Rent vs Buy A House: How To Evaluate Your Options

by Silicon Valley Blogger on 2007-09-2133

Everyone I know will say that you’d be crazy not to own a house, especially in California. In other words, they’re convinced that real estate only goes up, courtesy of what we’ve seen in the last couple of decades.

A particularly vocal colleague who just stretched his budget to accommodate a million dollar home around 6 months ago tells me that there’s no way that coastal real estate will ever decline, since he fervently believes that demand will always be great for homes over here. He argues that there’s just nowhere else to build and develop new houses, so homes in certain older areas should command a premium. He’s right about one thing — that supply and demand will dictate the price of your house. But whether demand will continue to be strong…. well that remains to be seen.

This just shows that the home buying mentality is something we’re deeply ingrained with, having it become most people’s number one financial goal. We pay a big premium for feeling that pride of home ownership after all.

But don’t let the pressure of buying get to you before you read the rest of this article. The typical recommendation is that you should make the home buying decision based on your personal circumstances.

Housing, Real Estate Slump

Here’s what to consider when weighing renting versus buying (assuming that this is about owning a principal residence):

Home Buying or Renting Considerations

#1 Time

Renting:
If you’re going to stay put in the same location for less than two years, then you shouldn’t be committing yourself to a home purchase given the overhead and costs incurred after a home purchase. Those who move a lot may not find this option to be financially feasible.

Buying:
Time is good to a homeowner who has a long term view. The best thing about home ownership is the equity building and home price appreciation that occurs as time marches on. Also, whatever closing costs and purchasing expenses that are incurred can be spread out across the length of time that a home is owned.

-ooOoo-

#2 Savings

Renting:
If you don’t have hefty savings earmarked for a house, you’re out of luck. Don’t forget that home ownership also entails a lot of outlay such as home maintenance, PMI, property tax, home insurance and the like. You’ll need to find out if you have enough money to buy a house. You’ll actually need to add another 40%-45% to your base mortgage to get the true picture of what you’ll be spending per month!

Buying:
Not long ago, there were new mortgage products introduced to help accommodate the homebuyer who did not have sufficient savings. The traditional down payment for a house is 20%, and many mortgage types allowed you to get away with less than 20% down payment. But much more recently, we’ve seen a turn in the mortgage industry that has caused a tightening of credit. With tougher credit requirements, you’re going to need bigger savings to acquire a home. This is good, because this helps to prevent homeowners from taking too much risk and ending up with potentially owing more than their properties are worth.

-ooOoo-

#3 Investment Potential

Renting:
The money you would have otherwise applied to a mortgage, you are free to invest in anything else, including the stock market. Historically, the stock market has had better returns than the real estate market, if you can believe it.

Buying:
The main point of owning a home is to build equity via your down payment, mortgage principal payments and property appreciation. Real estate is known to be a great investment and is a powerful hedge against inflation.

-ooOoo-

#4 Cash Flow and Payments

Renting:
If you don’t have a stable income source, renting is the way to go. Expenses are limited to the rent itself. However, your rent will vary according to where you live and will be subject to landlords’ terms. Rents may be raised multiple times throughout the length of your tenancy. Another reason you’d want to rent is this: if your rent is so low (2/3 or less of your monthly outlay for a house) then it’s a better deal to simply rent and apply the rest of your money to work elsewhere.

Buying:
You can lock in your mortgage payment throughout the life of your loan or even refinance for better rates. Having predictable payments is one of the biggest advantages of buying a home. Financial obligations include monthly mortgage payments, property taxes, homeowners insurance, HOA fees, etc. Be prepared to spend an average of 28% and at most 33% of your income (as per mortgage company requirements) on these various housing expenses and around 1% of your home’s value in yearly maintenance costs. If your monthly expenses exceed 40% of your gross income, you won’t qualify for a mortgage. It’s true that you will eventually stop making monthly payments to your mortgage but your monthly housing expenses for insurance, taxes and maintenance will live on as long as you own a house.

-ooOoo-

#5 Taxes

Renting:
There may be minimal tax impact for renters: please check with your CPA or tax professional on this matter. I remember being able to claim tax credits when I was a renter a long time ago.

