Common wisdom holds that owning a home is wiser than renting over the long haul. Perhaps the most important factor in the rent vs. buy calculation is the length of time you plan to stay in one place. The deeper your roots, the more logical it is to own your home. But other factors come into play: The economic health of your hometown or state, your financial discipline and your aptitude at home improvement projects, to name a few.
The Case for Homeownership
If you finance your home purchase with a fixed-rate mortgage loan, you will know the precise amount of your principal and interest payments for the life of the loan, whose term could last as long as 30 years. This long-term predictability fosters financial stability. If you rent, however, you’ll have much more difficulty accurately predicting your monthly rent for years to come. You’ll likely be at the whim of your landlord and the rental market every year.
Of course, for a homeowner, principal and interest payments are only part of the homeownership equation. Homeowners insurance premiums aren’t fixed, and they can — and sometimes do — soar. Property taxes and homeowners association dues are additional variable costs. Don’t forget repairs. If you need a new roof or air conditioner, you’re on the hook for the replacement costs.
Nonetheless, taking out a 30-year fixed-rate mortgage means you can expect the same cost for principal and interest for 360 months, which provides considerable peace of mind. Also, if your income rises during that time, your principal and interest will dwindle relative to your overall budget.
One of the most compelling reasons to buy is the realtor’s mantra: Why throw away money on rent when you can buy a home? During the seven decades from the end of the Great Depression up to the Great Recession, that was decent advice. For the most part, home values were stable or rising during that time. During the bubble of 2005 to 2007, double-digit price appreciation meant the folks who timed the housing market just right made out like financial geniuses. Then came the crash of 2008, and home prices in many markets plunged as much as 50 percent. Now, though, prices are bouncing back. If you buy today, your home’s value will likely appreciate, especially if you live in an area with a strong regional job market. However, you should never depend on rapid appreciation. Even if your home value remains steady, your home will provide another type of investment: A mortgage is a forced savings account, one that requires you to essentially pay yourself every month.
Uncle Sam wants you to own a home, so much so that U.S. income tax policy contains several fat breaks to entice would-be homeowners. As a homeowner, your first big break comes in the form of the mortgage interest deduction. This perfectly legal loophole lets you subtract your mortgage interest from your taxable income. So, for example, if in December 2014 you took out a $200,000 loan at 4 percent interest for 30 years, you’ll pay nearly $8,000 in mortgage interest this year, or $8,000 that you get to deduct from your 2015 taxable income. The bigger the loan and the higher the interest rate, the more valuable this deduction becomes. Because interest is front-loaded in amortization schedules, the value of this tax advantage declines as you pay down your loan. No worries — you also get to deduct your property taxes every year. In addition, you pay no capital gains tax on the profit you reap after selling your home, up to a limit of $250,000 for single taxpayers and $500,000 for married filers.
Predictable monthly payments, return on investment and significant tax benefits – these are all sound, logical reasons to own a home. But they’re also bloodless. Let’s face it: Homeownership is quite often an emotionally charged decision, one driven in large part by lifestyle preferences. Homeownership means you are the boss and have the biggest say in your lifestyle and family decisions. Suppose your kids are in public school and you don’t want to risk having them change schools because your landlord doesn’t renew your lease. Owning a home would remove much of the risk of having to move. Do you have pets you don’t want to part with? Apartment complexes can be finicky about dogs, cats, rabbits and reptiles, but if you own your house, you’re generally the captain of your menagerie. Do you love gardening or redecorating? Need a place to store your boat? As a homeowner, you can more easily enjoy these leisure activities without worrying about logistics or restrictions.
Researchers have found that children of homeowners tend to do better in school, spend less time staring at screens and generally have healthier upbringings compared with children of renters. Of course, there’s a huge chicken-and-egg question here: Does homeownership really create better parents or is it simply that the folks who can afford homes also suffer from less financial stress? Sure, great parents can rent and terrible parents can own. In general, though, the evidence seems to bolster homeownership as a better environment for children, according to a National Institutes of Health’s sponsored study that refers to the “intangible benefits” of homeownership among differing income classes.
If you stay put in your house for more than five years, owning is generally a better deal than renting. A rent vs. buy study by the listing site Trulia found that in cities such as Miami, New Orleans and Oklahoma City, buying is nearly 50 percent cheaper than renting, assuming you stay in the same home for seven years. Even in pricey markets such as Honolulu and San Francisco, people who can afford to buy save more compared to renters. Nationwide, homeownership is 35 percent cheaper than renting. Of course, that’s just an average – if your home value skyrockets, you’ll do even better than average. If it plummets, you’ll probably wish you had rented.
