Owning versus renting your home is a longstanding and often passionate debate. The reasons for owning or renting are tied to financial calculations along with your personal preferences.
Questions To Consider
If you are seeking to own a home, do you prefer stability, building equity, control over home and its responsibilities and tax benefits? Will you enjoy a sense of pride of ownership? On the other hand, does flexibility and freedom appeal to you, not having to deal with the home’s repair and maintenance, freeing you to use savings to make investments, and not have to worry about declining home values?
I understand the allure of owning your home as I have had with our primary home. We continue to own a second home which we may one day make our primary spot. I grew up in the Bronx in an apartment building that was intended as affordable middle class housing. As a result, my family paid a relatively low stabilized rent. Owning our home as inspired by the American Dream was out of the question for my family at that time.
My husband, Craig, is a real estate attorney dealing with residential and commercial transactions. When I went to law school, I was fascinated by the real estate field and became an investor for a time.
Before we review the advantages and disadvantages of owning and renting your home, let’s address key factors to consider in making this important decision.
Housing Market Trends
When it is the right time for you to buy or rent, it may be worthwhile to be aware of the overall housing market, that is, home prices, interest rates, and mortgage rates in particular. US home ownership has grown from 45.6% in 1920 to 66.2% in 2000. Home ownership rates peaked in 2004 at 69.2% (in both April and October of that year) then retreating to 64.1% in June 2019.
Generational Gap In Buying Homes
Part of that decline may be explained by the age of the typical home buyer being older now at 44 years versus 25-34 years in 1981. Only 37% of people aged 25-34 owned a home at the end of 2015.
Despite lower mortgage rates, Millennials, born between 1981 and 1997, have been slow to purchase their homes, as they grapple with high student debt and slower wage growth since the Great Recession. They own a smaller percentage of homes at 32% as compared to Gen X (60%) and Baby Boomers(75%).
A major consideration in timing a purchase is the level of mortgage rates. Generally, mortgage rates rise during periods of strong economic growth and decline during weak or recessionary periods. Mortgage rates have been low for a longer period of time than normal as the Federal Reserve has kept overall interest rates low based on its monetary policy.
By pursuing a home purchase, make sure your finances are in order. That means being debt-free and establishing or expanding your emergency fund. When we review the financial costs, you’ll better understand the need to have a strong financial condition.
Substantial Financial Differences Between Home Buying And Renting
Financial costs differ between purchasing a home and renting. Home buyers face substantial costs.These expenses can be divided into one time payments upfront and at the closing. Purchasers are usually dumbfounded by the number of one-time upfront and closing costs that are required in addition to the ongoing or recurring expenses.
The process of buying a home through closing may be overwhelming but each step is well defined.
Upfront And Closing Costs
Home buyers are usually surprised by the number of payments that are required to those professionals (home inspector, bank attorney, title closer, appraiser, broker, attorney) who are assisting in their purchase. There are also other costs that are made in the process of securing the mortgage and protecting the lenders as they will effectively own 80% of your home. You will pay mortgage application fees, points and origination.
This can range from 1%-3% up to 10% of the price of the home depending on the locale. This money is consideration for the mutual acceptance of a deal with the seller. It is credited toward the purchase price at the closing. If you default before the closing the earnest money can be the measure of liquidated damages to the seller.
It is important for an inspection of the home to be done by a qualified inspector. An inspection is done when you have decided on a house to buy but before you put money down. The fee amounts vary based on type of home, square footage and the locale. This is an essential cost as you may find structural damage or disclose other issues that can be used to reduce the price you are willing to pay.
These fees are paid to an independent certified appraiser. It is required by the bank to protect their exposure for their collateral. The fees vary. They are paid directly to the bank after inspection but before the closing and in conjunction with the mortgage loan agreement.
There are different purposes for each escrow account. One is for the benefit of the bank and related issues and the other is for the attorney to hold until the closing.