Buying:
You will need to pay property taxes. The flip side is that you can deduct them along with mortgage interest from your taxes. When you sell a house, you may get a tax exclusion for $500,000 of capital gains per married couple and $250,000 per individual.

-ooOoo-

#6 Debt

Renting:
You won’t have any debt to worry about. That’s a plus at this point in time!

Buying:
Most likely, you’ll be taking on a mortgage. To be able to qualify for one at a good rate, you’ll need a pretty good FICO credit score. The lower your score, the less attractive that mortgage rate is going to be, so this is one of your main reasons for keeping your credit score in good standing. Now that credit is tougher to get for larger loans, home ownership has just become harder to achieve for so many who actually have good credit standing.

-ooOoo-

What I Would Do If I Were A Homebuyer

As for how this decision applies to the current financial climate — at first glance it may seem that now would be a good time to lock in and buy a house given the price slumps in real estate. But because of the instability in the markets, I’d prefer to wait things out if I happened to be a potential homebuyer. Who knows if property values will continue to fall and what the fate of interest rates will be in the coming months? I’d wait to see some stability in the markets before committing any money in this manner.

There are other great articles on the same subject. You should definitely check these out before making that big step of buying a house.

Renting Makes You Richer
Renting vs Buying: The Realities Of Home Buying
Renting Vs Buying A Home, Which Is Better?

You can also take this test and this one to help you determine if you’re ready to be a homeowner.

Copyright © 2007 The Digerati Life. All Rights Reserved.

{ 22 comments… read them below or add one }

The Decision Strategist September 21, 2007 at 11:14 am

I know there are a million spreadsheets out there, and a bunch of posts on this topic. It’s a raging debate.

Here is my post and spreadsheets.

In today’s market I can’t imagine considering buying a house unless the local conditions varied substantially from the national conditions or I was in desperate need because of my family.

Lazy Man September 21, 2007 at 12:03 pm

I guess it depends on who you know. Everyone I know will say that you’d be crazy TO own a house, especially in California. You’d think that since we live a few miles apart, there wouldn’t be such a gap.

Also in Massachusetts, (Believe it or not!) renters can deduct half of their rent from their state taxes (up to $6000 I believe). As always, see your tax professional before taking this credit. I’d call that a nice impact for renting.

david September 21, 2007 at 12:06 pm

Great article on the pros and cons of buying and renting.

Eric September 22, 2007 at 2:49 pm

Great article! In many areas, like California for instance, it’s much more expensive to buy rather than rent. In that case, #3 makes sense. You can invest the money that would have gone to your mortgage payment.

But in other areas, like Texas (where I live), the cost of renting is often as much, and for a time here was actually higher, than buying a home. I bought my first home when I found out I would be paying *less* in monthly payments for a house than I would have renting. Granted I still have to cover the costs of maintenance, but I think I’ve probably averaged less owning my home even with maintenance involved (I’d have to do the math to be sure).

Not only did I pay less for the house, I’ve also built up some hefty equity that I will use to buy our next house.

I never viewed my house as an investment. It was just a cheaper way to live for me. I think where you live seems to have a pretty big impact on this topic.

Silicon Valley Blogger September 22, 2007 at 3:01 pm

Decision Strategist,
thanks for your post and spreadsheets. I appreciate the resources you can offer to help others understand this dilemma.

Lazy Man,
You are right about how there could be some tax implications for renting in certain places. Now about California though, on the one hand, it may seem that buying a home here is crazy. To buy at today’s lofty prices would be crazy, esp. if we’re expecting the market to dive further. But in the long run, buying in California is a WIN because long term appreciation of homes here is expected to fuel some massive nest eggs in the future.

Eric,
I have some close friends who have absolutely no experience in real estate investing. All of a sudden, they’ve decided to start looking into investing in property given the downturn we’re seeing in the markets. They live here in Cali but guess where they want to buy their rental units? In Austin, Texas! Their reason: it’s affordable there, with a fairly healthy rental market. I’ve been checking out their plans a little bit and some of what you’re saying seems to tie in to their strategy.

home loans mortgages September 24, 2007 at 12:15 pm

Hi,

Thanks for sharing this information. Well, I guess I’d rather buy a house than renting. It’s much expensive and all through out your life your not going to own a home. Anyways, great post! Best of luck. :)

-Sweet Apple-

The Happy Rock September 25, 2007 at 6:49 am

Great job, the more honest discussion we can get on the subject the better. I think the unbalanced talk about the benefits of homeownership has really muddied the water and caused people to despise renting. It really makes sense in a lot of situations. There are a whole host of other tangible and intangible reasons to rent too. Like less work, etc…

My wife and I were just talking about selling our home and renting for a year when we move to Pennsylvania.