Homeownership Pros & Cons
Homeownership is a tricky decision, one that brings both advantages and disadvantages. Do you like the idea of repainting your white picket fence every five years and filling your basement with clutter? Maybe owning is for you. As you weigh your options, here are some factors to consider.
Barring another price crash, homeownership is the equivalent of a forced savings account. You pay your lender every month, but ultimately the cash comes back to you in the form of equity as the market value of your home appreciates over time.
With a fixed-rate mortgage, your monthly principal and interest payment is set for as long as you keep the loan. Sign a rental lease, however, and you could see your rent rise the following year, the year after that and so on.
Customizing Your Living Space
Love purple wallpaper? Have a hankering to plant wildflowers? Found the perfect spot for your grandmother’s crystal chandelier? If you own a house, have at it.
Mortgage interest is tax deductible and so are property taxes. When you sell your primary residence, you can avoid capital gains tax on a profit of $250,000 (or $500,000 for married couples).
Homeownership goes hand-in-hand with voting, volunteering at schools and general civic roots. If you own a home, you may be more likely to put roots down and connect with the people in your community.
Pride in Ownership
Ever been on a home tour in an apartment complex? Didn’t think so. Renting a place can feel temporary, but ownership often fosters a sense of pride.
Pay for Your Maintenance
Toilet flooded? Fridge on the fritz? That’s on you — homeownership means you bear all the unexpected expenses. You are the on-site property manager who handles a burst pipe on a frigid winter morning or a broken air conditioner on a sweltering August afternoon. On these days, homeownership can be a drag.
Risk of Decreasing Value
Homeownership is never risk-free. You may end up purchasing in a period that’s followed by economic decline, which affects your home’s value. What is the economic strength of the city you want to live in? What trajectory is your city or state riding — stable growth, likely decline, boom and bust? Predicting the future, especially that of a specific region, is out of your control and often depends on local or state politics. A downward trend may negatively affect the equity in your home.
Homeownership comes with a steep buy-in in the form of a down payment that can be as little as 3 percent but can rise to 20 percent or higher. You must come up with the funds for a down payment before you can apply for a loan. And once you choose to purchase a home, you are effectively placing a large bet on a real estate asset over another type of financial investment, such as stocks and bonds.
Difficult to Move
Renting is freedom; ownership creates roots. So if you want to move, you’ll need to market your house and wait for a buyer to offer the right price before you cash out the equity in your home. Depending on the market, you may end up waiting a lot longer than you’d like before you can move elsewhere.
Depending on where and what you buy, a homeowners association or condo association could require you to pay hundreds of dollars a month in fees. The association may increase fees to keep pace with inflation or at times impose special assessments to pay for capital improvements. You may exercise little control over the amount or timing of these fees, especially if you don’t sit on the association’s governing authority.
Be prepared to pay several thousand dollars a year in property taxes, which for many municipalities constitute the bulk of their revenue. In some parts of the New York metro area, the average tax bill tops $10,000. Your municipality imposes your property tax based on your home’s assessed value. You probably won’t always agree with the assessed value and hence the property tax amount, and you might attempt to appeal the assessment, but you are obligated to keep your property clear of tax liens.
The Case for Renting
In the nation’s priciest housing markets, homeownership appears out of reach for many Americans. The median home price in San Francisco was $907,000 in the first quarter of 2015 — and only 14 percent of homes sold there fell within the median-income family’s budget, according to the National Association of Home Builders’ affordability index. Mortgage website HSH.com calculated the numbers another way and reached an equally daunting conclusion: To buy a $748,000 home in San Francisco, you need to make Google money — more than $140,000 a year — even with rock-bottom interest rates. If you have an average income, renting is the only option in high-cost cities.
Compare this with low-cost cities, such as Cleveland, Detroit and St. Louis, where you can earn less than $35,000 a year and afford a median-priced home. Does this mean you should go out and buy a house just because it’s cheap? Not necessarily — the median home price in Detroit has fallen 10 percent over the past two decades, even as home prices in some cities have more than doubled.
If you’re an upwardly mobile worker in an industry that rewards or demands frequent relocation, renting can be the right call. For career-minded professionals who think they might be in Atlanta this year, Los Angeles in 2016 and Chicago a few years after that, renting offers you the flexibility to pick up and go with minimal financial penalties. In these cases, the answer to the rent vs. buy question seems obvious. “Renters can move very rapidly and get a better return to their income,” says Ken Johnson, a real estate economist at Florida Atlantic University. Homeownership roots you in a place where your prospects might not be so great. Indeed, during the Great Recession, economists lamented that many workers couldn’t move to areas with better job prospects because they were stuck in homes they couldn’t sell. Even in a normal market, the transaction costs of buying and selling are steep — brokerage fees, closing costs, inspections, appraisals, repairs.