The attorney escrow account holds your down payment for the house. The bank’s escrow covers prepayments for property taxes on homeowner’s behalf up to six months. Additionally, the buyer will be paying a full year’s homeowners insurance premiums upfront and one-twelfth of the premium into escrow. Some borrowers, if applicable, pay private mortgage insurance (PMI) premiums. PMI is required if the buyer is making a down payment less than the 20% of the home price preferred by the lender.
The final part of your purchase involves a number of closing costs associated with formalizing the processing of the mortgage and concluding the transaction between buyer and seller. They include costs for the loan application, processing and underwriting. The latter may amount to about 1% of the loan. So if you are borrowing $300,000, you will pay $3,000.
You will be paying for a title search and other title-related costs in order to ensure you are purchasing a home with “good title” free of fraud and any liens for unpaid taxes, etc. The title company collects a premium and receives recording fees.
In most states, you will also be paying an attorney for closing your deal and representing you as the buyer. The attorney’s fee ranges from $750-$3,000 depending on the deal’s complexity and your locale.
Recurring or Ongoing Costs
Your monthly ongoing costs of buying a home are your mortgage payments, utilities, garbage, property taxes and homeowner insurance. These are predictable or fixed costs.
If you are buying a house (rather than an apartment), maintenance, repair, painting and appliances may vary depending on the condition and age of the house. This is often difficult to estimate and may depend on your DIY abilities. You will also have other costs for lawn care and snow removal which differ based on your geographic location.
Costs of Renting Your Home
Upfront costs are far less. Landlords usually require 1-2 months for a security deposit at the time of the lease signing. Some landlords will increase additional security or fees for any pets you have for potential damage to their property.
There may be an application fee required by the landlord for administrative costs as well as a possible broker fee unless the landlord pays this. There may be a move-in fee depending on the type of of home you are renting.
Recurring Rental Costs
Tenants are responsible for monthly rent, all utilities and renters insurance. While the homeowner has homeowners insurance, that doesn’t cover your personal property including your furniture, clothing, electronics, computers, jewelry and anything of value to you or liability insurance. The landlord will require you to purchase renters insurance.
Landlords are required to provide you with at least 30 day notice in most states with any increase in rent unless it is stated as part of a multi-year lease.
What Is Your Financial Situation?
Before going house-hunting if you are planning to make a purchase, it is a good idea to check your credit report for any errors or issues you need to correct and be aware of. You should know your credit score and what amount of mortgage you can afford. There are steps you can take to raise your credit score.
By the way, your credit report matters to your landlord also. A poor credit report could be a thumbs down on your ability to rent. If your credit score is fair, it may mean providing your landlord with more security. However, a poor credit score has far more of a negative impact on your ability to borrow.
MyFICO’s loan calculator is very useful for estimating your APR, monthly loan payment and total interest paid. For example, using a $300,000 loan your payments for 30 year and 15 year mortgages as of September 13, 2019 based upon your FICO score will be:
30 Year Mortgage
Credit Score APR Monthly Payment Total Interest Paid
760-850 3.355% $1,323 $176,269
700-759 3.577% $1,360 $189,622
680-699 3.754% $1,390 $200,410
660-679 3.968% $1,427 $213,618
640-659 4.398% $1,502 $240,694
620-639 4.944% $1,600 $276,077
15 Year Mortgage
Credit Score APR Monthly Payment Total Interest Paid
760-850 2.897% $2,057 $70,245
700-759 3.119% $2,089 $76,012
680-699 3.296% $2,115 $80,650
660-679 3.51% $2,146 $86,302
640-659 3.94% $2,210 $97,810
620-639 4.486% $2,293 $112,710
A Few Observations
Irrespective of your FICO Score, the lower the credit score, the higher your APR, monthly mortgage payment and total interest paid will be.
Financial Implications For 30 Year versus 15 Year Mortgage
When comparing the different loan maturities on a $300,000 loan:
- The APR will be higher for the 30 year mortgage than 15 year year, all else being the same.
