When you rent your home, writing a check to your landlord each month can feel like a waste of money when compared with paying a mortgage on property you own. But it is not that simple – there are costs and benefits to both owning and renting, and it’s important to understand them when deciding which is best given your situation.
The Benefits of Renting
Renting has had a bad rap for a long time, but after the housing crisis, many have quickly changed their mind. Sure, it may be the American Dream to own a home, but you probably never dreamt of owing more on your house than it was worth, right? So let’s get down to the financial benefits of renting.
- You don’t have to worry about maintenance or repairs. The landlord is responsible for most of the maintenance and repairs, which can average hundreds of dollars per month.
- You don’t pay taxes. The landlord is responsible for all real estate taxes. They can cost thousands of dollars annually, saving you a lot of money.
- You don’t have to make a down payment. Down payments can get costly. A 5% down payment on a $150,000 home is $7,500. A security deposit, on the other hand, will typically only cost one or two months’ rent.
- Lower insurance premiums. Homeowner’s insurance can cost several hundred to several thousand dollars a year. Renter’s insurance, on the other hand, covers only your personal belongings and costs a fraction of what homeowner’s insurance costs (for example, Lemonade starts at around $5 per month.
- You don’t have to worry about depreciation. If the home loses value, it doesn’t directly affect the tenant. You pay the same amount of rent for the length of the lease. If you own the home and it drops in value, it affects the value of your investment. You could even owe more to your mortgage company than the home is worth in extreme cases.
The Risks of Renting
Like everything, renting does have some financial downsides including:
- You pay for someone else’s investment. As a renter, you don’t gain any profits when the home appreciates. The landlord could decide at any time to sell the home and make a profit. You don’t see any return on your investment made in rent payments.
- You may be stuck in a lengthy lease. If you cancel a lease before it expires, you may face financial penalties. Each lease is different, but there is generally a penalty, such as two months’ rent, outlined in your lease agreement.
- There’s no end to rent payments. Unlike mortgage payments that end once you pay the full amount back, rent never ends. There isn’t a 15, 20, or 30-year term. You pay rent for the rest of your life.
The Benefits of Buying a Home
Buying a home is more expensive, but it has several financial benefits:
- Your payments earn equity. Buying a home is like investing in it. As you pay the mortgage down, you earn equity in the home, which may appreciate in value. When you sell it, you keep the profits after paying off the mortgage. If you pay the mortgage off in full before selling, you keep 100% of the proceeds (minus the costs of selling)
- You can deduct the mortgage interest. The IRS allows you to deduct the interest on up to $750,000 in mortgages, as long as they were used to buy or significantly renovate the home, including interest on a home equity loan. This decreases your tax liability.
- You can better predict your costs. If you have a fixed-rate mortgage, you know the cost of your mortgage for its term. You don’t have to worry about increasing payments that you may or may not be able to afford.
- It’s a long-term investment. You may earn a decent return on your investment by investing in real estate. If you are in it for the long haul, it can serve as a nice retirement nest egg, assuming the value appreciates.
- Limited capital gains taxes. You may not have to pay taxes on the first $250,000 (singles) or $500,000 (married couples) in capital gains when selling the home. As long as you own the home for at least two years and you live in it as your primary residence, you may qualify.
The Risks of Buying
Understanding the downside of buying can help you make the right decision.
- You can lose your investment. If you default on your mortgage, your lender can foreclose on your home. You lose not only your home but the rights to any money you’ve invested in the home thus far.
- All maintenance and repairs are on you. You are responsible for paying for all maintenance and repairs on the home. Your homeowner insurance may help offset some of the costs, but you still must pay the deductibles and homeowner insurance premiums.
- High upfront costs. You may need a hefty down payment depending on the chosen loan program, plus closing costs. Expect to pay between 2% and 5% of the home’s price in closing costs.
Making the Rent vs Buy Decision
So how do you make the rent vs buy decision? You should consider the opportunity cost of putting your money toward a home. In other words, what will you miss out on by investing in a home and not investing your money elsewhere?
You’ll need to look at the big picture. What will it cost you over the long-term to rent or buy? How much profit could you potentially earn if you buy? Using a rent vs buy calculator, you can look at the long-term using today’s factors, enabling you to make a solid decision.
Navigating the rent vs buy decision is a big one. Take your time and think about all factors. In addition to the financial aspect, look at how it affects other areas of your life. Do you see yourself staying in the same location for many years or do you like to move from year to year? Is your job stable or do you think you’ll be relocated in the future? Consider these factors along with the financial aspects when making your decision.