Rent vs. Buy: The Pros and Cons of Homeownership
04/16/2019 Alena Savchenko
Homeownership has been a keystone of the American dream. The ability to decorate your walls, paint a room sky blue, and live with a furry companion without landlord approval makes buying a home attractive, as do the substantial financial benefits such as tax savings and equity building. What’s more, there’s nothing like the peace of mind that comes from the knowledge that your home is truly yours.
Still, there are many important factors to consider before deciding between renting or owning a home. Let’s begin by looking at some of the pros and cons of both, and then take a closer look at the financial implications and lifestyle considerations that you’ll need to keep in mind in order to make an informed decision.
Comparing the Pros and Cons of Buying and Renting
As with any major decision, there are advantages and disadvantages to both renting and buying. Take a look at the comparison tables for both options here, and then we’ll get more in-depth with each item below.
Homeownership Pros and Cons
|Buyer builds equity in the home||Requires upfront costs for down payment, closing fees, etc.|
|Credit scores increase with positive payment history||Process can be complex|
|Mortgage interest and property taxes may be tax deductible||Property taxes and HOA fees are the buyer’s responsibility|
|Buyer has full control over home improvements and upgrades||Buyer incurs any maintenance and repair cost|
|Homes frequently increase in value over the life of a mortgage||Typically a long term investment|
Renting Pros and Cons
|Fewer upfront expenses||The landlord can decide at any time to raise the rent|
|Certain utilities may be included in the rent||A landlord has the final say on pets, property modifications, etc.|
|No long-term commitment once the lease ends||Less stability—it’s the landlord’s choice whether or not to renew a lease|
|Landlord pays for necessary repairs and maintenance||Renting does not build equity|
|Rental insurance is inexpensive||May be required to allow landlord access to home for inspections|
Financial Considerations for Buying
While your financial picture is not the only deciding factor in the rent vs. buy debate, there’s no denying that it is among the most important. After all, buying a home is one of the biggest purchases (if not the biggest purchase) you’re likely to make in your lifetime. Let’s consider the largest costs of purchasing a home.
While the majority of your home’s purchase price will be financed into the mortgage, you will still need to come up with a down payment. This can be anywhere between 3% and 20% of the total cost of the home. For instance, for a $275,000 home, the down payment would be between $8,250 and $55,000.
While the 20% down payment that comes with a traditional mortgage might be out of reach for some buyers, there are a range of other options, from down payment assistance programs, to help from your family members. Don’t let a down payment discourage you—there are many alternative funding sources out there to help!
Along with a down payment, a homebuyer will typically pay an additional 2% to 5% of the home purchase price in closing fees. These are fees that cover the costs of title companies, appraisers, real estate brokers, attorneys, and other third parties involved in the buying process.
While you may ask the seller to cover part (or all) of the closing costs, the reality is that the buyer is generally on the hook for these fees, which can vary widely depending on your loan program, location, and other factors.
Beyond the Mortgage: Other Costs Associated With Homeownership
The financial considerations of homeownership do not end when you sign on the dotted line. There are plenty of costs associated with owning your new home.
You Pay Property Taxes
Based on the assessed value of your home, property taxes are used to pay for roads, schools, emergency services, etc. in your area. Depending on your location and the terms of your mortgage, you may pay them monthly (as part of your mortgage payment), quarterly, or annually.
You Pay for Upkeep and Repairs
When you own your home, there is no landlord to pay for repairs. This means if your heater quits during a blizzard, or your septic tank fails just before houseguests are due to arrive, it’s your responsibility to take care of the necessary repairs. Likewise, the general upkeep of the property is also your responsibility. For these reasons, it’s more or less mandatory to have an emergency fund set aside.
Utilities Are Your Responsibility
When you rent, sometimes the owner will cover certain utilities such as water, garbage collection, and sewer. Some landlords even provide internet and cable television services. However, as a homeowner, these now become line items in your own budget.
Financial Benefits of Homeownership
Despite the aforementioned costs incurred with homeownership, there are some serious financial benefits as well.
You Get Tax Deductions
If you plan to itemize your deductions on your income tax return, you may be able to deduct your mortgage interest on loans up to $750,000. You also can deduct your state, local, and property taxes up to a combined $10,000. This can significantly reduce the money you owe on your federal income taxes, effectively allowing you to keep more of your hard-earned money.
You Build Equity
Equity is defined as your assets minus your liabilities.
For instance: Imagine you buy a $275,000 home with 20% down. This leaves $220,000 still owed. Using the formula assets minus liabilities, you have $55,000 (or 20%) in equity—the percentage of the house you already “own”—straight out of the gate. The equity will continue to increase as the amount you owe decreases and if your property value appreciates.
It may help to think of home equity as “forced savings”—a way to contribute to your future without even thinking about it, knowing that your money is being saved in the form of a property asset. You may not be putting money into a savings account each month, but if you’re paying your mortgage each month, you’re building equity.
There are ways to build equity faster. You can pay more than the required monthly mortgage payment, thus contributing more to the principal balance. You can also make improvements to your home that increase its value—an increase in value means an increase in equity.
Home equity has the added effect of increasing your borrowing power. The greater your equity, the more money you can borrow against it. Home equity loans are a popular way to get cash for just about anything—renovations, the purchase of a second home, or other long-term investments for your future.
