Is it better to rent a place to live or to buy one?
It’s a question that I get asked multiple times per week in some form or another. Usually, it comes from young couples who are being pressured by older people in their life to get out of renting and buy a home or by couples who are seeing their family size increase and need to move into something larger.
The problem with this question is that there is no ready-made answer. It depends on many, many factors – your monthly income, your other existing debts, your monthly rent, the annual change in that rent, the price of the home you’re looking at, the interest rates on mortgages, the state of the housing market you’re looking at, how much down payment you have saved, the property taxes in the area you’re looking at, and how long you plan on staying in the area. In order to answer the “buy versus rent” question, you need real numbers for each of those things. Let’s walk through them one at a time. If you’re serious about your housing decision, you should have an actual number for each of these elements before moving on.
Your monthly income How much do you bring home per month? (We’ll leave taxes out of this question in order to make things easier.) This should be a family-wide calculation, so if your partner also earns an income, you should include that monthly rate into your figures.
Your other existing debts How much is your total monthly debt payment right now? You can fudge this a little if you’re about to pay off a debt or will clearly do so before buying a home.
Your monthly rent How much are you paying in rent right now? This provides a baseline for figuring out the cost of renting. Of course, any money you pay in rent essentially “disappears” (but so does any interest you pay on a mortgage and the property taxes).
The annual change in your rent How much is your rent changing each year? Is it staying steady? Is it going up consistently? Try to figure out the average change in rent over the last five years. If you haven’t lived there long enough, try to find people in the area who rent from the same landlord and see if they can help you out.
The price of the home you’re looking at How much does the home you’re thinking about actually cost? This, minus your down payment, will indicate how large the mortgage is that you will have to take out.
The state of the housing market you’re looking at Use a site like Zillow to figure out how the housing market in the area where you’re looking to buy is changing. Are housing prices going up? Staying the same? Going down? What is the average percentage change each year?
Your down payment savings How much do you have saved for a down payment? If you have less than 20% of the value of the home saved, you’ll probably be paying a premium of some kind on your mortgage, whether it’s mortgage insurance or a second loan with a higher rate. Figure it will add up to another 1% on your interest rate if you don’t have 20% saved up.
The current interest rates on mortgages What interest rates are available on mortgages right now? As I write this, mortgages seem to be floating around 4 to 4.5% for a 30 year fixed rate.
The property taxes in the area you’re looking at Look for a property tax assessment website for the area you’re househunting in. If you can’t find one, call the city hall of the area that you’re hunting in and ask for an estimate.
The number of years you plan on staying in the area Are you going to stay there for a long time? Or is this just a quick stop before you move on to somewhere else?
If you aren’t interested in or aren’t willing to figure out these numbers, you probably shouldn’t make the enormous financial move to buy a home.
When you have all of those numbers in hand, the first thing you should do is visit this wonderful calculator for figuring out whether you should rent or buy. Plug in all of the numbers that you acquired above – monthly rent, home price, down payment percentage, mortgage rate, property taxes, annual home price change percentage, and annual rent change percentage. The tool will produce a nice little graph that will show you exactly how many years from now buying becomes better than renting.
For example, let’s say you have a rent of $800, you’re looking at a home costing $200,000, your down payment is 20%, your mortgage rate is 4.75%, your annual property taxes are 1.5%, and both the rent and the value of the home are going up 3% per year. In that situation, buying is worse than renting for the next eleven years, so you shouldn’t buy unless you’re planning on staying more than ten years.
If this graph leaves you uncertain as to what to do, renting is probably the better option. The big reason is simplicity: it’s easier to just move on to a new situation when you’re renting, there’s less maintenance involved (and maintenance isn’t something that’s included in this calculation, which actually creates a bias in favor of buying).
An enormous debt load should push you toward renting. It is never a good idea to put yourself in a situation where you’re spending more than 40% of your take-home income on housing (whether rent or mortgage) and other debts. That type of situation begs for disaster if you were to lose a job. So, if buying a house pushes your monthly debt above 40% of your take-home pay, you need to either target a less expensive home or stick with renting.
The tool linked above will tell you what your monthly mortgage payment will look like, so add that to your monthly debt payment and divide that number by your monthly take-home pay. If the result there is 0.4 or greater (in other words, 40% or more), you shouldn’t buy because your personal debt load would be overwhelming.
Here’s the take-home message: if you’re not financially stable enough so that home buying makes a lot of sense, you’re probably going to make a financial mistake by buying a home. Instead, you should focus on renting as cheaply as possible and building up your financial situation so that buying a home becomes an obvious choice.