Is buying better than renting?
One of the biggest financial decisions you’ll ever make is whether to buy or rent your home. This decision can feel more important than mere numbers and ratios. After all, most realtors will quickly whisper in your ear “it’s not a house, it’s a home!”
Once you’re settled in a career and have some money in the bank, the idea of renting quickly becomes less appealing. Moving every few years is a pain, landlords raise rent, and you’ve always wanted a backyard for your concrete alligator collection! And don’t forget, if you owned you could paint the dining room that perfect shade of fuchsia…
As for the financials, even the President of the United States says it’s a good thing to own a home:
Today I’ve come to Phoenix to talk about the second component, which is the most tangible cornerstone that lies at the heart of the American Dream, at the heart of middle-class life — and that’s the chance to own your own home. (Applause). The chance to own your own home.
So what’s not to love about owning a condo or house?
- The fees paid when buying or selling a house are substantial. So- called “transactions costs” can really add up!
- Expect that selling a house will cost about 8% of the sales price. The practical result of this is that in order to break even on your house, you need to sell it for at least 8% more than you paid.
- A house or condo is a very illiquid asset. Think of how easy it is to sell stocks or cash in a certificate of deposit. Selling a house can take months and unless you have significant equity, you won’t necessarily be able to get a Home Equity Loan.
- If you need to move suddenly you may have to sell at a lower price. Owning your own place ties you down in a way that renting doesn’t.
- A downpayment can tie up a huge amount of your cash. If you put 20% down in order to get a non-FHA conventional mortgage, that’s serious cash in hot real estate markets!
- Maintaining a house can be a huge hidden burden. If you’re handy, this isn’t a problem, but if you need to call a plumber every time a sink drips or an electrician to fix a light switch, then you’ll be hemorrhaging money. There’s no landlord to call when the basement floods on New Year’s Day (which happened to the Frugalwoods home last year).
- Student loan debt can make qualifying for a mortgage in the first place a real challenge. Mortgage lenders want to see a certain Debt to Income (DTI) ratio and student loan payments can put you in a bind. They also make saving for a substantial downpayment that much harder.
So wow, never buying a house right? Terrible idea! Only suckers would buy a home!
Not quite. For the right person and the right situation, buying a house can be a great financial decision.
Here are a few reasons why buying can work out in your favor:
- Not having to worry about rent increases means that a major component of your cost of living is permanently fixed. Maintenance costs and taxes will increase over time, but that mortgage payment never will.
- Paying off principal is effectively paying yourself back. This cuts the “real” monthly cost of ownership substantially. Of course you can’t easily access this wealth that you own, but it’s yours nonetheless.
- The United States government dramatically subsidizes home ownership. If you’re in a high tax bracket, the mortgage interest deduction can be a substantial help on taxes. Plus, there are homeowner programs for energy efficiency and property tax abatements that don’t apply to renters.
- If you buy a place that needs work, you can build significant value by fixing it up while you’re living there. When you sell, that sweat equity is tax free thanks to the capital gains tax exclusion ($250,000 for singles, $500,000 for married couples).
- Owning a home is a massive leveraged hedge against inflation. If inflation increases, your housing costs aren’t indexed to inflation whereas rentals are. The value of your home would likely increase with inflation though, which is amplified by the fact that you borrowed most of the money. Win!
So now you’re probably nice and confused. Home buying is simultaneously the most responsible and irresponsible thing you can do for your financial future! Let’s see if we can break it down.
You should think about buying a house if:
- You are debt free or your debt is under control.
- You’re certain you’ll stay in the geographic area for at least 7 years. Anything less than that is gambling with appreciation and you’re just as likely to lose money on the transaction than make money.
- You won’t outgrow your prospective place in 7 years. That 2 bedroom, 1 bathroom bungalow looks great now, but will it look just as good with 2 kids, 2 dogs, and 1 miniature donkey? Don’t overbuy for your needs, but don’t buy something you’ll immediately outgrow.
- You aren’t intimidated by maintenance. Even if you end up hiring it out, being generally handy is essential for avoiding being ripped off. Tradesmen can smell a home improvement rube from a mile away and will happily bleed you dry. Being able to confidently say “yes, do this but leave that alone, it doesn’t actually need replacing” will save you tens of thousands of dollars.
- You believe housing prices are sustainable in your area. This is subjective and deserving of its own post. But if housing prices are increasing by double-digits every year in your neighborhood… maybe it’s not sustainable. Remember that not too many years ago real estate was considered an extremely safe investment. We see how that worked out.
