There’s a certain fantasy that penetrates the American psyche, we like to call it The American Dream. It varies slightly between regions, but basically, it involves the triad of homeownership, stable employment and a marriage with 2.3 kids. Maybe that white picket fence was ideal in 1950, but times have changed dramatically since the American Dream was the universal goal for all Americans.
Today, fast-paced lifestyles, jobs that require frequent travel and increasingly longer unemployment lines have taken huge bites out of what’s possible for most Americans. And while homeownership has its benefits, it’s not always the right move for everyone, everywhere. There are times when it’s much better for you to rent than to buy a home — it’s knowing the difference that will help keep you financially fit.
Before we get any further, I think I should disclose my financial horse in this race: I am a homeowner. I’ve owned since 1998, but I’ve also rented and couch surfed with friends, so by no means do I believe that homeownership is the hard and fast solution for everyone. If anything, my living arrangements over the years have helped to open my eyes to the different ways Americans live and how we’re not all really ready for The American Dream right out of college or trade school.
Home Ownership Benefits
There are a number of tangible benefits to purchasing a home, even if you have to do it with a mortgage. After years of working with potential homeowners, I can tell you that people have lots of different reasons they want to buy a home, ranging from purely financial to purely emotional. All of these are completely valid reasons to purchase a home, if you can comfortably afford one. You have your reasons, too, or you wouldn’t be reading this article. Let’s run down the most common benefits people appreciate about homeownership.
Building Equity for the Future
Equity-building is perhaps the most universal reason new buyers give for wanting to own a home. They’re tired of paying rent to someone who will take their money and use it to pay off a property that they have no real rights to outside of their lease agreement. Equity-building works in two ways: by you paying down your mortgage and by you staying put.
Over time, your home should gain value, and aside from the few nasty real estate bubbles we’ve experienced in America, that has always been the case. You pay $150,000 in 2014 and by 2024, you’ve gained enough by natural property value gains to feel pretty sure that you’ve got some equity to take to the next purchase. That’s a great benefit for a lot of homeowners, to be sure. But even assuming that your home doesn’t gain any actual value once inflation is figured in, as long as it retains its value over time, you’re still paying off your mortgage.
In fact, with today’s low mortgage rates, your 90 percent loan to value, $150,000 Conventional 30 year mortgage at 4.25 percent can shake off the PMI after payment 73 (6 years, 1 month into the mortgage) and reaches a point where you’re paying more principal than interest at the end of payment 164 (13 years, 8 months into the mortgage). At that point, even if by some freak financial accident your home doesn’t increase in value, you still have a little over 38 percent of your home’s value in equity. And all of that is possible just by making your payments instead of paying rent.
|90% TLV||95% LTV||97% LTV (FHA)|
|Equity After 5 Years||$27,409.61||$20,599.03||$17,874.80|
|Equity After 10 Years||$42,751.63||$36,793.39||$34,410.09|
|Equity After 15 Years||$61,719.01||$56,814.51||$54,852.71|
|Equity After 20 Years||$85,168.41||$81,566.65||$80,125.95|
Percentage Equity for 30-Year Mortgages Over Time on $150,000 Home (Ignoring Inflation)
The other big financial argument I hear, often from older people, is that buying a home with a fixed rate mortgage means that you’re going to know what your payment is through the life of the loan. This is quite true, and with the rate of inflation of national rents being as high as it is (134.6% from 1990 to 2000, based on Census data), it can be a scary thing to look to far into the future if you’re wanting to retire sooner rather than later.
Although your mortgage payment will fluctuate based on your taxes and homeowner’s insurance and any mortgage insurance, you can be fairly certain your payments won’t change too much. As a renter, your rate is only locked in for the length of your lease, which may be as short as a month or as long as a year under typical arrangements. That means that you can expect to spend a little more each year you live in a rental unit, or have to pay a lot more to rent a similar unit if you decide to move at some point even if you landlord never raises the rent.