The housing crash has come and gone, but the hangover remains. In some boom-and-bust markets, home prices fell by 50 percent, which wreaked financial havoc on buyers who purchased near or at the peak. Many of their homes wound up in foreclosure or short sale, hurting the former owners’ credit scores and, quite possibly, draining their bank accounts. True, the housing collapse was an aberration in a housing market characterized by decades of stable, steady price gains. But the crash also proved that homeownership isn’t a risk-free endeavor.
Renting Pros & Cons
No perfect solution to the rent vs. buy conundrum exists. Every homeowner experiences moments when buyer’s remorse overshadows the upsides of owning, and every apartment dweller grows weary of the noisy neighbor upstairs. But if you break out in hives at the mere thought of a trip to Home Depot, you might be a renter. Here are some factors to consider.
Easy to Move
Weary of your once-charming neighborhood? Move when your lease is up. Job offer in another city? Take off and take it. Looking to downsize to cut costs? Easy to accomplish. No house to sell before you can book the movers.
Not Stuck With a Depreciating Asset
Holding real estate can be risky, as the housing crash proved. If you rent, the risk belongs to someone else. You’ll never risk getting stuck in a home because you’re underwater on the mortgage loan.
Repairs are Paid For
Plumbers, electricians, carpenters, air-conditioning guys? That’s the landlord’s problem, not yours.
No Property Taxes
You don’t get the property tax bill, so you don’t pay it. But your landlord may pass this cost on to you, so you still end up paying it in a roundabout way. And if you find that your landlord is passing on too much for your liking, you can always move on by moving out.
Avoiding a Bad Investment
There’s a reason the smart money is in the stock market rather than single-family homes: Stocks are often a better investment, but if you’ve already put your money in homeownership, the only way to back out of your highly illiquid investment is to sell your property.
Rent Can Increase
How much will your rent cost in a year or two? You won’t know until the time arrives, which means your annual budget is always uncertain. If real estate prices appreciate rapidly, you’re stuck with significantly higher rental payments.
Doesn’t Build Equity
Your monthly payments are building up your landlord’s wealth, not yours. The idea of throwing away money is depressing.
Can’t Modify Property Without Owner’s Consent
Want to add a hot tub? Hankering to replace the Formica with granite? Don’t bother.
No Tax Benefits
If you long to stick it to Uncle Sam, renting’s not for you. No mortgage deduction, no property tax deduction, no break on capital gains when you move.
Must Be Disciplined Investor
Homeownership forces you to build equity, but renting makes it easier for you to blow your extra money. To build a nest egg, you need the discipline to save outside your rent.
Weighing Your Rent vs. Buy Options
Homeownership rates correlate almost directly to age: The older you are, the more likely you are to own a home, with the exception of a slight dip in homeownership for Americans 75 and older, who are prone to health problems that hamper their ability to live independently. In the first quarter of 2015, only 34.6 percent of Americans younger than 35 owned their homes, according to the Census Bureau. But 79 percent of Americans 65 and older owned homes. Low homeownership rates among young adults are an American tradition. After all, most people in their 20s have yet to marry and have kids, and they’re not in their peak earning years, so they lack the motivation to buy and the ability to afford homes. For decades, Americans have followed the pattern of higher homeownership as they mature.
Homeownership Rates by Age
|Less than 35||34.6%|
|35 to 44||58.4%|
|45 to 54||70.1%|
|55 to 64||75.8%|
But did the devastation wrought by the housing crash change young Americans’ desire for homeownership? That’s a topic of intense speculation and debate. Real estate economist Ken Johnson predicts the U.S. homeownership rate gradually will fall to 55 percent as Americans grow more mobile and less keen on homeownership. Others argue that the shift to “Renter Nation” is a temporary condition. With a weak job market, stagnant wages and hefty student loans, millennials aren’t buying houses because they simply can’t afford it, the thinking goes. “The young adult population is still digging out from the Great Recession,” says Mekael Teshome, an economist with the PNC Financial Services Group. “But I don’t think it’s a permanent shift away from homeownership.” In fact, several recent surveys revealed that millennials still have a strong desire to own homes.
Mobility Required in Your Chosen Career
If your career requires you to move frequently, renting probably make more sense. Four to five years is the breakeven point for ownership, says real estate investor Gary Carmell, president of CWS Capital Partners and author of “The Philosophical Investor.” “Houses are illiquid and they have high transaction costs, so your time horizon is very important,” Carmell says. Before the Great Recession, the large companies that shuffled managers from place to place every few years were willing to offer generous relocation packages. But those relocation packages have grown far stingier in the years after the financial crisis. If you’re a high-level executive with a gold-plated relocation deal, buying and selling every few years might not hurt. But if you’re a middle manager, renting is probably the wiser, more economical move.
