The decision to rent vs buy is a timeless issue. Every renter and every homeowner has probably considered it at some point.
A lot of thought goes into this decision. I would not recommend basing your whole decision on just what the numbers dictate. As with anything financial, there are emotional and personal factors that will influence your decision, even if that means deciding against what “makes sense.”
With that being said, this is an issue that I am in the process of figuring out right now. My g/f and I pay about $1,000/month in rent right now. There are plenty of $200,000 houses around where I live, which would equate to about the same monthly payment. However, each house I’ve looked at is in a popular rental spot and has a spare bedroom or two. If I rented out one room, the numbers look even better even when I use a 3 year timeframe! My parents also mentioned selling their house in Maryland because they want to downsize. Now that the kids are gone they don’t want a 5 bedroom house. They already have a winter condo in Florida, and they want to have a place to live in the North East. So I have also been looking at some multi-family homes, or even single family homes that would work for the same purpose.
With all of that being said, I have been using a lot of rent vs buy calculators. What are the costs that those calculators are accounting for?
What You Actually Pay For
Whether you are renting or buying, there are different costs that you must factor into your decision. Some are monthly, some annual, and others variable. These are actual cost outlays on your part and you must calculate expected increases, inflation, investment returns, and other such things.
Renting:
- Monthly: Rent and renter’s insurance (optional)
Owning:
- One-time payments: Down payment, closing costs
- Monthly for 15 or 30 years: Mortgage payment (Principal, interest, PMI)
- As long as you own: Taxes, insurance, maintenance
As I mentioned, in my situation the monthly payments would be about the same. So the cost differences I am looking at are the one-time payments and perpetual payments involved with owning.
Tax Benefits
Your decision to rent or buy could carry different tax implications. This is based on the United States tax code.
Renting:
- None
Owning:
- Deduct interest on mortgage, PMI, and property taxes as long as you itemize. Rent it out? Go ahead and deduct insurance, maintenance, and depreciation on the portion rented, too… no itemization needed.
- You probably won’t wind up paying capital gains tax on the sale of your house.
The US Government likes to use tax incentives to motivate people to do things they deem worthy. In this case, their is an obvious preference for people who own. The calculators account for the mortgage interest that you are able to write-off at the marginal tax rate you input. They usually assume that you will meet the requirements to avoid paying capital gains tax on your house.
Investment Opportunities
This is one of the biggest opportunity costs that gets examined in rent vs buy calculators. The decision to rent or buy has more to do with the investment factors than the actual payment amounts.
Renting:
- Take the amount you would have used for a down payment and put it into an index fund or other investment vehicle depending on your risk tolerance.
- If your mortgage payment would be greater than your rent, take the difference and invest that, too.
- You are sacrificing the main benefit of renting if you do not invest this extra money.
- This allows you to start investing immediately, serves to not “tie you down” to any location, and is generally less hassle since you don’t have to worry about maintenance.
Owning:
- Your house is your investment. As you pay it off, you build equity. And as you live in it, it (should) appreciate in value.
- How do you “capture” these gains? Sell your house and receive your equity, live payment free once the loan is paid off, or a reverse mortgage (not a good idea in MOST circumstances).
- You can kill this investment opportunity if you buy the house for more than its worth or agree to unfavorable interest terms as we saw with a lot of people who got ARM mortgages.
- Classic definition of leveraging money: You put x% down, put the appreciation is on the entire value of the home… which includes the banks money.
Rent goes up as time goes on, but your mortgage payment is constant. If you are staying in a geographic area for a period of time, a rent vs buy calculator may lean towards buying. If you are renting, you need to be more vigilant about investing the money to ensure that you aren’t leaving too large of an opportunity cost on the table.
Resources
Here are a few calculators that you may find useful:
If you have any other calculators that are more comprehensive, link them please!
I'm MLR. After graduating from college debt free, I decided to write a blog encouraging people to adapt responsible and sensible personal finance rules.
November 16th, 2009 at 10:46 am |
Nice summary. Glad I’m investing heavily, then, while I rent. There is also the added psychological component to being in one situation or the other that might also confer monetary benefits – simply because you might be more productive and happy being in one situation over the other. For me, I find it more of a hassle actually that in renting I always depend on a landlord to fix things (due to contract terms, etc.) – so you have to wait it out on their schedule, you don’t get to choose who does the maintenance, etc. whereas it seems to me that once you’re owning you have a lot more control over this.
MoneyEnergy´s last blog ..Investing in Diamond Mining and Production with TSX and TSXV-Listed Diamond Stocks
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MyLifeROI Reply:
November 16th, 2009 at 1:07 pm |
@MoneyEnergy,
Yeah, if you weren’t investing than you wouldn’t be practicing the assumptions that the rent vs buy calculators make. I know a few people who will quote the calculator and say “See, I shouldn’t buy cause I don’t expect to be in the house for more than 6 years!” Meanwhile, they aren’t investing with what would have been the down payment and earning the x% that they put into the calculator as average investment returns. Kind of makes the calculation entirely different when they choose not to follow the assumptions!