- The monthly mortgage payments will be significantly higher for the 15 year mortgage given the shorter period. If you can afford to pay the higher monthly amount, you are better off with the 15 year mortgage because you are paying less in total interest.
- Assuming you have a 720 credit score, the total home price, inclusive of total interest paid and down payment will be lower with a 15 year mortgage loan.
- The 30 year mortgage is much higher because you are paying interest on your loan longer, so total home price or principal is $375,000 plus $189,622 equalling $564,620.
- If you opt for a 15 year mortgage, your total home price or principal is $375,000 ($300,000 loan + $75,000 down payment of 20%) + $76,012 in total interest equals $451,012 for principal and interest.
Advantages Of Buying Your Home
1. Building Equity
Paying your mortgage over time will result in building some equity in your home. You should be aware that your initial payments are predominantly for interest on your loan, especially if you have a 30 year mortgage, and equity builds relatively slowly.
On the other hand, you will certainly be owning your home much more quickly with a 15 year mortgage. A mortgage amortization calculator is helpful to compare the principal and interest portions for the 15 and 30 year mortgages. Assume your loan begins September 2019.
The comparison reveals that more than half of your first monthly payment goes to principal than interest with the 15 year mortgage. However, only about a third of your payment goes to principal with the 30 year. The amount between principal and interest does reach parity until the year 2031 and equity rises slowly thereafter until year 2049 when you satisfy the 30 year loan.
2. Your Home As An Appreciable Asset
Depending on your time frame, US new home median prices reflect appreciable growth. Median new home prices have risen from $17,200 in 1963 to $212,300 in 2011 according to the US Census of Housing. That is a 5.38% compounded annual growth rate. However adjusted for inflation, the growth rate is 1.8%. On the other hand, inflation adjusted monthly rent grew from $568 in 1960 to $934 in 2010 according Apartment List Rentonomics. This 68% hike in rent is well ahead of the 18% rise in household income during the same period.
Your investment in your primary home largely keeps pace with inflation rather than generating strong investment returns. When calculating returns you need to factor in the interest costs to total price. That said, you are living in your home and hopefully enjoying a high quality of living which can be priceless for many.
There have broader differences in select markets across the US that exhibit stronger appreciation due to higher population growth, demand and other factors.
The US housing bubble was particularly troubling for homeowners in the mid 2000s. Housing prices peaked in early 2006, then leveled off until record drops of 18% were reported by the S& P Case-Shiller index in October 2008.
While this drop was exceptional, it still provides a warning sign for those interested in purchasing their homes as loss in home values is real. However on a positive note, some markets have recovered from the Great Recession and recent housing price trends seem more favorable.
3. HELOC As A Source of Funding
Once you have built some amount of equity and have paid your mortgage on time, you may be able to set up a home equity line of credit or HELOC. Often you are able to get a loan more quickly and at lower rates because you are using your home equity as collateral. Part of these funds could go to building a new kitchen or expanding the house.
The HELOC, if not maxed out, can positively help your credit score. This is because the HELOC has increased the available amount of credit, lowering your utilization rate and improving your financial situation. Credit utilization accounts for 30% of your credit score. HELOC is added debt so make sure you pay this loan on time and in full. To avoid a hit to your credit score don’t close the HELOC, unless you are too tempted to use the money or about to close on the house, as it will then lower the available credit.
4. Possibility of Rental Income
When you are living in your primary residence, you don’t often think about renting out your property. However, you or your spouse may need to relocate for your firm for a couple of years, or your kids are moving out and you want to travel more. You may decide to rent out your home or list it with Airbnb.
5. Stability In Owning Your Home
It is wonderful to raise your kids in one home, become part of the neighborhood and community. There is a certain calm feeling of not having to search for a place to live and pack and unpack boxes. (Having just moved to new home, I can share that I will be immensely happy when our family is finally settled in our home and the last box is gone.)