To put this into perspective, let’s pretend your principal and interest mortgage payment on that $150,000 loan was a rent payment. With a 90 percent loan to value and a 4.25% interest rate, you’re going to pay $664.12 this year, but if your payment increased like rents have historically, by your tenth year in your home, you’ll be paying $893.91 each month! By Year 20, that payment has crept up to $1,203.20. Sure, inflation may keep up with you, but if you’re living on retirement funds, that ever-increasing payment is probably not something you want to even think about down the line.
|90% LTV||95% LTV||97% LTV|
|House Payment (P+I)||$664.12||$701.01||$715.77|
|Rent in 10 Years||$893.91||$943.56||$963.43|
|Rent in 15 Years||$1,008.80||$1,064.83||$1,087.25|
|Rent in 20 Years||$1,203.20||$1,270.03||$1,296.77|
Projected Rent Increases Based on National Rent Increase Factor From 1990 to 2000 (134.6%)
Perhaps the least tangible, but most important reason people buy homes is because they want the freedom to do what they will in their homes. Although you generally have the right to quiet enjoyment in your rental unit, this can be hard to enforce, especially when your landlord doesn’t understand what that right entails. Surprise inspections, maintenance men showing up at all hours of the day or night for routine checks without your consent or your landlord showing your unit to another renter without asking permission are just a few of the most common violations of quiet enjoyment that push tenants into considering homeownership.
Even if your landlord respects your privacy, you may want to make modifications that would improve your ability to use your unit or get a pet, both items that are often excluded explicitly in a typical lease. When you own your own home, even if there’s a mortgage in place, there’s not much that’s off limits. If you want to build a pool or a giant green garden in your sunroom, that’s your business, and if you want a cat or three, it’s up to you to decide what you’re capable of maintaining.
That being said, your mortgage will place some reasonable limits on what you can do with your property to protect themselves in the case of foreclosure. You can’t make damaging modifications to your property, you must maintain it in the same condition or better as when it was purchased and you absolutely must follow the local ordinances to prevent liens from being attached to your home. Other than these common sense items, though, you’re free to come and go as you will, paint your home’s interior any color you like, knock down walls to open your living room up more and have a pet or two without asking anybody for permission or having to put up a big deposit.
Benefits to Renting
Just because I own and don’t rent doesn’t mean that no one in their right mind should consider a lease. In fact, rentals are excellent choices for many people, especially if they’re working in a new area or simply don’t want the responsibility of caring for a piece of property. Yes, you’ll continue to make a rental payment each month for the benefit of living in the unit, but you won’t be expected to make any repairs (unless explicitly stated in your rental agreement) or stay in the unit for any time beyond the end of your lease. Let’s look at the top reasons for renting.
By and large, the best reason for renting is because you’re not yet in a living or financial situation that you expect to continue for some time. Whether your job transfers you frequently or you’re still waiting to meet the right person to settle down with, it’s wise to rent if you need to keep your options open. When you don’t know where you’re going to be living from one year to the next, or have a move planned in the short term, it’s financially irresponsible to buy a home that you’re going to have to turn around and try to sell quickly.
There was once a time when you might have come out on your home in the short run, but in today’s market, this is an invitation to a massive financial loss. Instead of spending the six or so percent it costs for your Realtor to market your home, plus whatever concessions you may have to provide for a buyer to buy it, you can simply buy out of your lease and walk away. Renters have a reputation for being nomadic, but that’s the beauty of rental units — if you want to live in a lot of different cities, or simply haven’t found the right job, you can rent relatively inexpensively and leave when you’re ready to try something new.
When my neighbor’s kids knock a baseball through my bedroom window, I have to deal with it. I have to fix the window, or call a guy and pay him, but either way it’s an incredible pain and may ruin my weekend plans. The unexpected happens, more often than it should, when you live close to other people, but if you rent, it’s not usually more than a minor inconvenience. You don’t have to pay to fix the window, you just have to call the landlord who sends you a repairman right away. It’s beautiful, really, and great for people who don’t want to get their hands dirty.