You’re right about the other concerns, which is why I mentioned it shouldn’t be done entirely on numbers. But you can’t quantify the feelings, so I didn’t spend a lot of time on that part! :)
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November 16th, 2009 at 12:22 pm |
I am not up to that part of my life yet but it seems that that decision really should only come once you decided to officially settle down somewhere. if you think you could be moving somewhere within 3 years, probably best to just rent.
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MyLifeROI Reply:
November 16th, 2009 at 1:10 pm |
@Craig,
Define “settling down.” Is settling down 3 years? 6 years? The purpose of the rent vs buy calculator, for me, is to define what the minimum amount of settling down I need to do in order to not be making a poor financial decision.
Depending on the house, it seems to be from 2-4 years for me. I don’t consider myself settled down, but I think I’m settled enough that I could purchase a house if I only have to stay in it for 2 years to break even!
I have one other advantage, though. My company will pay all of the closing costs for selling an old house and buying a new house if I have to move for the job.
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November 16th, 2009 at 12:35 pm |
This is a great topic which I can go on and on and on about, but I won’t. There’s something people don’t tell you when you finally “own” your place, and that is the priceless feeling of home. You feel you’ve arrived, and you’re setting up roots. Nobody can kick you out and tell you what to do. You’re not funding someone else’s retirement with your rent payment, only your own.
Once you own, you make different types of long term decisions in your life. It changes the way you view the world and you become more involved with the community.
$1,000/month in rent is really around $1,400 in gross income you have to make to pay $1,000. The higher your tax bracket, the more it helps to own due to the deduction (which is not a reason to own, just a side benefit).
Renting is great, due to the flexibility. But, once you know you want to be in a certain place for a while, it’s better to own.
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MyLifeROI Reply:
November 16th, 2009 at 1:13 pm |
@Financial Samurai,
My parents frequently use that line of reasoning with me ;)
One thing: You’re not funding someone else’s retirement with your rent payment, only your own. — That seems to be slippery reasoning. Having a mortgage is also paying for someones retirement, be it the bankers, the mortgage brokers, or whomever.
I didn’t think of rent in terms of gross income, that is a good point. Good thing I didn’t have to, though, the calculators did it all for me :)
I am just curious, I know you live in an expensive area. Mind doing a Rent vs Buy with typical numbers in your area? I’m wondering about the time frame!
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Financial Samurai Reply:
November 16th, 2009 at 3:18 pm |
@MyLifeROI, all homeowners have been renters before (well almost all i guess), so take my perspective for what it is.
The one thing you will find out is the housing stock to buy is much more superior than the housing stock to rent. Over time, a landlord generally lets their property go, given rent control laws. There comes a time in your life, when you have the “30/30/3 Rule” down pat, and you’re stick of renting a place with a decrepit kitchen.
In my area, the absolute cost of owning has ranged from 50-100% more than renting pre tax deducations. It’s been that way for a long time. Go to middle America, however, and it’s close to parity or a 20% premium at most.
Good luck with your search, but please make sure you follow the 30/30/3 rule before taking the plunge!
FS
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Credit Card Chaser Reply:
November 16th, 2009 at 7:44 pm |
@Financial Samurai,
I hate to use these types of qualitative reasons in a traditionally quantitative discussion like this but I have to say that you are exactly right. There is something about owning my own home that is just a great feeling compared to the feeling I had as a renter.
Credit Card Chaser´s last blog ..The Man With the Most Credit Cards – 1,497 To Be Exact
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Financial Samurai Reply:
November 17th, 2009 at 6:24 am |
@Credit Card Chaser, cool. Yeah, I remember when I bought my first place, it was one of the greatest feelings on Earth! It’s a rental now, and will be part of my retirement portfolio.
I’ve never bought any of my properties with the thought to make money from them. It’s 100% a lifestyle decision for me. If when I do sell, they go up great, if not, ohwell.
Financial Samurai´s last blog ..The Katana: Favorite Posts of The Week Ending 11/15
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November 16th, 2009 at 1:13 pm |
@MylifeROi I consider settling down a long term mentality of family, kids, long term career focus. You are right that you could break even in 2-3 year period and a lot of people may do that, for me it seems like a lot of money and time, and paperwork and planning to do that. I look at buying a house as a long term decision, at least 5 years but more 10+.
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November 16th, 2009 at 8:55 pm |
I think its a tough case to make in going with renting over buying. I think there are too many benefits to owning.
