Is it better to rent or buy a house?
There are very few questions in personal finance that will elicit people from both sides who adamantly insist they are right.
From the “rent crowd”, you’ll hear how they have flexibility and freedom to do anything. If they want to move, they can. If something breaks, the landlord pays and spends the time arranging the repair. If they invest the savings from renting, they will create greater wealth over time than building home equity.
From the “buy a house crowd”, you’ll hear renting is throwing money down the drain. They will claim homes are great investments; it’s how most people build wealth. They will also state the value does not go up and down every day like the stock market. If they want to paint a wall, they can. They can rent it in the future if they want to move and someone will cover their mortgage.
They both can be right.
The New York Times has a useful rent vs. buy calculator.
Make a few assumptions and run the numbers for yourself.
I prefer starting with the numbers and then breaking down the more intangible preferences unique to each person.
For example, let’s say you are located in Seattle and you want to buy a home. Let’s make the following assumptions using the rent vs. buy calculator:
- $700,000 purchase price
- Live there 10 years
- 3% 30 year fixed mortgage rate
- 20% down payment
- 3% home price growth rate
- 2.5% rent growth rate
- 6% investment return rate
- 2% inflation rate
- 0.95% property tax rate
- 24% marginal tax rate
- 4% cost to buy home
- 6% cost of selling home
- 1% maintenance costs per year
- $2,004 for homeowner’s insurance
- $100 monthly utilities
- 1 month security deposit if you are renting and $321 for renter’s insurance
Based on the calculator, if you can rent a similar home for less than $2,004, renting is better. If not, buying is better.
Listing the assumptions, it’s more clear the decision is not as cut and dry as everyone says.
For example, I used the default in the calculator of the home price growth rate being 3%. Will that happen in the future? Nobody knows. Real estate has been on fire here since real estate bottomed in 2012.
Check out the image below from the Seattle Times. Homes prices nearly doubled in six years.
From the first quarter of 2000 to the first quarter of 2020, Neighborhood Scout reports that Seattle real estate appreciated 5.06% per year.
Below is an image of the Case Shiller Seattle Home Price index, which tracks the value of single family homes.
What if you bought January of 2007 and held until January 2012? The rate of return was -6.7% per year.
What if you bought January 1991 and held until January 1996? The rate of return was 2% per year.
Same market, different time frames, very different results.
This is one geographic location. Depending on the person you talk to, their experience will be unique to where they bought.
Talk to someone in Las Vegas during the housing decline. Below is a chart of Las Vegas real estate prices.
How would you like to be on that roller coaster?
While I joke, the consequences are very real. Home prices declined over 50%. People lost their jobs. They lost their homes. Families were uprooted. Credit histories were destroyed for years.
You can read about it here.
10 years later, there were places where homeowners were still 20% underwater, which is where the mortgage balance is higher than the property’s value.
10 years. Let that sink in for a moment. People were paying their mortgage for 10 years, and their home was still worth less than the debt on it because of how much the home price dropped in value.
Depending on who you talk to, when they bought, and where, you will hear very different stories about owning.
People who bought in Seattle during 2012 probably will always think real estate is one of the best investments. People in Las Vegas who bought in 2006 probably will always think real estate is one of the worst investments.
If you stood in their shoes, you’d probably agree with both of them.
Home price growth rate is one assumption with different outcomes. What about rent growth rates? Home repairs? Investment returns? Inflation?
Historically, depending on the index used, home prices have appreciated between 3 and 5 percent per year on a national level, according to Zillow.
As previously discussed, different geographic regions can experience very different appreciation rates depending on the time frame.
From a purely financial perspective, it’s impossible to know whether renting or buying is a better decision. You can put a framework around it to make an educated decision, but I would maintain it’s never as clear as people make it out to be.
Is it Better to Rent or Buy A House?
Buy a Home Pros
Since we explored the numbers, let’s focus on the intangible advantages of owning a home.
- Fixed Mortgage Payment
- Forced Savings
- Tax Deductions
- Home Appreciation
- Creating a Home
- Interest Rates are Low
Assuming you select a fixed mortgage (15 year or 30 year), your mortgage payment is set for a specific time until it is paid off. You do not need to worry about price increases, except for property taxes, insurance, and repairs.
