The dream of home ownership is a long standing tradition in American culture. Many think that all you need is a down payment and the keys will be handed over to you. However, there are many costs to home ownership. When you really understand them, you may be asking, “should I buy or rent?”
First, I want to make sure that I address that where you live depends on so much more than just “which is cheaper”. There are sentimental values, geography, space requirements, and safety to consider.
I am going to address which is more expensive, renting or buying, as if you could either rent or buy the exact same house. I'm not going to address the “where you live”.
So keep in mind that there are many things you can do to reduce your housing expenses that aren't factored into the question of “should I buy or rent?”. For example, you could reduce the number of bedrooms or find a less expensive neighborhood.
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Are you ready? Let's find out which is cheaper! Should you rent or buy?
Don't just compare Rent vs Mortgage
You should always do your due diligence when renting. Research how much rents cost in your area and understand the value of each additional bedroom or feature you want in your home. Also, research the management of the property. If it's a management company, you will quickly learn how prompt they are with maintenance requests. These things will make sure you’re not overpaying for your rent.
However, Investors are always looking to make a profit. In real estate, that profit comes from a renter. That means that your rent likely covers the cost of a monthly mortgage, taxes, insurance and maintenance, and gives a little bit of profit to the owner. In return, the owner takes on expenses when things break like air conditioners, dishwashers and roofs.
As a general rule, every $5,000 is another $30 you have to pay in mortgage. That means if you buy a $100,000 house, your mortgage will be around $600. Depending on your credit and interest rate this may be more or less.
The benefit of a mortgage is that you pay down the balance of the loan. Each month you pay interest and principal, and the principal portion goes to the balance of the loan. When you pay down the loan, you gain “equity”. Equity is your ownership in the house. If the house sold (for the same amount you paid for it) you would get the equity back.
However, what many first time homeowners don't count is something called “Escrow”. Escrow includes your insurance and taxes (and sometimes more expenses). Escrow is included in your monthly payment, so you have to count this when you compare expenses.
While you're renting, your landlord probably requires you to cover some sort of renters insurance. This covers the things you own inside the home or apartment, but it doesn't cover the structure itself. The landlord has an insurance policy on the building.
When you own, your insurance policy covers your home (the building) and also the contents (like TV's and jewelry), in case of any disaster. This will be more expensive than your renters insurance because it covers more potential damage.
As a renter, you don't pay any taxes on the property. If you buy a property, your will start to need to pay taxes. With a mortgage, the bank will divide your annual taxes by 12 and add it to your monthly mortgage (escrow) payment.
If you're trying to calculate taxes, be aware that the house you're buying may be undervalued in taxes. Say that your area's property taxes are 2%. If your house is currently “valued” at $100,000, your taxes are $2,000. However, if you buy that same house for $150,000, your taxes will now be $3,000. If your house has appreciated quickly, you may be in for a bigger tax bill. (There are ways to offset the taxes with things like homestead exemptions, but I wouldn't count on those until you're sure you qualify.)
But it doesn't end there!
Costs of Purchase
It's easy to compare the monthly costs of renting versus buying. However, if that's all you consider, you may make a costly decision. When you buy a home, there are some transaction fees that you will be charged. Appraisals, loan origination and inspections all cost money, and you will likely be required to cover them, which can be more than $1,000.
Additionally, upon the sale of the house, you may also have to pay. If you or the buyer uses a realtor, the realtors will be due a commission. Commissions can be up to 6% or more of the sale price of the house. Yikes! For example, if you buy a $100,000 home, the realtors will take $6,000 just for helping you find it and complete the transaction.
You can't really factor this into the monthly expenses because you don’t know how long you'll live in the house, or how much the house will sell for. If the house sells for more, maybe the appreciation will cover it, but you can't bank on that when you buy. This is why many real estate investors buy homes and rent them for decades: they can spread this fee out over a long period of time, and save up some of their profits to pay the commission when it sells. The longer you hold the house the more time you have to spread out that sales commission.
Regular maintenance will be required wherever you live. Every lease is different, but even if it's just changing the lightbulbs, renters are responsible for some of the maintenance expenses. However, when you're renting the required repairs and maintenance is usually limited.
For example, you may be required to keep the lawn mowed, but when the trees need trimmed, the owner will take that expense on. When you buy, plan for your maintenance expenses to go up a lot!
Water, gas, sewer, trash, internet and cable should all cost about the same when deciding to rent or buy a similar property. Where this gets tricky when you move from something like an apartment complex to a single family home. You may be air conditioning more space, you may be watering a lawn, and you may not have the group discount that an apartment complex gets for internet or cable. These cost increases add up fast. So, before you commit to buying consider these factors.
Should I Buy or Rent?
So, what's the answer? The answer is, it depends on how long you're going to stay. If you're renting and buying the same size house, you are more likely going to save money in the long run if you're buying.
There are two primary reason that owning a house for a long time pays off. First, you pay down the equity (the portion you own in the house). The longer you own the house, the more equity you pay off. When you sell the house, you can get that money back, less any closing costs. But the closing costs are tricky–keep reading!
Second, the closing costs that you have to pay upon sale (mostly the real estate agent commissions I talked about earlier) can be averaged over the time you own the house. For example, let's say you had to pay $6,000 in real estate agent commissions when you sold a $100,000 house. If you own the house for 2 years, you'd essentially be paying $3,000 per year in real estate agent commissions. That could be a few month's rent! If you own the house for 10 years, that's $600 per year, which is a little bit more reasonable. But, if you own the house for 30 years (the length of a traditional mortgage) you'd pay $200 per year!
I recommend that you only buy a house if you believe you'll own it for at least 5 years. Every market is different, and that makes it tough to set a hard and fast rule. However, if you think you'll be happy with the house for at least 5 years, you should be able to gain enough equity and divvy up the closing costs enough that you come out on top! (cross your fingers for appreciation, but don't count on it!)
What rent vs buy decisions are you considering? Leave your answer in the comments!
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