Many would have you believe that renting is just throwing money away. But is this actually the case? The decision of whether to buy or rent depends on four main factors: Cash on Hand, Stage of Life, Quality of Life, and Opportunity Costs. Be sure to check out the awesome calculator at the end of the article.
CASH ON HAND
This is a fairly easy one to digest. If you don’t have much cash on hand then you should not be looking to buy a house. First, you won’t have enough to make a down payment. Second, and more important, if you buy a house with limited cash then you’re just asking for trouble. As soon as a major repair is needed (sooner or later this will happen) how will you pay for it? Credit cards? Borrow from 401k? Rob a bank? (please don’t do this). Do yourself a favor and rent for a time if you don’t have a lot of cash on hand so that you can save money for a possible future house purchase.
If you’ve got ample cash for a down payment (if possible put down 20% to avoid private mortgage insurance) and have a sufficient emergency fund (at least 3 months of expenses if single or 6 months if married) then home ownership can be a suitable option.
STAGE OF LIFE
Your stage in life will likely determine whether or not you buy or rent. If you’ve just graduated college or are in your 20’s you may not be quite ready to settle down. Or perhaps you’re close to retirement and looking to downsize and no longer worry about home maintenance and upkeep. For many people in these situations, they find that renting is most appealing.
If you’re thinking of getting married and / or starting a family then you may not want to deal with possibility of having loud tenants around you; especially if you have a baby. In this stage of life home ownership is the better option.
QUALITY OF LIFE
If you just don’t want the responsibility that comes with home ownership (i.e. taxes, insurance, maintenance costs, time spent keeping the house up, mowing grass, etc…) then renting is better for you. You can allow your landlord to handle all these items so that you can enjoy your time. In other words, if this sounds like you, then time is a more valuable commodity than equity. And as a result, renting is your better solution.
Are you the type of person who desires to have their own space? Do you desire to have your own blank canvas that allows you to design your indoor and outdoor space however you want? Perhaps you want a place for your children to run around. Or maybe you love yard work and want to have a garden or do some decorative landscaping. What about knocking out a wall and creating a much bigger room in your house? Perhaps it’s these types of things that really motivate you and would increase your quality of life. If so, then consider purchasing a home instead of renting.
Let’s talk numbers. Is it possible to quantify whether or not you should buy or rent?
The answer to the question is that it depends. Don’t you hate answers like that? It depends on factors like length of time in home, amount of down payment, maintenance costs, rate of return on your investments and home, loan interest rate, length of loan, tax and insurance costs, amount of rent increase each year, and many other things.
I started building out a calculator to help answer the question, but then, I ran across a wonderful calculator, created by Mike Bostock, Shan Carter, and Archie Tse, on NY Times’ website. I tested it out and it appears to be very accurate. Below, I’ll go through an example from their calculator, but I encourage you to check it out for yourself if you are wondering whether you should buy or rent.
Using the calculator, I sought out to determine whether I should buy a $250,000 home or rent a similar home. I assumed that if I bought a house, I would make a 20% down payment and finance the remainder at 4.25% for 30 years. I then reflected that I would stay in the house for 10 years. Also factored in is Opportunity Cost. This is defined as the cost of not doing something else. For example, if I buy a house and make a down payment of $50,000, I’ve essentially lost the opportunity to do something else with that $50,000, such as invest it. The “opportunity cost” is the interest that I could have earned on the $50,000 and is calculated by declaring an investment rate of return. I used 8%.
The results of the calculator reflected that it would be better for me to rent if I can rent a similar type home for less than $855 / month. Otherwise, it would be financially better for me to buy my own place even though the loan payment is a bit higher at $984 / month.
So, as you can see, there is in fact a way to financially quantify exactly which option is best for you. However, as mentioned above, not all decisions should based on financial reasons. There is no one-size-fits-all approach. You must look at all of the factors and make the decision that is best suited for your circumstances.
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2 thoughts on “Is it Better to Buy or Rent?”
Brad, thank you for your thoughts. I couldn’t agree more. So many think that renting is throwing money away, but I believe that we are all paying a rent or fee to live in a home or apartment. One of the best reasons to buy is that it is a forced savings that many would not do otherwise. Each time someone makes a regular monthly mortgage payment, a portion is going toward equity. Another is the diversification of investments, but this return is generally only about 3%. Home buying does allow a person to leverage their investment with minimal risk. I do believe that it is important to make a 20% down payment. This amount will provide protection and will usually survive a downturn in the housing market. What do you think?
Hi Dan. Thanks so much for your comments. I agree with pretty much everything you said. Not everyone can afford to put down 20%, but if they can, we recommend it so that they avoid the Private Mortgage Insurance (PMI). The one area where there might be a little disagreement is the return on residential housing. Next Wednesday, I’m posting an article I wrote titled “Should You Pay Off Your Mortgage Early”. In that article, I quote Robert Shiller (who is known for his work on housing prices) who said that housing prices have only risen at a clip of 0.6% per year. But whether it’s 0.6% or 3.0% it’s certainly not a big investment return like many people think.