The case can be made, but I thkn it requires a great deal of discipline
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MyLifeROI Reply:
November 17th, 2009 at 10:11 pm |
@David/yourfinances101,
Are you speaking of benefits in financial terms? Psychological terms? Financially, it definitely isn’t a tough case to go with renting over buying. Just look at any major metropolitan area (for the most part).
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David/Yourfinances101 Reply:
November 17th, 2009 at 10:37 pm |
@MyLifeROI,
I would say that its a combination. Psychological from the peace of mind of living in your own home. And, more than likely the “peace” of not lving in an apartment. Financially speaking as well. When I moved into my first home, my mortgage was $50 more than my rental payment, and it was invested into something that was mine–rather than simply paying the money to someone else.
David/Yourfinances101´s last blog ..17 Ways to Save Money on Insurance
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November 17th, 2009 at 1:17 pm |
Great job on having the numbers up for rent vs buy and mentioning the non-financial factors. We had this discussion Friday night with some friends. There are definitely pros and cons with each choice.
We’ve been keeping an eye out for housing prices in the area awhile while we were building our savings. We ran the numbers and while owning house would work, we also wanted to make sure this is what we wanted to do.
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MyLifeROI Reply:
November 17th, 2009 at 10:17 pm |
@Elle,
That’s where I am at right now. The numbers seem to work for me. But I am stuck in that spot where I am wondering if it is right for me.
Financially? Yes. Otherwise? Nervous and not sure.
I hope you make the best decision for your situation!
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November 18th, 2009 at 10:39 am |
It all depends on one’s financial situation. One choice is certainly not better than the other but definitely these suggestions will help those who are having trouble making up their minds.
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November 19th, 2009 at 10:19 am |
The people that say is a no brainer “buy always wins over rent” are so mistaken. That is probably why we are in the middle of a huge economic mess in the US.
Please run the numbers (I recomend the Buy vs Rent calculator over at the New York Times: http://www.nytimes.com/2007/04/10/business/2007_BUYRENT_GRAPHIC.html?_r=2&adxnnl=1&adxnnlx=1258642963-yznzFyGqkXDaScjRoIl8Xw#).
I live in Houston in one of the more desirable locations of the city and rent a very nice apartment for $1050. Most of the houses sorrounding me start at $400K. A comparable apartment costs $225K. I ran the numbers several times and the only way to buy is if I’m 100% sure I’ll stay put for 6 years. Working in the oil industry mobility is very important to keep climbing the corporate ladder.
Also remember that when you sign on the dotted line you DO NOT OWN anything, you are just signing a commitment to “Rent” from the bank for 30 years. You also pay interests, property taxes, PMI, insurance, trash collection, HOA, maintenance,etc. which you don’t pay when you rent. To get the Tax deduction you need to have a mortgage of at least $300K so you can itemize.
For me, I prefer to have $300K in liquid investments (stocks, bonds, ETFs, etc) and not $300K in a home’s equity that the only way to access is to sell the house (if you can and the market did not come down since you bought). If you look at the long term appreciation rate of most houses in the US is only 1% over inflation while stocks have averaged 6%.
I agree with this post in that it is essential to have an investment strategy to put away all the money you’ll save renting. Once I retire I’m sure I’ll have a lot of liquid assets that will allow me to buy any place I like cash knowing that is the place where I’ll spend the rest of my life. My two cents.
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November 19th, 2009 at 4:42 pm |
I’ll have to side with Tony. I live in NYC and my calculations for renting vs. owning are pretty much in line with his. That being said, I’m definitely looking to buy given the right personal circumstances: income, expenses, net worth, price of the house I’m buying, and so on.
When I do buy, it won’t be because I feel I need to buy so I can stop renting, it will be because I can comfortably afford it, as I can afford to rent now).
Investing 101 For Dummies´s last blog ..How To Get Started Investing In The Stock Market: How And Where To Find Profitable Stocks
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March 4th, 2010 at 4:31 pm |
Are there legal benefits given to property owners that are not extended to renters? I’m thinking of using your house in lieu of bond payments when arrested, etc. Would you be able to put up the value of your investment account as collateral for a bond?
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March 4th, 2010 at 8:58 pm |
In this case, their is an obvious preference for people who own.
*there
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March 5th, 2010 at 1:27 pm |
House prices in my area went down for ten years. At the same time the roof, well, septic, and furnace failed. This would be no problem for a renter. Also, over half of homeowners can’t take the interest and taxes deduction because it is less than the standard deduction.
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March 26th, 2010 at 6:03 am |
Personally i prefer buying a home, but this decision is good if you really want to settle down somewhere for a long term. Actually, i think, it’s better to make up your mind first and then decide, rent or buy.
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May 5th, 2010 at 4:54 pm |
Fantastic articles & Nice a site….
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