Feeling Grounded vs. Being Free to Move Easily
Sometimes, intangible benefits tip the scale a certain way in the rent vs. buy question. For some, pride in ownership, although it can’t be measured, is an important enough reason to own a home. For others, civic pride is a squishy concept that doesn’t qualify as a compelling reason to own a home, and being free to move when they feel the need is a priority that surpasses any pride in ownership. This personal decision really is a matter of preference that comes down to individual emotions. If freedom is your primary concern, then rent. If putting down roots is more important, you should buy.
Long-term Economic Development in Your Area
Local housing prices require some counterintuitive rent vs. buy decisions. Sure, San Francisco and New York are prohibitively expensive. But home prices there have risen and continue to rise. In a span of two decades, from the first quarter of 1995 through the first quarter of 2015, San Francisco’s median home price soared 232 percent, according to an analysis of National Association of Home Builders data. In the New York metro area as well, prices jumped 215 percent, compared to a national average of 84 percent. In Detroit, the median home price fell 10 percent. And in Youngstown, Ohio, the median price rose 30 percent.
If you’re leaning toward homeownership, you may want to avoid buying in an area where you think the economy will decline or remain stagnant in the long run; the value of your property will surely reflect the region’s economic health. No growth in the economy means little or no appreciation in your home’s value. So that $1 million apartment in Manhattan might seem ridiculously overpriced, but once you’re in even small gains can mean a lot. “Would you rather have a 5 percent gain on $1 million or a 5 percent gain on $200,000?” asks real estate economist Ken Johnson. “A 5 percent gain in New York is going to mean a lot more than a 5 percent gain in Topeka, Kansas.”
2 Experts Debate Renting vs. Buying
In determining whether to buy or rent, your decision-making process should look beyond convenience and on-the-spot price comparisons. You’re also deliberating a long-term financial bet. How you should play it depends on your personal situation and finances. Whether you already have enough saved to buy a home or you are just at the planning stages to buy a home, consulting with a financial advisor or expert to see which option makes more sense for you is a wise move. You’ll need to figure in your own time horizon and financial situation, your passions and hobbies and your feelings about homeownership. Keep in mind that a completely right or wrong answer to the rent vs. buy question rarely exists, just better and worse options depending on your circumstances.
Financial Advisor No. 1: Buying Makes More Sense
John H.P. Hudson is a true believer in the magic of homeownership. He sees it as a sure path to the American dream. Hudson, vice president at Mortgage Financial Services in Southlake, Texas, and communications chairman for the National Association of Mortgage Brokers, says the benefits of buying far outweigh the disadvantages.
I’m debating whether to buy a place or to keep renting. What factors should I consider?
I’m probably biased, but I see homeownership as a key to wealth creation for Americans. And research shows owners are happier than renters. If you’re paying $1,500 a month in rent and you can find a house for $1,500 a month, you should buy a house. There’s something to be said for the pride of ownership. You will be a different consumer and have different behaviors once you own that house. You’re just more vested in the community than you are when you’re a renter.
The conventional wisdom is that if you’re going to stay in a house for less than five years, you should rent. What do you tell clients?
I don’t necessarily agree with that. If you’re ready to buy a house, why delay it? If you think you’re going to move in two or three years, you may have the opportunity to push the home into an investment vehicle, where you convert it from your primary residence to an investment property. I’ve been doing this for 17 years, and I’ve found there’s no such thing as two identical buyers.
What’s the biggest challenge faced by potential buyers?
Affordability. It’s just hard for a lot of American families to set aside money to buy a house, and we’ve got a growing wealth gap. In San Antonio, where I live, builders aren’t building homes for less than $200,000, and that makes it difficult for first-time buyers. The average consumer today is much more debt-burdened. Millennials have a lot of student loans. At the same time, you’ve got a massive regulatory cloud that’s overhanging the mortgage industry and limiting access to credit. A lot of first-time buyers have unrealistic expectations. If you’re going to buy a house, think about what you can really afford. Everybody wants granite countertops, but maybe you need to make do with Formica.
You’re a big fan of homeownership. Is there anyone who shouldn’t buy a house?
I certainly don’t believe that everyone should buy a house. If you just graduated from college and you’re not sure what you’re going to do, I would say wait. The same goes for consumers who are burdened with large debt loads. You need to have some emergency savings, and if you’re carrying a lot of debt, it might be too stressful to take on homeownership.