Mrs. Frugalwoods and I did end up buying a house. We meet all of the above bullets and so far, it seems like a good decision. I wrote up our specific situation here, but suffice it to say we carefully considered our particular circumstances before pulling the trigger.
We at Frugalwoods aren’t the first bloggers to ponder house buying. Here are some other awesome write-ups on the topic:
Why buying a house is a terrible investment by JCollinsNH. A classic in the FIRE world and a must read.
NY Times Buy vs. Rent calculator. Great for running through scenarios.
Do you own or rent? If faced with that decision again, would you make the some choice?
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The truth is neither one is really a good financial decision. Renting and owning are both liabilities and not assets. For that reason you want to find a way to limit as much as possible. For me the best way has been to own lower end homes in very nice neighborhoods. These homes are relatively easier to sell based on location and usually can sell for more than what you paid to help cover your expenses living there!
Definitely agree that buying the cheapest home in the neighborhood is often the best strategy. Ours was lowest price-per-sq-ft home sold in our town that month, by almost $100/ft! When we saw the listing we basically said “as long as it’s better than a tent, this is a good deal!”.
In planning for the future, I always count on breaking even with buying. Anything else is gravy, though it looks like our current home will have a darn good ROI as a rental.
Just going through the archives…hope you don’t mind the late comments. The 7 year timeframe is nice, but not guaranteed. We bought our house 10 years ago in a DC suburb and today it’s still worth about 80% of what we paid for it. In my mind, the only to real reasons to buy a house are 1) if it can rent cash-flow positive, or 2) if it is a permanent “dream home” dwelling. We rent out our house and rent another one to live in.
Hah, no worries. Yeah, I agree about the timeline. It seems like “5 years” is a common trope, but that has always seemed way too quick in most markets.
Glad to hear you’ve managed to turn that place into a cash flowing rental! We certainly bought our current place with cash flow in mind for the future… and it’s a nice safety blanket 🙂
One thing to consider is whether it will be a family home or an investment. For most people their first home isn’t very useful as an “investment” because unless you made a huge down payment, that home’s equity is all tied up in where you live. My dad is fond of telling me his house was worth a million dollars on the day he retired, but that might as well be zero if you have no plans to ever move out or take out a future home loan. 🙂 For my husband and I, on the other hand, we’re 30 years younger and absolutely intend to downsize in the next five years, when our teenagers move out. It frees up half the money we put into this place, and we’ll use that for another investment rental which will bring more income. I guess you can see that I think real estate is a good investment, but only if you’re smarter than the average bear – that is, do more homework than most people, and then do some more after that – and know for sure that you can make it pay YOU.
For us putting our money in our retirement accounts and paying off student loan debt versus putting all our savings towards a down payment has made more sense in our twenties. Our employers have significant 401K matches, and we know the importance of saving early for retirement given the great rewards of compound interest. We’ve built up a good emergency fund (at 4 months of all our expenses, targeting 6) and are almost done paying off our student loans…cannot wait! In another 6 months we will fully own our educations, have over $120K in retirement accounts and have a steady 5 month emergency savings account. Then we’ll start putting our extra money towards a down payment, but do not plan on adjusting (or at least decreasing, all raises go right towards upping this) our retirement contributions. We don’t intend to buy without 20% down, that PMI can make way more money in a mutual fund. So who knows, we may not buy a house till we’re 40. But we’ll own it by 55 with ensuring we have at least 20% down, a 15 year mortgage and all the while socking away at least 20% of our income into retirement. Some days I feel like we’ll be renting forever as others are buying condos and homes, some with bidding wars. Scary stuff seeing as how we are not that far from the housing crash. Very few people actually “own” a house till at least 55 anyways. The bank does. I’m pretty debt averse, have never carried credit card debt and we own our car (yeah to city living and the ability to have only one of these!). Still I must admit there is something very enticing about the “American Dream” and homeownership. Hard to deny this “dream” when your own president admits it’s still there, too. Something is shifting though. Seems freedom to work, access to health care, and the desire/need to be educated are dominating how we dream and less so a picket fence. Overall I love reading frugalwoods so thank you for your posts!
We live in a small University town where real estate is booming. We love it here and don’t plan to move. Currently we are pretty happy with our house. We live right below the mountain–wife walks to work. We bike to downtown for drinks and even I’m only a 20 min bike ride from my work.
I have researched and researched this and I have started to see the math in the J Collins approach to seeing buying a house as a terrible investment. I guess i just can’t get over the feeling that it would be so simple and easy to stabilize your living expenses by paying off a mortgage.
