Renting or Buying a House: How to Decide What Makes Sense for You

  • Posted by Jeremy Bachmann
  • 08/17/2012
  • renting
Renting or Buying a House: How to Decide What Makes Sense for You

With home prices and interest rates low right now, renters as well as anyone considering a home purchase have a good problem: options!

Record low mortgage rates increase your buying power because the same monthly payment of a few years ago can now buy much more house. Also, housing prices in many parts of the country remain down from where they were a few years ago.

As a result, the decision on paying rent vs. buying has become a little more complicated. Here's some advice to help you decide on a few key questions:

How Long Will You Remain in the Home?

The long standing rule of thumb is that it takes an average of six years before buyers start to reap some of the financial benefits of homeownership. Since rent rises with inflation, a homeowner's monthly mortgage payment can eventually become less than a monthly rent payment – but it takes time.

Also, closing costs on a home purchase can commonly be $8,000 - $10,000 or more. Staying in the home longer allows you to essentially spread those costs over more years.

So, if you plan to move within a few years, it may make more sense to rent. Generally, experts suggest that buyers should stay in their homes 5-7 to break even over renting.

Plus, as a renter, you have the flexibility to pick up and move at a moment's notice - no strings attached. In contrast, you could lose a lot of money if you chose to leave soon after moving into a new home.

What do the numbers say?

A helpful tool to determine whether to buy or rent is the Price-to-Rent ratio. This simple calculation provides a ballpark figure (called a ratio) that can help determine which makes better financial sense.

The Price-to-Rent ratio compares the cost to rent vs. buying by dividing the typical asking price of a property for sale by the average annual rental cost of a second similar property. The calculation theoretically takes into account all of the costs associated with buying a home, such as closing costs, taxes, insurance and other home related expenses.

According to fans of the Price-to-Rent ratio, if the resulting ratio is below 15, the housing market benefits buyers. If the ratio is above 20, the housing market favors renters.

For example, let's say you find two identical condos located in the same building. One is for sale and one is for rent. They have the same number of bedrooms, bathrooms and square footage. The condo for sale costs $150,000. The condo for rent costs $12,000 to rent annually. After dividing the price of the condo for sale by the annual costs of the condo for rent, your resulting ratio would be 12.5. Time to buy!

What is your monthly budget?

Buying a house can be tremendously rewarding, emotionally and financially. Of course, without careful planning, the sudden monthly expenses can be a bit shocking. It's really important to work out your realistic budget.

Beyond the mortgage payments, owners have to deal with utility bills and property taxes and a host of unforeseen problems, like a leaky roof or fallen tree limb.

While all of these costs can be daunting, buying a home may make sense for you long-term, if you have the room in your budget. Remember, you'll be creating equity and your housing fees will not be subject to inflation (unlike renting).

When budgeting though, think about other bills and saving needs you may have, such as paying off student loans, building a retirement account or growing an emergency fund. In any of these cases, renting will give you greater flexibility and will allow you to continue saving for that perfect home.

So, should you buy or rent your next home? Chances are in most areas, the low interest rates and home values make this a great time to buy. However, be sure to budget carefully and plan to stay in the home for at least 7 years to maximize the benefits of owning.