How wonderful is it that you know your payment for the next 30 years?
For many people, that is peace of mind. Let’s say your mortgage is $1,500 today. It will be $1,500 29 years from now. Over time, that payment will feel like less and less because of inflation.
Since mortgage loans are amortized, a portion of each payment will go towards the principal. At the beginning of the loan, very little goes towards principal. Most of the payments are applied to interest. Near the end of the loan, more of the payment is applied to principal.
Because you need to make your mortgage payment each month, it is a form of savings; however, I heavily discount this advantage. You cannot use the equity in your home unless you sell it, take out debt on it, or do a reverse mortgage. All have costs.
“A home is not an investment” my uncle once told me, “It’s a place to live.”
Some will argue it’s an investment. I disagree.
It produces no immediate financial return you can use. It costs you money each month. The only time you can use the return is if you sell and downsize.
Mortgage interest and property taxes are tax-deductible; however, these are only deductible if you itemize. In 2020, the standard deduction is $12,400 for single filers and $24,800 for married filing jointly.
In other words, your itemized deductions need to add up to more than that for you to receive any tax benefit.
For example, if you are married filing jointly and your mortgage interest is $15,000, property taxes $6,000, and you have no other itemized deductions, such as charitable contributions, medical expenses, or state and local taxes, your total itemized deductions total $21,000, which is less than the standard deduction of $24,800. In this case, you received no tax benefit for owning the home.
Over time, most homes have appreciated. As discussed earlier, the average appreciation is 3-5%, or about 1-2% over inflation depending on the time frame and index used.
This is a valid advantage, but I would be wary of certain people claiming their home is the best investment. I rarely see people include the costs of upkeep, their time, and acknowledging their luck.
Some people get lucky when they buy property at a low. Others get lucky being in the right geographic location that experiences great appreciation.
People who bought in Seattle during 2012 saw their home prices double in 6-8 years. If you had asked people in 2012 how much their home would appreciate in the next 6-8 years, I imagine most would not have guessed their home would double.
You’ve heard it before – it’s yours!
You can do with it what you want.
Paint the wall, tear up the carpet, put a hole in the wall. It’s all okay, assuming you do not have a homeowner’s association or other community guidelines you need to abide by.
When I moved into my home, I could finally install soft carpet – not the cheap rental carpet that feels like I was walking on concrete. I could also install bike racks in the garage for the bike I had been talking about buying for over five years.
Sometimes, the small things are important.
Creating a Home
It’s challenging to create a series of memories in rental properties. It never feels the same as when you do it in your own home.
I know families who tracked their children and grandchildren’s height on the door frame. They had generations worth of memories in the space.
First steps. Mourning loved ones.
Cooking with friends. Celebrating engagements.
Having a constant, safe, and loving place to experience life creates a home.
If you want a dog – or even five dogs – you can. You are not subject to the whim of the landlord and associated costs, or as they call it in Seattle, “Pet Rent.”
Interest Rates are Low
Interest rates are near historical lows. To get the best rates, you’ll want to build a good credit history.
Who knows what the future holds for rates, but if you obtain a $500,000 30 year fixed mortgage at 3%, your monthly payment is $2,108. At 4%, the monthly payment increases to $2,387. Over the life of the loan, you’ll pay $100,440 more.
It’s cheap to borrow money now. You’ll hear older people say, “Back in my day, mortgage rates were 12%.”
Check out the chart below. They are not lying.
Historical 30 Year Fixed Mortgage Rate
Please keep in mind that just because interest rates are low is not a reason to buy a home. It’s a huge financial decision with other factors to consider.
Buy a Home Cons
Owning a home is not all rainbows and sunshine.
Below are a few cons:
- High upfront cost
- Transaction costs
- Maintenance costs
- Value fluctuates
- More difficult to move
- Extra costs
High Upfront Cost
You’ll need to put 20% down to avoid private mortgage insurance (PMI), unless you qualify for a VA loan or Physician mortgage loan. Yes, there are loans that allow you to put less down, but you’ll pay more in the long run for it.
