to have on a day-to-day basis.
But with that, you’re also having to share these spaces with others and it is not customized to your liking.
And you’re also not able to really customize and decorate your unit how you’d like.
Hopefully, we were able to clear up the major financial and nonfinancial differences between buying vs renting a home.
Ultimately, you should not only seriously consider the financial impacts of both, but the non-financial, lifestyle considerations as well.