The same goes for major problems, too. Let’s say my pipes burst at 3am on the coldest night of the year. That’s a real bummer, but it’s my problem. I have to get the water shut off, clean up the mess, call a guy who can fix it all and hope I can manage to live in my house without water for the days it may take to get it all fixed. Not so for the average renter — if your pipes burst and your landlord can’t get it fixed right away, you probably have the option to move into a different unit without such heinous problems. No headache, no hassles, no maintenance for you.
Whether you’re starting out and short on cash, a widow living on her own for the first time in decades or a newly divorced person trying to rebuild, your problems can be reduced dramatically by renting. Caring for a home is like caring for a child that never grows up and always needs attention — if you’d rather be dancing the night away, quietly cuddling your cat or just trying to pick the pieces back up, renting gives you a sort of freedom from responsibility that a homeowner can’t match.
No Hidden Costs
Not only do you get to avoid the emergency repairs if you’re renting, you don’t have to plan for the routine ones either. The parts of a home have limited lifetimes and if you stay in your home very long, something is going to need to be replaced. Roofs, air conditioners and furnaces are the bigger items that eventually have to be upgraded, but even smaller items like hot water heaters, dishwashers and toilets can really add up after a while.
Renters don’t even have to consider these hidden costs, but their landlords do. Once in a while, you may get a notice that someone will be around to swap out your furnace, but most landlords wait until their units are vacant to do these necessary equipment replacements. Regardless of when it happens, though, you’re not going to have to plan for years to pay off a major repair when the time comes.
According to Business Insider, homeowners need to budget as much as two percent of their mortgage balance each year for home repairs. If you’re renting, it could be because you have somewhere else you’d rather put that $3,000. You also avoid HOA fees, taxes and homeowners insurance, which can add a pretty sizeable chunk to a house payment.
Bottom Line: Should You Rent or Buy?
Before you decide whether renting or owning makes more sense for your particular situation, there are a number of things to consider. Whether you’re considering selling your home and renting or you’re a renter and wanting to become a homeowner, today’s real estate climate necessitates a careful examination of your individual circumstances.
If you decide to buy today, you may well be in your home for many years, so make sure that buying is the right choice for you. The future of the real estate market is always uncertain, but in the short term, it’s unlikely that we’re going to see a return to the crazy days of the early to mid 2000s, so if you’ve got to sell your home sooner rather than later, you’re going to be facing a potential financial hit.
Long before you examine any financial tools, look at price indexes, consumer confidence reports or anything else, you need to be sure that ownership is the right choice for you. Even if all indicators say now is a great time to buy, if you’re not ready, you could still find yourself in a serious pickle. A home is a commitment and if you discover that you’ve bitten off more than you can chew, it’s not an easy one to get out of. Take a look at these items before you’re tempted by low mortgage rates and inexpensive homes:
Your Career Trajectory. I can’t really stress this enough — if you’re not settled in your career and feel like you’re going to be in the same job for the next five to 10 years, don’t even think about buying a home. Anything can happen in today’s world, even people who believed they had secure employment are now facing the unemployment line.
If you own a home when your job moves overseas or your place of business simply closes due to lack of interest, you may find yourself with a serious problem on your hands. You may not only struggle to keep up your payments, but regular maintenance is going to fall by the wayside as you try to keep food on the table. Don’t borrow trouble or a mortgage unless you’re confident that you’ll be able to make your payments — a foreclosure or late pay on a mortgage is incredibly damaging to your credit.
Your Family and Lifestyle. I don’t want to give the wrong impression: homeownership isn’t the exclusive privilege of the married couple, but it is a huge commitment that needs to be taken on with your future family and lifestyle in mind. Selling a home quickly isn’t in the cards for the foreseeable future, though you will be able to sell your home eventually if you need to upgrade or downsize.