Traciatim September 28, 2007 at 6:47 am

This is an excellent article. However it really depends on your area and the conditions. I would argue that in every situation unless you move frequently the buyer comes out ahead. The sole reason is that for THE SAME ACCOMMODATIONS renting has the exact same expenses plus someone’s profit.

Sure, the argument is that you can get by with less and save your money; You can in a house too. I could have stayed in my apartment for $655 a month heat included, or now I live in a 1150 sq foot bungalow with a yard for around $1100 a month. It’s more expensive? Sure. My kids can walk to school without crossing a street except my own crescent with little to no traffic? You bet.

Here are a few things that Buying has over renting. Keep in mind, I do agree that many people buying are doing it all for the wrong reasons. People should be buying because they like the freedom to do what they want with their property, because they like to BBQ on the back deck, because they like to tinker with something and try to improve it. Almost never, unless they are a professional real estate investor, should they be buying to make money.

1) Inflation protection. My mortgage on my modest $102K property will be the same in 5 years, will your rent? How about in 20 years? In our area rents usually go up at around the pace of 4% per year. So how many years will my $655 take to get to $1100? 14. In 14 years I will know that for a 700 sq foot apartment with people attached to you and sharing a washer and dryer with 7 apartments I’ll be paying the same amount.

2) Property Taxes. You claim this to be a negative, however, in my area they are lower for owner occupied residences. This will be factored in to rental properties so you will pay more or get less (or both) for the same amount of money.

3) Forced Savings. I would argue that many people would take their savings on their inferior accommodations and spend it on luxuries. Very few people have the discipline to save the difference. On my mortgage payment around 135 bucks a month currently goes in to forced saving in the form of equity in my home. With every payment I make this gets higher and higher. With renting your costs simply get higher. For the average person that will spend away their money the house will be their only real large savings.

4) Money Savings. Lets say in 10 years you want to buy a car. If you’re renting you get car loan from a bank. If you own a home you get a HELOC at prime. Where I live a car loan for 60 months is around 8.5% and a HELOC will be around 6.25%. Over 5 years on a $40,000 car the car loan will cost $615.49 per month for a total of $36,929, while your HELOC will be $583.47 for a total of $35,008. That’s a savings of $1921 just because you own a house. You could argue that the renter will buy the house outright from the savings from living in his shanty, so this point may be moot.

5) Pride. When I drive down the street and pull in to my driveway I feel like I’m home. I never had that with any apartment or home I’d rented in the past. I used to have a place, now I have a home.

6) An end. When my final mortgage payment is paid there will be a huge sense of accomplishment and I will actually own my own place. Sure, I will still have to maintain it, pay taxes, and the like. If I pay off my mortgage in 20 years though, the rent on my old $655 apartment will be somewhere near $1435 a month. How about in 40 years when I retire? $3150 a month. The rent will always go up and my taxes and maintenance will probably not be quite thas high. You claim in the article that this is a disadvantage ” . . . will live on as long as you own a house.” I would ask, when does your rent end?

As always, every situation is incredibly unique. As I stated when I opened I still think people should only buy home because they want to live in their own place and not as an investment. I realize rent is not ‘throwing money away’ but I have also yet to see rents be less than owning the exact same residence anywhere. Who is going to rent you a place at a loss?

Traciatim September 28, 2007 at 6:53 am

Sorry, in point 4 on the last sentence I meant car, not house.

Early Retirement Extreme February 10, 2008 at 7:38 pm

I had this discussion with wifey recently. It seems that I see cars as a way of getting from A to B and houses as something that keeps the rain and wind out. I mentioned that it was cheaper to rent a motel room than our house which sent her flying ;-P While she agrees on the car the house (read nest) is much more important to her than me.