Financial Advisor No. 2: Renting Makes More Sense
Licensed financial advisor Ed Conarchy is the rare mortgage broker who sometimes advises clients not to buy a home. Homeownership makes sense in the right circumstances, he says. But, Conarchy argues, many homeowners rush into a buying decision. Then, when they realize they made a mistake, they’re stuck paying hefty fees on both sides of the transaction. Conarchy, of Cherry Creek Mortgage Co. in Gurnee, Illinois, takes a contrarian approach to ownership.
I’m debating whether to buy a place or to keep renting.
What factors should I consider?
Unless you can foresee living in that home for five to seven years, don’t bother. If you stay in a house for three years, you get crushed on transaction costs. Here’s an example: I had a customer who was buying a house for $455,000. The title fees were $3,100 for the buyer and $2,100 for the seller. I’ve had clients argue with me: “It’s $200 a month cheaper to own than to rent.” Yeah, but when your water heater goes out, you just lost two years of that monthly savings. I had a potential client who’s 33 (years old) and doesn’t know what the future holds, either professionally or personally. She wanted to buy a house, but she didn’t know where she’d be in three years. I told her not to buy.
So you’re a mortgage broker who advises clients not to take out mortgages?
Isn’t that funny? You’ve got to do what’s right. I have this independent, objective approach. The real estate industry tries to create this artificial scarcity to get you to buy a house. Realtors put gas on the fire: “Home prices are going up! You better buy while you can still afford it!” The mortgage industry has (its) own can of gas: “The Federal Reserve is going to raise rates! You better buy before rates go up!” But I tell people to slow down and make sure it’s the right thing to do. If you’re moving somewhere new, go there and rent for a year to make sure you like it. It shouldn’t be spur of the moment. If you make this a short-term thing, it will crush you financially. I had a client who was thinking of moving to Kalamazoo, Michigan, for a few years, and he wanted to buy a house. I tried to talk him out of it. If you look at home price trends for the past few years, Kalamazoo is in the red. People like this whole Camelot approach and think you have to own a house. They think there’s a stigma of being a renter. But the American dream is not merely to own a home. It’s to be financially independent, to save for retirement, to have a rainy-day fund, to pay off your credit cards. Your path to financial freedom doesn’t have to include owning a house.
When does it make sense to buy?
If you’ve got a good job at a stable company, if your kids are in a good school district and you’re not planning to move, then ownership makes sense. I don’t advise people to buy starter homes. The American dream is to own a home, not a condo. If you buy a house and then sell it in a few years, you get crushed. The mortgage interest deduction is a good thing. I call it a 25 percent off coupon. Most of my clients are in the 25 percent income tax bracket. So if you’ve got $100,000 in taxable income and you pay $10,000 in mortgage interest, you get to take 25 percent of that $10,000 off your taxes. It’s a good thing, but it’s not going to make up for all the costs of buying and selling a house.
You’re skeptical about the benefits of homeownership. Do you own a house?
I own two houses. But I have very little equity in either house. I’ll tell you why: The Standard & Poor’s 500 index since 1926 has gone up 9.7 percent annually, according to Ibbotson. Over the long haul, I’d rather have money in the stock market than in a house. It’s totally counterintuitive, but I’d rather be cash rich and house poor. Our parents had a loan in the days of 18 percent mortgages, and for them mortgage debt was a bad thing. They looked forward to the mortgage-burning party. But what was right 30 years ago isn’t necessarily right today. With rates at 4 percent, paying down the mortgage just isn’t efficient. It isn’t the worst thing in the world, but I’d rather max out the 401(k). You pay no income taxes on that money, and you can put it in a diversified portfolio of stocks and bonds rather than having it stuck in a house.
You mentioned Kalamazoo’s weak home prices. Why is it that the flat markets seem like bastions of affordability, while the markets that are really good investments look unaffordable?
Isn’t that weird? Everybody in Manhattan rents as the prices go through the roof. I’m in Chicagoland, and our peak was in September 2006. The trough was in 2012. From peak to trough, we were down 40 percent. We got hit just as hard as the sand states — Florida, Arizona, Nevada — and we haven’t recovered as fast. Still, people in Chicagoland look at homeownership as an investment. I just want people to see there’s another side to it.
How do you conduct a cost-benefit analysis of homeownership? Even if you pay more to own a house, you’re building equity in an asset that, on average, will appreciate. On the other hand, when you sink equity into a house you tie up money that could be invested elsewhere. Neither option is perfect. Stocks can go down, of course, so you’ll need to consider your risk tolerance. And if you avoid owning to invest, make sure you actually invest the money you would have spent on a house.