If you want to buy a $500,000 home, you’ll want to have $100,000 for the down payment. Depending on your income, that may take a very long time to save.
After that point, you’ll start to pay the mortgage, but as we discussed earlier, most of your payment is going towards interest – not principal. This means you are not building very much equity for the first few years of the mortgage.
Want to buy a home?
You’ll likely pay for an appraisal, credit report, title costs, and recording fees. Plus, you’ll likely pay at least a few months’ worth of property taxes and homeowner’s insurance.
Depending on the location and home price, you might pay $3,000-5,000 in closing costs.
Although you won’t pay the real estate agent commission directly because the seller pays, it is baked into the home price. Most real estate transactions have a commission of 6%.
Generally, you should budget 1-4% of your home’s value for maintenance each year.
For example, if your home is worth $500,000, you should budget between $5,000 and $20,000.
You likely won’t spend that amount every year, but you should be saving in preparation for the big items: replacing a roof, electrical issues, siding repairs, and the list goes on.
Not only are you responsible for the costs, you are responsible for the time. Either you have to fix it or hire someone to fix it.
For example, the prior owners of my house had to replace the water heater and tile in the basement after the water heater broke. After I bought the house, the gutter started leaking. I had to hire someone to fix it. Then, the dryer stopped working. I had to order a new dryer.
Life happens. Costs add up.
Even though your home value does not fluctuate on a daily basis like the stock market, the value still fluctuates.
If you buy a $500,000 home, put $100,000 down and your home declines in value by 20%, your home is now worth $400,000.
In this example, you have no equity in your home despite putting $100,000 into it. If you wanted to sell it, you would have to pay out of pocket for the real estate transaction costs.
Although people rarely think about it, a mortgage is leverage. If home prices rise, that’s helpful, but if home prices decline, that can quickly destroy the money you put into the home.
As a general rule, many people say it takes 5-7 years of home ownership to break even before selling.
Of course, there are exceptions. But do you want to rely on being the exception?
More Difficult to Move
If you own a home, you can pack up and leave tomorrow, but you still have to pay the mortgage. Unlike the stock market, you can’t sell a home and have funds available within a week.
In a very competitive market, you might be able to sell it in a month, but realistically, at least a few months. During a slow down in the economy, it might take much longer.
Can you rent it? Sure.
Can you rent it for more than your mortgage? Maybe.
Can you rent it for more than your mortgage, repair costs, and other costs? Again, maybe.
Do you want to be a landlord? Even if you hire a rental property management company, you’ll still have to be involved.
You also have the risk of tenants damaging your property.
With a home, you are more tied to the area.
I rarely see this mentioned, but because you can customize the home, you likely will.
Did I care what countertops I had when I rented? No.
Because I couldn’t change them, I did not think about it.
When I bought my home, did I want to change the countertops? Absolutely! And I did.
Did I start a garden when I rented? Nope.
Did I start a garden when I bought my house? Yes.
To be fair, I enjoy the modifications I made, but they are an added cost.
You may also see higher utility costs when you own. When renting, you may rent a smaller place or inside an apartment building, where you use less electricity.
You might also spend extra on the following:
- Security system
- Decks, patios, sheds, etc.
- Pest control
There are many home ownership costs – some more apparent than others.
Is it Better to Rent or Buy A House?
Now that we covered home ownership pros and cons, let’s explore renting.
Don’t let anyone make you feel like you need to buy a home. I rented for over 10 years before buying a home, and I would still rent in the future under certain circumstances.
Below are the pros:
- Move any time
- Sharing costs
- Lower upfront costs
- No maintenance costs
- Fewer extra costs
Move Any Time
Okay, maybe not any time. But, very close to any time.
Want to try a different neighborhood? Move after your lease ends.
This is a great way to see different places, figure out what you want in a house, and where you want to live.
I bounced around a couple different neighborhoods and even within neighborhoods. I was surprised by how different even moving within a neighborhood would feel. At each new location, I started making a list of features I liked and what I disliked.
When I was ready to buy a home, I knew exactly what I wanted. I wasn’t making the biggest purchase of my life a giant experiment.
It’s easier to share costs with a friend or significant other.
