The decision to buy or rent a house is one of the decisions that every adult will have to make at one point or the other. It is one of those decisions that tend to involve more factors than just the financial sense of the decision. There are personal, social, and psychological factors that play into the buy or rent decision.
This is one area where it is important to recognize the “personal” in personal finance and admit that the right decision for A might not be the best decision for B.
Let’s take a look at this age-old question and think through some of the important factors that go into this decision.
Buying a Home
Buying a home involves taking out a mortgage to pay for the cost of a house. When you buy a house, the house is yours; it is your property. However, many costs come with buying a home. The monthly mortgage payment (with interest) constitute the biggest chunk of the cost. However, there are other costs you should know when you buy a home. Some of them include:
- Homeowners insurance
- Property taxes
- Flood insurance
- Private Mortgage Insurance (if you paid less than 20% down payment on the cost of the home)
- Maintenance and repairs
- Homeowners association fees (if they exist)
There is also the opportunity cost of other investment opportunities. Once you make a down payment, you have locked up your money.
You can buy a home through real estate agents and shop around for the best mortgage plan.
What are some advantages that come with buying and owning a home, especially when compared to renting a home?
- Equity: The home can grow in value over the years. If you buy a home in a good location, it can grow over the years and build up considerable equity for you.
- Opportunity for passive income: You can decide to rent your home later on and earn passive income from the rent. You can even live in a part of the home and rent the other units depending on the type of house you buy.
- Lower living expenses in the future: You can pay up your mortgage and reduce mortgage payment from your monthly budget in the future. This will constitute a huge saving in your budget
- Stability: When you buy and own a house, there is stability. You don’t need to be moving from one place to another. A landlord cannot tell you he or she wants to sell the house and you have to leave. There is no increase in rent.
- Freedom: It is your house, so you can do whatever you want with it. You can redesign and remodel it to conform to your new and changing needs. You don’t have to answer to anyone except yourself.
- Tax deductions: Though the change in tax laws in 2018 makes this more difficult; you can get tax deductions for your mortgage interest payment.
What are some common disadvantages when it comes to buying and owning a home?
- Maintenance and repairs: You will have to handle all maintenance and repairs yourself or pay those who will do it for you.
- Fall in home value: While you can build equity in your home, you can also lose equity when the value of your home declines. This is especially bad if you have plans to sell
- Extra Expenses: When you add property tax, private mortgage insurance (if it applies), homeowners insurance, among others, the cost of owning a home is substantial.
- Upfront payment: It is always advisable you make up to 20% down payment on the value of the home. You are locking down that upfront cost even if there are investment opportunities that could bring in significant returns.
- Inflexibility: It is difficult to move when circumstances demand it, especially when the value of your home is currently less than the amount you paid for it.
Renting a Home
When you rent a home, you will make monthly payments as agreed with the landlord. The other costs involved with renting include security deposit and insurance premium. If you leave the house without damaging anything, you get to claim a refund of the security deposit.
You can rent a home through real estate agents and also shop around for the best deals.
What are some advantages to renting a home as compared to buying and owning a home?
- Lower upfront cost: You will only need to pay the first-month rent with the last month’s rent and security deposit.
- No maintenance or repairs: The landlord is responsible for all maintenance and repairs
- Flexibility: You have the freedom to move anytime, as circumstances demand without worrying about the current value of your home.
- No extra expenses: You don’t have to pay property taxes, homeowners insurance, or HOA dues.
- The value of the home is irrelevant: When you rent a home, you don’t stress yourself over the decline in the value of the home
However, renting a home also has its disadvantages.
- No freedom: You can’t do what you like with (in) your home. You have to act by the lease agreements and get permission from the landlord, anytime you want to do anything that the agreement may not cover.
- Increase in rent: The landlord can increase the rent anytime.
- No stability: The landlord can sell the house at any time. You will have to move multiple times
- No equity: You don’t build up any equity as you pay monthly rent. The property belongs to the landlord
- No tax deductions: You don’t get to enjoy any tax benefits when you rent a home
Making the decision: Important Factors to Consider
Given the advantages and disadvantages of both renting and buying a home, how do we proceed? It is important to consider some very important factors when making this decision. A consideration of these factors will help you decide which of these options is best for you as a person given your circumstances, future goals, and personality. Each of these factors is important in the buy or rent debate.
Credit Score and Debt Ratio
If you have a poor credit score, it will be difficult for you to get a good interest on a mortgage. Similarly, if your debt ratio is up to 50%, it will be difficult to get good loans. If you are in this situation, you should rent a home, pending the time you deal with your credit issues, ceteris paribus.
Length of stay
If you don’t plan to stay in a particular place for five years and above, it makes little sense to buy and own a home in that location. The growth in the value of the asset in those five years (assuming there is growth at all) will likely not compensate for the cost involved in buying and owning a home. So if you want to stay for less than five years, it is better to rent a home, ceteris paribus.
Freedom or Flexibility
If you value freedom more than flexibility, you will be better off buying your property. But if you want the flexibility to move at any time, you will be better off renting a home.
Attitude towards maintenance
Some people love technical work. While others don’t. If conducting maintenance and repairs is not your thing, and you can’t spend money to have people do it for you, you should rent a home, ceteris paribus.
Nature of employment
If you have a job that is unstable or insecure- maybe the job involves a lot of mobility, or there is much insecurity; you will be better off renting a home. If you have a stable job with little mobility, you will be better off buying and owning a house, ceteris paribus. This is an important factor in the buy or rent decision.
How much do you value stability? If, for social and personal reasons, you like to be in the same place and experience little uncertainties, you should own a home. But if you don’t mind uncertainties and instability (higher rent or sudden sale of the property), you can choose to rent a home, ceteris paribus.
If you don’t have a retirement plan set up or you are not saving enough money towards retirement, it is better to rent a home than commit to mortgage payment (and other associated expenses).
If you qualify for tax deductions on mortgage interest, that might encourage you to buy a home rather than rent, ceteris paribus.
Some locations have little prospects for appreciation in property value compared to other locations. You also need to consider the prospect of your location to decide if buying a home is worth it (ceteris paribus).
Availability of other investment opportunities
If there are better investment opportunities, you might not want to lock up your money in upfront cost (ceteris paribus).
Stage of life
At some certain life stages, you need flexibility more than stability, vice versa. If you just graduated from college, you need more flexibility. If you just married or had a child, you need more stability. If you just divorced, you need flexibility. Renting a home is better for those who need flexibility while buying a home is better for those who need stability, ceteris paribus. Understand the stage of life you are and take it into consideration in the buy or rent decision.
When it comes to the buy or rent decision, it all boils down to your life goals. Understand how this particular decision fits into your financial goals and how your financial goals flow from your life goals.
None of these factors stand alone. This is the reason for the repeated emphasis on ceteris paribus. You need to consider all the factors before making a decision. One factor might hold more weight for you than the other, but considering all the factors will help you make a better decision.
The most important of all these factors is the last. Every finance decisions you make must flow out from your life goals. Always keep this in mind irrespective of what the decision entails. Finance is not a stand-alone affair; it must align with your life pursuits and goals.