6. Tax Benefits After The Tax Law Changes
The 2017 tax law did impact some of the tax deductions enjoyed by homeowners. If you itemize your deductions on a joint filing, you still claim mortgage interest payments up to a $750,000 face value loan. Qualified loans, include your mortgage, home equity loans and HELOCs. This is a reduction from $1,000,000 prior to the recent tax law change. You can no longer deduct interest associated with home equity debt unless it is to buy or improve your home.
Deductions for state and local taxes (known as the SALT deduction) along with property taxes are capped at $10,000. This is okay in some parts of the country like Ohio but not in high tax states like New York or California. This is a reduction from unrestricted amounts previously deducted. You are still able to deduct the proportionate interest associated with your apartment building’s mortgage if it is a co-operative.
Certain states, like Florida, offer exemptions if you meet certain requirements. This exemption may protect a surviving spouse when the homestead spouse dies. A homestead exemption is a law that protects the value of a home from property taxes and creditors. Depending on the state, a property tax can get an exemption in the range of $25,000-$75,000 of a home’s assessed value from property taxes.
7. You Have Freedom To Do What You Want
Are you creative? Your home can be a good option for you. There may be some conformity required but design and remodelling is limited by your wallet. You can do gardening and grow vegetables. Owning your pets is easier in your home is easier. Your childrent can listen to loud music with less rules of noise after hours. Peace of mind can be very valuable for you and your family.
8. Sense of Pride In Ownership
For those who have rented for a long time. owning your home feels like an accomplishment. Land is a natural resource and there is a good feeling of knowing you own the land you walk and live on.
Ask any refugee that has had their home taken away from them what a home meant to them. My mom was a refugee when she came to the US having lost her family. Her home was taken away illegally and violently. While owning a home eluded her, she always considered owning a home a way to wealth.
Disadvantages of Owning A Home
1. High Costs To Own
We addressed the one time and recurring costs a homeowner has to realize but it bears repeating. In particular, there are unforeseen events that require homeowners to do planning ahead of the purchase. Having an ample emergency fund is really essential for all but homeowners need to expand that fund to avoid borrowing unnecessarily.
The age of the home and its condition must be considered when factoring in maintenance and repairs. Are you handy? We are not and so we rely on a plethora of plumbers, electricians, and those who can help us around the house with showers breaking and leaky pipes. I keep wanting to spent time watching YouTube so I can pick up some tips but I am always afraid of starting a fire.
Our teens are more handy but not always available given their schoolwork, friends, sports, video games, and sleeping in.
It may be worthwhile to watch the 1986 movie The Money Pit with Tom Hanks and Shelley Long. It left an indelible memory on what not to do with your house.
2. Lack of Flexibility
If you are adventurous, you may feel stuck in the same house and environment especially as your friends may be picking up and leaving to try life in another place or country. You may want to sell your home and retire to another locale but the local economy is weak.
We had next door neighbors who experienced that predicament. They lived in Connecticut and had bought a house in Florida. The market had been terrible for the better part of a decade. They had to stay put in the colder climate they planned to avoid in their later years. They finally sold last year.
3. Your Home Has An Opportunity Cost
A home is usually the largest asset you own. The mortgage, the maintenance, repairs and property taxes require a lot of capital that may be better invested in a diverse investment portfolio. Many people believe that when they sell their house the money will be used for retirement. That is true but there is no guarantee that you will be able to sell your property quickly or not be facing declining values.
Too much concentration in one asset is very risky. You need to have investments in other assets but saving to invest in other vehicles is difficult when so much capital is to tied to real estate.
One way to avoid this difficulty is don’t buy a house too big for you. The amount of space homeowners have been buying has greatly increased since 1973. Specifically, median size homes have recently expanded to 2,467 square feet, up 1,000 square feet. During that same time, the average living space per person in the household has nearly doubled to 971 from 505. This is partly due to small household sizes averaging 2.54 persons, down from 3.01 in 1973.
Do we need all that space, and then have to furnish it too?