If you are living with a friend or significant other, it’s easier to end a lease than ask them to move out of your own home. With a home, you’ll want to consider drafting legal documents to protect one another in case something does not work out or in case of a break up.
Lower Upfront Costs
Unlike a mortgage down payment, you may need first and last month’s rent plus a security deposit. Instead of tens or hundreds of thousands of dollars, it’s likely a few thousand dollars.
No Maintenance Costs
Dishwasher broken? Call the landlord. Hopefully you have a good one who is responsive to your requests.
Roof leaking? You guessed it – call the landlord.
With rent, you know your maximum monthly payment. With a mortgage, you don’t.
You also don’t have the headache of finding reputable repair professionals and being home when they fix it.
Your place may have a gym, pool, community kitchen, or other amenities that are rare or expensive in a home.
You’ll pay for it in your rent, but if those are important to you, it’s nice to have them available without any extra cost or maintenance.
Fewer Extra Costs
Since you can’t customize much, your costs are likely lower. Unless you have a very kind landlord, you likely won’t paint, create a huge garden, or buy patio furniture and a grill.
Again, your rental payment is likely the extent of your monthly costs. Plus, if you are renting in an apartment building, utilities are likely to be lower. I remember spending less than $40 a month for electricity some months when I was renting.
Renting also has disadvantages.
Below are a few:
- Rent increases
- No customization
- No equity
I know this one well. My first place in college, which was in a fairly desirable location next to a university and popular neighborhood, was $1,600 a month for a 2 bedroom, 2 bath. I shared this with a roommate, so I paid $800.
Fast forward about five years, I had a 525 square foot, one bathroom, one bedroom loft in a less desirable location for $1,650 a month. I know it seems strange to say, but compared to other housing options, this was a pretty good deal.
And it was still about the same cost for 50% less from what I was living in five years earlier.
Seattle experienced dramatic rent increases – some years exceeding 10%.
Unlike a mortgage payment, you are at the mercy of rent increases, which means you may be priced out of a home and neighborhood you love.
Ugly paint colors? You’re stuck with them.
Dirty and stained carpet? Unless you want to pay, you’re living with it.
There are ways to make a rental feel like yours, but the truth is, you can’t change everything you want.
People with homes may tell you that you are throwing money down the drain, but you’re not. You’re paying for a place to live.
But, that also means you are not building equity. If where you are living appreciates 10% in a year, you don’t participate in the appreciation.
And, there is a good chance your rent will go up because the landlord will have higher property taxes.
Some rentals allow them. Some don’t.
Some rentals charge extra. Some don’t.
If you own a pet, renting is challenging. You limit your options and at least in Seattle, most of your options will be higher end buildings that are more expensive.
If you are renting, there is likely a higher chance you will move more frequently. It might be because of relationships, rent increases, or something else entirely, but moving can be expensive and time consuming.
I moved 9 times in 11 years.
Not every move was necessary, but most were because of education, finding a cheaper place, finding a new roommate, relationships ending or starting, or buying a place.
Looking back on it, I spent a lot of money on UHaul trucks and thanked many friends with food.
Be aware you may move more often than desired when renting.
Is it better to rent or buy a house?
Hopefully you see the financials of buying a home are not simple. There are many assumptions you’ll need to make and live with. Most of them will not be accurate.
As someone once told me, “All models lie. You just don’t know if it is to the positive or negative.”
There are many unknowns with buying a home, but it has significant upside – not just financially.
You get a place that’s truly yours (and the bank’s). You are stabilizing your mortgage payment and building equity in something. You have the privilege of creating memories and customizing your home to fit your needs.
Hopefully you also see the benefit of renting. It provides immeasurable flexibility. You also know exactly what you will pay over the course of a year. There are very few, if any, unexpected surprises.
Although you need to weigh everything for yourself, in general, most people should not consider buying a home if they plan to live there less than seven years. There will always be exceptions, but I like this general rule of thumb.
Besides that rule of thumb, think about what you want from life.
Do you want the flexibility to move?
Do you want maintenance to be some other person’s problem?
Are you okay not customizing a space to fit your needs?
If so, renting might be better.
Either way, renting or buying is an important decision. Be intentional and know your reasons for why you do one or the other.