If you know you’re getting married and plan to have two kids, go ahead and buy the three bedroom house now, instead of waiting to upgrade — you’ll have a better rate when the kids finally come and have several years of payments under your belt. But even if you’re single and plan to stay that way for a while, as long as your lifestyle is stable, buying a home can provide you with a lot of security — and who doesn’t need that?
Your Other Debts. You may have noticed how the concept of stability keeps coming up when I’m talking about knowing when it’s time to buy. Well, the same goes for other debts outside of your home. If your car payment is pretty much where it’s going to be, your student loans are under control and your credit card isn’t getting ready to make a huge leap in monthly payments, you can safely estimate how much you can afford to spend on your new home.
Spending more than you can comfortably afford because you don’t currently have a car payment (but plan to buy a new car in the future) or your student loans are in forbearance is setting yourself up for a failure. There was a time the industry may have advocated for doing just this, but the reality of it is that you’re not going to be looking at exponential home value growth to bail you out if you need to make a major repair to your home. You won’t likely be eligible for a HELOC for a very long time, make sure you can afford the home you buy today.
External Financial Considerations
Even when you’ve determined it’s the right time for you to buy, some times are better than others for getting into homeownership. There will always be someone buying, like there will always be someone selling, but if you’re in no hurry to get into your home, consider these external financial issues before you jump in with both feet. You may find out you’re better off to wait a little while longer to buy, giving you more time to save money for a bigger down payment or better financial cushion.
The Price-Rent Ratio. Comparing the median price of homes to the median monthly rents in an area can, according to some experts, help predict whether it’s better to buy or rent. Keep in mind that this number is just one of many, so before you let a single magic number predict when it’s time to buy, make sure you look at other factors, as well, including home supply and rental supply, because a lack of either of these can skew the price-rent ratio dramatically.
You can calculate your area’s price-rent ratio by dividing the average home price by the average annual rent. You may have to call your Realtor for help with these figures, though you can often find them online through Census data or Zillow.com. Let’s say you live in St. Louis, Missouri, where Zillow says the average rent for all single family homes and condos in February 2014 was $1,099. During that same month, the average price for all single family homes and condos was $130,800.
If you multiply $1,099 by 12, you get $13,188 — we’ll use this figure for the average annual rent. Now, divide $130,800 by $13,188 and you get 9.9, which is a pretty amazing ratio. Anything below 18, though, indicates that it’s a good time to buy, especially if historical data shows that the ratio has been much higher in the past. At the end of the day, this ratio is supposed to be able to predict if housing prices are likely to fall further, but we’ve seen that it’s harder than that to really know what’s going on in the market.
Consumer Price Index. We recently discussed how useful the Consumer Price Index (CPI) can be when you’re thinking about buying a home. Not only does it tell you where the prices of things are, but where they’ve been, which can help you make better financial decisions. For example, if you wanted to see if rents were increasing rapidly, you could turn a the page in the index where that information is broken out, such as the table showing the Consumer Price Index for All Urban Consumers on page 29. There, you’ll see that the rent of primary residences had increased by 2.9 percent year-over-year in January 2014.
Rents went up last year by a fair amount, so if you’re looking to make the move to buy, this might be a good time. There’s no good way to know when they’re going to stop increasing, just like there’s no good way to know when housing prices are at the brink of bottoming out, but if your rents are steadily getting larger, purchasing a home that you’re financially prepared to care for will lock in your payment. It may seem like a little thing, but if you’re already considering taking the leap into homeownership, the documented continued rise of rents may be the little push you need.
Ultimately, the decision to buy or rent is dependent on where you are in your life, how much money you can comfortably afford to lay out for repairs and how badly you want to own a home. After all, if you really want to buy so you don’t have to listen to another upstairs neighbor drag a chair across the floor at 3:30 in the morning, you may find that you can create a healthy savings account simply by making some small changes, like giving up your morning mocha.