Should You Buy or Rent?

Get any group of people together for a discussion on whether it is better to buy or rent your home and you will be sure to have a passionate debate on both sides of the argument.  There are a lot of points thrown around as "set in stone" rules that all should abide by, but the truth of the matter, as in most debates" is - it depends.  That sounds like a cop-out answer so let's dive in a little deeper and see what it depends on and what factors sway the decision.



How strong are you financially? We'll start here because if you can't pass the financial strength test, there is no reason to dive deeper and torture yourself over the decision to rent or buy.  Continue renting as frugally as possible until you can answer Yes to all of these questions:

• Do you have enough saved up for a reasonable down payment (ideally 20% to avoid Private Mortgage Insurance)? 
• Do you have adequate reserves to cover at least 3-6 months of expenses, including your new mortgage if you become unemployed? 
• Can you afford the mortgage from a cash flow perspective?  A couple of rule of thumbs that most banks look for is to keep your mortgage at no more than 28% of your pretax income and total monthly debt payments below 40%.

How do prices compare to rents? This sounds obvious but is often overlooked in the excitement of purchasing your very own home.  Compare a monthly mortgage payment, including taxes and insurance, with monthly rent on comparable properties that you are interested in.  In almost all markets, home prices have been rising much faster than rents over the past decade.  As of May 2019, the National Median Home Price was a whopping $315,000.  Estimating for property taxes and insurance (which will vary depending on location, construction, etc.), you are looking at a mortgage of about $1550 with a $63,000 (20%) down payment and a 4% interest rate 30 year loan.  The Median National Rent stood at about $1500 in 2019.  The problem with these statistics is that they are medians.  You really have to dig into your own market to see how prices stack up to rents on comparable properties.

How long do you expect to live there? Determining how long you expect to stay in your home is one of the most crucial factors.  There are significant costs to purchasing and selling real estate including closing costs, loan fees, and realtor fees.  You can reasonably estimate 2-5% of the loan amount in closing costs and 6% of the sale price at disposition.  In most cases (but not always) you won't recover these costs through appreciation in less than a couple of years unless you are "forcing appreciation" through sweat equity like remodeling the home.  Remember that you are most likely going to pay capital gains taxes on any profits unless you live in the home for two of the five years previous to sale.   One other caveat is that the housing market is somewhat unpredictable and selling may not be an easy or profitable endeavor if you have to sell quickly.   Bottom line: unless you have a specific strategy- it is better to rent if you plan to move within a few years.

What is the growth rate of prices and rents? There are a lot of data sites such as City-data.com that will give you historical growth rates of median home prices and rents but you will have to make some educated guessed on where things are heading.  If you expect rents to rise significantly over your time horizon and can lock in a fixed rate mortgage that you are comfortable with, that may be your best bet.  

What is important to you? It will take more than a financial analysis to help you decide if you should buy or rent.  What is important you?  The freedom and flexibility to move that comes from renting, the long term stability and pride of home ownership?  Do you enjoy fixing things yourself and maintaining a property as your own or would you rather have someone else be responsible for repairs and maintenance so that you can spend your time (and money) doing other things?
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Here are a few myths that I hear a lot but don't believe to be true:

• "The mortgage interest deduction makes purchasing your home a way better deal" - Regardless of your tax bracket, you only get to deduct a percentage of the interest you pay so you are still a net loser with interest expenses.  Plus you can only take this deduction if you are itemizing deductions instead of taking the standard deductions.
• "Owning your home is the best way to build wealth" - It is true that over history, home prices have appreciated greatly and you will be earning equity by paying down the mortgage each month.  This really only does you good if you sell your appreciated home and move to a significantly less expensive area or downsize your digs.  If your home appreciated that much, most likely those around it did too, so moving into a new home will cost you as much as you sold yours for.  You also need to consider the "lockup" of capital used in your down payment that may be better utilized investing outside your home.

There is a lot to consider when deciding to buy or rent.  Answering these important questions will get you started in the right direction but it will take some serious consideration and conversations with family members to decide what is best for you.  There really isn't a "right" or "wrong" choice if you can back it up with good data and reasons.

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