Recently, several readers have ed me arguing quite forcefully that renting gets a bad reputation and that in many cases renting is actually a better deal than buying a home.
In order to break down this argument, I defined three distinct cases: rent exceeds total monthly mortgage payments, rent exceeds the interest portion of total monthly mortgage payments, and rent is lower than the interest portion of total monthly mortgage payments.
Of course, I am defining a “mortgage payment” as the payment one would make on an acceptable home given whatever amount one currently has saved for a down payment.
Let’s look at each case.
Rent exceeds monthly mortgage payment. You’re actively choosing to throw away equity here, so this is pretty clearly a poor deal. If you are paying more in rent each month than you would be paying in a house payment, there’s pretty much no reason for you not to buy immediately, as you clearly are in a financial state where you can afford to buy. Many people are in this area, but their idea of an “acceptable” house is higher than it needs to be in order to justify not making a move.
Rent exceeds interest portion of a monthly mortgage payment. I usually define the “interest portion” as being what you will be paying for interest five years after the start of the mortgage rather than simply looking at the first payment, because with each on-time payment, you pay less interest and more principal. This is the gray area, in my opinion, where you have to look at several additional factors: are there any utilities covered in your rent? How much will utilities go up when you move? Will there be a large increase in maintenance time at a home versus an apartment? If the total cost of ownership of a home added to the interest exceeds the rent you’re paying, then it is justifiable to rent instead of owning if you’re putting some away each month for a large down payment or into a strong investment.
Rent is less than the interest portion of a monthly mortgage payment. In most areas, this is only true if you have almost nothing saved for a down payment, in which case you should be renting and putting a significant amount away each month towards a down payment. Once you have a large enough down payment to bump you up into the “rent exceeds interest portion,” you should recalculate things.
The biggest key here is understanding what you plan to buy and knowing what it will cost. This involves learning about the housing market in your area, defining what you want to move into as a first home (remember, once that is paid off, you can definitely upgrade), and knowing what that will cost and what the payments will be. Once you know these things, it’s easy to compare the payments and figure out exactly where you are and where you want to be.
It is also vitally important to note that all arguments in favor of renting assume that you’re investing the extra money and not merely spending it. If you’re racking up credit card bills and have a stellar wardrobe, but live in a tiny apartment and have no real hope of owning a home any time soon even though it is a dream of yours, it may be time to reevaluate your life situation.