Advantages of Renting
1. Rental Costs Are Less
The lease agreement with the landlord provides your financial responsiblities which are essentially predictable: monthly rent payments, utilities, lawn care, garbage disposal and snow removal if applicable. There are a minimum of upfront fees. Finding an apartment may be harder in certain markets and more expensive based on demand.
2. Benefits of Ownership Without The Property Taxes
You may be able to be fortunate to get the best of what property taxes are used for without having to pay these costs when you rent. Families are always willing to pay more money for a house to be located in a nice place with a great school district. Higher home prices and property taxes may put buying a home out of your range.
Our Recent Move To A Rental House
By renting, you have access to the beauty of the town, its infrastructure like transportation, town pool and its schools. This is a big reason why we made a move to a small town (from a big city) to a house rental (from an owned apartment) and switched our kids from a private school to one of the best public schools in the state, if not the country.
Our son joined the football team and our daughter is considering other sports not readily available at her previous school. It was a difficult decision, especially for me having grown up in the city. Although it is early it feels promising.
Renting may also help you get familiar with the area before purchasing and allow you to get your financials in order.
3. Free Of Maintenance And Repairs
Your landlord has primary responsibility for the care of the property. It is up to you to inform your landlord of the need for maintenance and care. For those not handy or not wanting to spend the money to fix things, renting can be ideal. Usually the landlord wants to use their own folks (eg. painters, electricians) for respective issues in the home.
4. Flexibility To Leave
At the end of the lease, you can leave the premises. Many people decide to move around and explore different areas or look for different jobs. You aren’t tied down and as long as your payments through the end of lease are made, you are good to go. It is very difficult to leave your own home as quickly as a tenant can.
Disadvantages of Renting
1. Higher Rent Or Sells Property
Your landlord can raise your rent with proper notice or sell the property. Renting has increased faster than household income has since 1960. Apartment List Rentonomics points out that inflation adjusted rent rose 64% from $568 per month in 1960 to $934 in 2010 while household income grew only 18%.
Many homeowners turn to renting if they are unable to sell their property due to a poor market. Once the market turns, they may ultimately sell the home you are renting.
Markets vary but in certain markets, there are fewer homes to rent.
2. No Equity Buildup or Tax Benefits
It is common for people to say that renting is throwing money away. Of course, this is not true as you are paying for the living space for a period of time. You have the freedom to find the best affordable apartment you can to live in an area you prefer.
You are not getting equity or tax benefits from your rent but you are getting a number of advantages. You can divert your savings into other assets.
3. A Bad Landlord
It would be a drag if you rent an apartment from a bad landlord but the good news it is not permanent. Before you rent, check out Yelp to see if there any red flags to know about your landlord. People are always willing to share their bad stories.
I recall some horrifying stories that painted their landlord as a reincarnation of Jack Torrance played by Jack Nicholson in The Shining. Torrance was the caretaker at an isolated hotel.
If you are having trouble with your landlord who is not providing services promised in the lease there are courses of legal action to take.
4. No Upside From A Strong Housing Market
As a renter you do not get the benefit of an improving house values. This may feel bad when your friends are experiencing some growth in their home value while you may be getting a notice from your landlord that they are getting ready to sell or raise rent.
Hopefully, this guide provided you with good information to make a decision between choosing to buy or rent your home. Frankly, you can look at the calculations related to mortgage costs, building equity, home prices, square footage but in the end, the choice is a personal one for you and your family.
If there is one point I would like to make, it is to consider how your preferences line up with your long term financial goals. Make sure that if you find your dream house, it is doesn’t break the bank. You don’t want to be too overladen with debt. Remain disciplined in your spending and make saving a priority.
If you rent or own your home, would you kindly share your experiences with us. We always like to hear how you made your decision which shed light for others about to go looking for a home.
With a passion for investing and personal finance, I began The Cents of Money to help and teach others. My experience as an equity analyst, professor, and mom provide me with unique insights about money and wealth creation and a desire to share with you.