Your Home Appreciates in Value
Appreciation is the increase in your home’s value over time, and nearly all homes tend to appreciate in the long run. Many things contribute to a home’s value including upgrades and renovations to the property, general improvements in the neighborhood, and changes in the real estate market. More often than not, all a home needs to appreciate is regular maintenance and time.
As long as you’re paying your mortgage, your home will essentially act as a de facto savings account that should keep pace with inflation (barring economic upheaval). Your home is likely the biggest investment you’ll ever make, and the greater the appreciation, the larger your return on that investment.
Financial Considerations for Renting
It is clear that homeownership comes with advantages (tax savings and equity) and disadvantages (higher upfront costs and responsibility for repairs). On the other side of the coin, renting has financial considerations of its own. Here are some of the most important things to keep in mind.
Fewer Unexpected Expenses
While homeownership can come with a myriad of unknowns, the cost of renting tends to remain the same month after month, for the term of the lease. During that time, you’ll pay a fixed cost to live in the rental—even if the bathroom sink refuses to drain on Tuesday and the water heater fails on Friday afternoon.
No Large Down Payment
Generally, the cost of moving into a rental is much less than a down payment on a home. While you do incur several costs—first and last month’s rent, a security deposit, and occasional extra non-refundable fees associated with cleaning or pets—renting requires less cash upfront than buying.
Monthly Expenses May Be Lower
Although mortgage payments are generally lower than rental costs, other factors come into play.
- Utilities can be lower in a rental. Sometimes the landlord subsidizes all or part of the monthly fees and since rental properties can be smaller than owner-occupied homes (think apartment living), it can cost less to heat, cool, and provide electricity for rentals.
- Renters insurance is far cheaper than homeowners insurance. The national average cost of renters insurance is $187 per year as of 2019 while the average cost of homeowners insurance is $1,083.
- Property taxes and other fees such as homeowner association (HOA) dues are usually included in the rent and handled by the landlord, saving a renter both time and money.
Calculate Your Price-to-Rent Ratio
Most renters pay 30% of their income in rent, while the average homeowner pays only 15% of their income towards the mortgage. Those numbers, however, may not be telling the entire story. Calculating your price-to-rent ratio can be a helpful way to see the true cost of renting vs. buying.
The formula is simple:
Asking price of the house ÷ your annual rent = your price-to-rent ratio
If the ratio is under 15, it’s a good time to buy. If it’s over 20, you might consider renting for a bit longer.
Do you know if you’re ready for homeownership?
As you’ve seen, there are long-term financial considerations for both buying and renting your home.
Online financial tools can be very helpful in giving you a general idea of whether it makes more financial sense to buy or rent.
But while money is a huge factor, it’s not the only factor. Always leave extra breathing room in your considerations for lifestyle ideas and future plans.
Lifestyle Considerations for Renting vs. Buying
Whether you buy or rent, the place you live should always feel like home. Just as high rent in an area you love might not be the best option for your financial future, a great deal on a house miles from your friends and family can impact the convenience of having loved ones nearby.
Money matters, but lifestyle considerations matter, too. Before you make the decision to rent or buy, ask yourself the following questions.
How Long Do You Plan to Stay?
Data from the U.S. Census Bureau suggests that the average person will move 12 times over the course of their life.
If you are planning to buy, consider what renovations you need to make to accommodate your lifestyle, in the near term and the future. Will you need to add to the house as your family grows? Are you prepared to lose money on the home if you need to move for work?
If you’re planning to rent, what will you do if a rent increase exceeds your budget? Are you prepared to pull up stakes in 30 to 60 days if your landlord decides to sell the rental to a new owner?
Are You Prepared to Put in the Time and Effort?
Homeownership can require more than just money; there’s emotional and physical labor as well. Things like lawn maintenance, basic repairs, and upkeep—even if you’re hiring someone to do it for you—take time and effort (and if you're outsourcing, money).
For most homeowners, it’s a labor of love, and the effort is rewarded with satisfaction. It’s important, though, to be sure that you’re ready for all the responsibilities that come with homeownership before you make your final decision.
Where Do You Want to Live?
Are you looking for a swanky townhouse, close to shops and entertainment venues? Is your dream home a tract house in the suburbs with a manicured lawn and a trampoline in the backyard? Are you looking for a property where you can have livestock and grow your own vegetables?
Urban, suburban, and rural homes all have their pros and cons, but someone who enjoys a Broadway show every weekend will never be happy on an upstate farm. The real estate slogan “location, location, location” exists for a reason.
Whether renting or buying, it’s important to consider all of the things that come along with every potential location. If you have children, or plan to have children, schools will certainly be a factor, along with other considerations, such as yard size, proximity to parks and green spaces, as well as the overall safety of the neighborhood.
You will also want to consider the day-to-day factors, such as proximity to work, entertainment, and friends and family. Take some time to imagine the unique benefits and challenges for each potential location. Parking and nighttime noise, for example, are factors that may not be immediately obvious when you’re touring a property, but will certainly affect your quality of life.
Deciding to Rent or Buy
Renting and buying each come with significant advantages and drawbacks, and it’s crucial to weigh them both before you come to a decision.
If you’re looking for flexibility, low move-in costs, and little to no responsibility for upkeep, repairs, and maintenance, renting may be for you.
However, if you’re interested in building equity and investing in your future while having complete control over the home you own, then it’s time for homeownership!
Ready to start your home buying journey? Begin your online application now, if you still have questions contact a PennyMac Loan Officer. We’ll help you evaluate your options and decide the best course of action for your unique situation.