Renting vs Buying
The question of when to buy and when to rent has always been a difficult puzzle to solve. The COVID-19 pandemic has brought new attention to this quandary as many first-time homebuyers worry about what the housing market will look like in months and years to come. But even without a global pandemic, the question of renting vs buying has rarely had a simple answer and there are a lot of factors that can go into a comparative analysis. These can include financial considerations like details of a potential mortgage, years you plan to be in the home, speculation of the home price growth, expected inflation, your income taxes, as well as maintenance costs and fees. But you should also take stock of the emotional concerns surrounding your decision to buy or rent? Things like the reasons behind your motivation to buy, the feeling that homeownership provides, the limited flexibility that comes from a mortgage, or the freedom that comes from being able to make your own choices about the property and its condition. Each one of these facets brings its own weight and value to your consideration based on what you deem most important. The following are some questions you can consider when thinking about whether you are ready to buy or whether it is better to continue renting.
WHY do I want to buy a home?
I put this question first since it is arguably the most important question you need to answer when deciding whether to rent or to buy. It can also be one of the harder answers to pin down. Because the decision to buy a home is motivated by both financial and emotional incentives, its important to understand what you are going to prioritize. For example, if your primary driver for purchasing a home is to start building equity and to stop “throwing away money on rent”, you probably want to focus on the analytical aspects and whether the math makes sense for buying. After all, if the goal is to make a better financial move, then buying only makes sense if it truly does save money in the long run.
On the other hand, let’s say your primary motivation for buying a home is so you can finally get a yard for your dog. While you obviously care about the finances of buying, you probably won’t let them deter you from going down that road. Your dog is a part of the family and she needs space to run around, I get it. It’s part of the reason we bought over 2 acres here east of Cleveland, Ohio. The point here is that knowing your WHY for wanting to move is a good first step in determining if now is a good time to buy or if it’s better to stick things out as a renter.
Do I have a handle on my finances?
One of the most important moves you can make when determining if you are ready to buy is to take stock of your personal finances. Homeownership comes with some serious and often unexpected costs that can be devastating for someone without a good financial plan in place. Start by taking stock of your income and expenses and developing a budget that works for you.
Be sure to include space for an emergency fund, disability insurance, and life insurance too. A proper emergency fund will help you take care of the unforeseen costs that crop up along the way. It can also stop you from reaching for your credit card to cover an unexpected cost without an easy way to pay it back. Good disability and life insurance can protect you and your family if any of your worst-case scenarios were to take place.
Unfortunately, this is a lot more common than many of us would like to believe. A 2015 study from the International Journal of Health Services found that in one US market, 57% of foreclosures were related to medical debts or a medical cause. A full one-fifth of respondents stated that income loss due to illness had directly led to their foreclosure. Likely your biggest asset right now is your future earning potential as a pharmacist. Protect that asset just like you would any other.
How long do I plan to live here?
As we’ve discussed, one of the primary financial benefits of owning over renting is the ability to build equity over time. Ideally, your home will appreciate and increase in value all while you are simultaneously paying down the debt you owe on. When things go well, homeowners can find themselves with considerable equity built into the property in just a few years. The problem comes when you won’t be able to give the home enough time to build equity. Fees, closing costs, repairs, these expenses can add up when you first buy a home. It can take years to spread out these costs and if you sell too quickly, the value you’ve added may not be enough to offset the losses. Plan to stay for a few years if you want to maximize the financial benefits of owning. How long is a few years? That depends. The break-even point varied considerably based on geographical area and price. There is a great tool available on Smart Asset’s website that can help you calculate the point where buying makes more sense than renting on a particular property.
For example, Let’s say I’m currently renting an apartment here in Cleveland, Ohio for $1,300 per month but I’m considering buying a $175,000 house. Based on loan costs, repairs, closing costs, and fees, I would need to live in that house for 3 years for it to be more financially beneficial to buy the property compared to continuing to rent. Check the calculator out for yourself here.
Do I have enough saved up for a down payment?
The typical down payment required for a conventional loan is 20% of the purchase price. On a $200,000 home, that’s $40,000 cash you’ll have to part with. Not to mention the $4,000 – $6,000 in closing costs that come with the lending process. For many, finding enough for a solid down payment can be one of the most daunting parts of setting about buying a home. Especially if you have student loans or other debts eating into your monthly cash flow. Of course, with decent credit and a pharmacist’s salary, its fairly easy to find other loan options that require less down. For example, both FHA loans and pharmacist loans can require as little as 3.5% down for first-time homebuyers.
Regardless of the loan, you end up using, nearly all home purchases will require you to have cash on hand when you buy. This also shouldn’t be confused with your emergency fund. Those dollars are separate and should only be used for the unexpected expenses you weren’t able to plan for. If you don’t have the cash reserves at the moment, consider waiting another 6 months or a year before buying a home and using that time to save up or pay down your other debts. In a pinch, family members can also assist with your down payment if they have the means.
Are there any broad market trends that could impact my decision?
Just like the stock market and the economy in general, the real estate market goes through its ups and downs. Understanding the current regional and local market trends can help in guiding your decision-making process. For example, if the market you’re interested in is currently favoring sellers with low inventory and short days-on-market, it might be better to wait until inventory increases before starting to shop. This could also be an indicator that the community is growing and things will only be getting more expensive for the foreseeable future.
Unfortunately, many times we simply don’t know where a market is headed. Now is actually a perfect example of this as analysts struggle to figure out what a pandemic-driven recession will do to the housing market. Keep in mind, Numerous websites and real estate brokerages put out regular updates on how the local market is fairing. Things that can help you determine if your market is geared for buyers or sellers include the average days on market, the list vs. sale price, and the number of homes selling with multiple offers. Ultimately, the best way to learn more about the market you are interested in is to get connected with a local real estate agent who knows the market well.
Is my city generally better for renters or buyers?
Certain cities are just more affordable to buyers compared to others. One quick way you can compare renting versus buying is to use the price-to-rent ratio. You can calculate it by dividing the average home value by the average annual rent amount. In general, if the price-to-rent ratio is less than 20, buying is generally going to be more cost-effective for that location. Obviously, city averages are only helpful for understanding broad trends and individual properties will provide different price-to-rent values. Fun fact: Cleveland, Ohio, where I call home, has a price-to-rent ratio of just over 8, making it a great place to buy! Check out this post for even more city-specific data.
How does the math actually look?
Many people make the argument that buying is always better than renting because you aren’t “throwing away money” and you get the opportunity to build equity. Another common statement I hear thrown around is: “if the mortgage payment is the same as the rent payment then buying makes sense”. In reality, mortgage amortization schedules are structured with a lot of interest due at the beginning, and very little of your payment goes toward the principal. Because of this, you actually don’t build much equity in the first few years of owning. Furthermore, owning a home is hardly just making the mortgage payment. There are taxes, insurance, some communities have HOA fees, and stuff tends to break over time. In fact, Many experts recommend budgeting 1% of the value of your home each year to cover maintenance costs. Many of these expenses are being borne by your landlord or apartment complex when you’re renting. Once you own a property, these extra costs become your responsibility. When weighing the financial differences between renting and buying, don’t ignore the total costs of each side of the equation.