I've always rented an apartment or house because I've basically been in school forever. Shoutout to my fellow docs out there. My brother has done the same thing.
But it seems like we spend more and more time on Zillow looking at homes every year. You know what I'm talking about. You are watching tv at night and then you open your phone or computer to see how much your dream would cost. Naturally, I've always ask myself: is it better to rent or buy a home?
And that's exactly what we are going to dive into today.
The arguments we've all heard for buying vs renting.
When it comes to buying vs. renting a house, there is always a passionate debate about which is the best financial move. Both sides have valid points, so it can be confusing. In truth the answer depends on a lot of factors. And recent changes in the tax law have also made owning a home less financially advantageous, so knowing if it's better to rent or buy isn't getting any easier.
The common argument for buying is, ‘Why would you pay rent to a landlord when you could build equity in a home?’
A common argument for renting is, “Owning a house isn't as simple as building equity. There are a ton of hidden costs associated with it, and you could even be worse off financially than if you just rented.”
In reality, there are many financial reasons why renting may be more compelling. And vice-versa.
To begin, you need to make sure you understand whether you are even in a good position to buy a house. Your finances are not your only consideration either. If your social, professional AND financial lives aren’t in order, now is probably not the right time to be buying. You heard that right. Even if you have the money saved up and ready to go, buying might still be a mistake if the other parts of your life aren't stable.
Also, is your credit score strong enough so that you don't get a crazy high interest rate on a mortgage?
Now, let’s break down this buying vs. renting decision and some of the important factors.
The True Cost Of Homeownership Is Higher Than You Think
There seems to be a widely held belief that buying a home always makes more sense than renting. That it’s a foregone conclusion. You often hear that ‘every dollar you pay in rent is a dollar you’ll never see again,’ while buying a house is a ‘great investment.’ This is misguided for a few reasons.
Paying rent isn’t a waste of money. Yes, you won’t see your money again, but you are getting something in return: shelter for yourself and your loved ones. Even when you buy, you’ll be spending a lot of money on interest payments, property taxes and other fees — money you will never see again. These interest payments aren't going to build equity for you. Owning a house isn’t just sunshine and rainbows.
When it comes to thinking about the true cost of homeownership, you need to have a holistic view of all of the related expenses. At first glance, a mortgage payment might be less than your current monthly rent, but that mortgage is just the tip of the iceberg. For many people, the associated costs of homeownership might run as high as 50%+ of their mortgage payment. Ouch.
Below is a list of homeownership expenses to get you started as you begin to think about buying a house. This doesn’t even take into account the additional cost of new furniture, upgrades or equipment (like lawn mowers) that new home owners will find themselves buying.
One Time (Non-Equity) Homeownership Costs (6-12% of home value):
- Mortgage Origination Fees (upfront fee charged by lenders for processing a new loan)
- Closing Costs (usually include escrow fees, property taxes, interest)
- Realtor / Lawyer Fees When Selling
Annual Ongoing (Non-Equity) Homeownership Costs:
- Mortgage Interest Payments
- Homeowner’s Insurance (HOI)
- Property Taxes
- Utilities (e.g. electricity, gas, water, etc.)
- Flood Insurance
- Mortgage Insurance (if downpayment < 20%)
- Maintenance & Repairs
- Condo or HOA Fees
- Investment Opportunity Cost (the cost of foregoing investments due to having your money tied up in a down-payment or other expenses you wouldn’t have if you were still renting)
Renting Might Cost Less Than Buying, But It Depends On Your Situation
After seeing that long list of expenses, it might start to sink in that the cost to rent can certainly be lower than the cost of homeownership.
A common rule of thumb is to not purchase a home if you know you won’t live there for at least five years. Why is this the case? For example, if you buy and own a home for 30 years, chances are the closing costs will be more than offset by the growth in the home’s value. On the flip side, if you only own the home for four years, there is a much higher chance that the home’s value won’t have increased (and potentially have decreased). Once you consider closing costs and fees, you’ll likely lose money on your investment.
Additionally, the payments at the beginning of the term of a mortgage go disproportionately to interest and not to paying down the principal balance (building equity). This is the perfect recipe for a bad investment.
In order to determine whether it makes more financial sense to rent or buy, you’ll need to compare the total cost you’ll pay when renting to the total cost of homeownership. In addition to the costs, you’ll want to take into account the benefits accrued if you were to sell the home, as well as any tax deductions you’d receive via homeownership. This seems kind of complicated, right? Not exactly.
Calculating Whether It Makes Sense To Rent or Buy Is Easier Than You Think
In 2014, the NYTimes published an incredibly helpful calculator that made it easy to calculate whether you’d be better off renting or buying a home. The more accurate your assumptions, the more accurate your results will be.
Keep in mind, as noted above, that the laws have changed significantly since the calculator was published. You'll also want to remember that not all taxpayers will be able to claim related tax deductions, which can affect your overall savings. Also, it’s tough to predict how long you’ll own a house, or whether it’ll go up in value, but just use your best judgement. If you and your spouse couldn't imagine living in any other city, there's a good chance you'll be there for a while. On the flip side, if you are 70 years old, there's a decent chance you won't live there for another 50 years.
For most people, this calculation will make it painfully obvious whether renting or buying a house makes the most financial sense. Once you’ve evaluated the finances and the other non-financial factors (e.g. social, professional), you’ll be on your way to making the best decision regarding whether to rent or own your home.
Is It Better To Rent Or Buy?
Finally, remember that there's more to life than money. Even if the calculator says that buying is more optimal, that doesn't mean you should drop everything and buy a house. If you hate mowing the lawn, shoveling sidewalks, or doing any kind of maintenance, then buying might be a big mistake. Don't drive yourself to misery to save a buck. Similarly, don't deprive yourself of your home ownership dream if you can afford it, and if buying isn't that much more expensive than renting.
Knowing if is it better to rent or buy is clearly a very personal decision, but if you take everything into account and make an informed decision, we are confident you'll be just fine.
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Francisco Maldonado, MD is a personal finance expert who was raised in poverty by a single mother and had to learn everything about personal finance on his own. In addition to running his personal finance site, The Finance Twins, with his twin brother, his site has been featured on Forbes, Business Insider, CNBC, US News, The Simple Dollar and other top publications. Francisco is a physician who borrowed over $200,000 to pay for his medical training and understands debt payoff strategies and frugal living. He received his M.D. from the Mayo Clinic School of Medicine, the most selective medical school in the country, and a Bachelors degree in physiology from the University of Minnesota. He is currently a radiology resident at Northwestern University. You can contact Francisco here or via Instagram @thefinancetwins.