Silicon Valley Blogger February 10, 2008 at 7:39 pm

@Early Retirement Extreme,
I wonder if it’s a guy vs gal thing — the house vs car debate, I mean. Guys seem to have less issues where they live and how their shelter looks like. While girls have different requirements… I would seriously have a cow if I were made to live in an RV, for instance ;) .

Though I have some basic standards I try to maintain, I’d go for the functional car (regardless of how it looks) but choose the fancier home. With the home as an appreciating asset, and my strong interest in interior design, it’s no surprise I’d prefer the house!

RacerX February 10, 2008 at 7:39 pm

The car thing is important to this guy at least…It has been the toughest Stuffitis to get over. But the house, eventually, is an appreciating asset!

She is right fellas :)

gearythedeptcounsellor August 12, 2008 at 9:54 am

I really enjoyed this article. I definitely believe that you should find a cheap place to rent first so you can let your down payment grow! I truly believe there is nothing better to have a large down payment so it comes off the principle amount of your house rather than paying the interest! When you are ready for all the extra payments then you can look for your house and who knows maybe while you were waiting you got a raise from your job and even more ready for all those extra payments on a house! Sadly I know so many people who lived their whole lives in apartments to do other things in life like vacations but if they only budgeted and were willing to cut down a bit, how much better it would have been!

Krishna Perkins February 2, 2009 at 7:05 am

How about an interest rate from zero to below market? There is a program called naca that I have personally recommended to my clients here in San Antonio TX. I have 5 currently in process and have witnessed first hand, home buyers using the prgram to buy interest rates using seller contributions to below 1%.

Maria June 1, 2009 at 11:19 am

It has always been a dream of mine to purchase a home, the tips on how to know when the right time to buy are very helpful. I plan on waiting a bit to purchase but I do hope to find a property near the Baltimore apartments I am currently living in.

Adrie July 2, 2009 at 7:25 am

I’m just a low level employee..who don’t have much money to buy my dream house now.
So, could you give me some suggestions about how I would be able to buy a house using my salary?

Ventura August 26, 2009 at 9:51 pm

I think that nowadays many people (at least in Perth) don’t consider the length of time they’ll be staying at a house so much as they used to. They see a house less as a lifetime investment they’ll live in for years (or their entire life) and see it more as something you can buy and, if you decide to move into another area, make money off of by renting.

Jeff Ragan December 12, 2009 at 2:29 pm

With the recent change in real estate values, one should really calculate the risk/reward before buying in today’s market.

I found these calculators that could be helpful in making a decision.

Jeremy Pritchard January 1, 2010 at 8:23 am

It really needs deep evaluation when deciding if you’ll rent or buy a house. It depends on your budget, needs and other reasons. But I guess it’s worth buying a house.

AAAA February 8, 2010 at 1:15 am

What happens when you retire, and you have no home? I still think it’s better to buy a home than rent. If you buy a home at 30 yrs. old or rent at 30 yrs. old – after 30 years you will be 60 – are you ready to retire? Or will you have a home that is paid for in cash? Or will you still have wonder where your rent money will be coming from? Do the math. I’m 43 and my home is almost paid off. I have about 50k left. Now would you rather be in my shoes, or when you’re 60 or 65 renting till you die? At least I have hundred of thousands of dollars in equity! I’m not going to have to worry about retiring and having have to pay rent or pay off a mortgage. The key for everything is to start early. I started saving up for my home when I was a teenager. I hired somebody to build my house when I was 25. I went to college after I bought my home. I know it’s a little backwards, but I got hundreds of thousands of dollars in equity and my mortgage is only 485 a month. I plan on paying the last 50k off in the next few years. So find a home that is really cheap, perhaps a foreclosed home, and put down at least 20 to 30 percent. Get a fixed rate loan and take in a roommate or two to help (only if you need to) trust me. I did that and I never regretted it once.

Plano Homes August 12, 2010 at 7:46 pm

I prefer to buy a house to rent, since the payoff and advantages will be great, but an exception to this will be whether you have a stable long term job and life style so that you do not have to keep selling or moving every 2 to 3 years.

Sell House Nashville July 18, 2012 at 5:51 am

Market posture is important, too. Right now, most are bullish on the market so buying has added benefits over renting. Renting is super competitive right now in Nashville cuz everyone’s doing it!

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