That being said, we rent way below market. Our landlord doesn’t believe in raising rent. The neighborhood we live in, for this square footage, a houses can sell for $260k while we pay 825 a month.
And yet we are looking to move into a “better” house. Ours is old and clunky in some ways–just not efficient in design. The wife is on board to just rent a nicer place…I am just stuck on the decision of whether to rent or buy. Does anyone have thoughts on our situation?
I posted before and one of the comments was to run the numbers. I have had a hard time doing this with ours. I think we have always come out in the middle. Like I said we rent for 825 a month. The particular neighborhood we live in …the smallest house in the hood(965 sq feet) is listed at 260k. That’s about the cost of our current rent. Frankly we would like something a touch bigger, perhaps 3 bed, 2 bath. I would guess this would be in 275k range here but we could find something in the 250k range in a different neighborhood, maybe as low as 235k.
I have $65,000 saved up in a liquid savings account. I have another $65 in our retirement accounts, mostly traditional funds. Planning to do the Roth conversion ladder whenever we hit FI.
Part of my struggle now is just not knowing what to do with the money. Frankly it’s eating me up watching it earn 1% interest. I would love to max out the retirement accounts, and invest the rest, maybe take a fun trip. But we plan to do a 15 year mortgage and we really need every penny of that if we do buy a house to make the payment affordable.
This would be our first home so I think we are both just struggling to see if we would like the lifestyle of owning or not. We definitely think wisftully about it but I also realize it could be a lot of headaches. Especially in this area…the houses people end up buying need a lot of work typically(or you really pay a premium).
Any math help really appreciated…any wisdom appreciated!
I have written in another comment on how my Affordable Housing apartment fell into my life, and that was certainly a unique situation. That said, I bought in 2004 at 25% below market value and by 2008, the property crash was so bad that even I was in negative equity! So just finance-wise, I could have bought then, too. Whilst I agree that rushing out to buy when your life situation is not yet stable enough, just on the mantra that buying is the thing to do, is foolish, I have never regretted buying. A number of points Mr FW has overlooked which speak against renting and in favour of buying are, in my opinion:
* If you have a variable-rate mortgage, your monthly payment does not stay fixed, but on the other hand, you can bring it down by systematic overpayments, both to improve your cash flow if necessary, and to hedge against later interest-rate rises.
* Many rental markets have boom and bust cycles just like real estate markets. If there is a shortage of rental housing, you may pay absolutely through the nose. My monthly mortgage payment is less than half of what it would cost to rent an apartment like mine, in my neighbourhood,, right now. This despite the fact that inflation in my country has basically flatlined since 2008.
* Landlords often do only very shoddy and cheap maintenance of a standard which may not be acceptable to you. The maintenance may also be late. I personally think the time-and-mental-energy expenditure to get the landlord to do right by you wholly eclipses any supposed “convenience” of the fact that maintenance is theoretically on them.
* You are at the mercy of the landlord in terms of rent increases regardless.
* If you are a member of a social or ethnic minority you may have a harder time finding rental accommodation in the first place, or it may cost you more to rent. In my country, that is actually illegal, but few cases arise because evidence is hard to come by for complainants. How would you know who gets that apartment or house in the end, or how much rent they pay?!? Just to say that for me as a member of the GLBT community, the knowledge that I could not be kicked out of my home any longer apropos of someone else’s prejudice, and the peace of mind which came with knowing that I would always have a home, was priceless. Deciding the rent-or-buy question solely on the basis of financial mathematics speaks of a lot of unconscious privilege, in my opinion. (Not saying that Mr and Mrs FW are in that camp!)
We are retired and are so glad we listened when our parents talked about how important it was to own a home free and clear before you retired. This is the second home we’ve owned, bought on a conventional 15 year mortgage and paid off just months before my husband had to take early retirement because of Parkinson’s Disease. I can’t imagine having to pay rent at this stage of life and worry about it increasing. I also can’t imagine making house payments at this time of life. Browsing real estate and rental ads and seeing current prices scares the bejeezus out of me. Homeowners’ insurance, taxes, and maintenance have NEVER cost anywhere near what current rent on a house would be. I think the key is to not get caught up in the McMansion fever. A lot of people who are bitter about home ownership tried to keep up with the Jones, bought an impressive house they could barely make the payments on, then lost it when someone lost a job, got sick, or was on layoff. Own a modest home you can make the payment on even during times of layoff or illness. We own free and clear a modest three bedroom ranch on a little over two acres in a growing semi rural area, now worth over twice what we paid 24 years ago. We are comfortable. If our home weren’t paid for, we would be pinched.