By Katie Cuccia Hebert
“Homeownership, like baseball and hotdogs, is an integral part of the American culture.”
—Wenli Li and Fang Yang, “American Dream or American Obsession?”
Throughout our lives, it is ingrained in us that owning a home is better than renting. The thinking goes that in buying a home, you are building equity in something that you own that will (hopefully) appreciate in value; whereas with renting, you are just “throwing money away.”
However, as the MoneyWise article “Here’s Why Paying Rent Isn’t Throwing Money Away” points out, these widely held beliefs have some limitations. They assume purchasing a home is the best investment you can make; they assume that homeownership is even an investment; and they do not take into account that you could earn higher rates of return with other investments.
I recently read an article that changed how I thought about renting. The author of the article was curious as to how paying for a roof over her head in a property she enjoyed and that she could afford, without the worries of hefty maintenance fees, such as replacing the air conditioner, was “throwing money away.”
She had a point. In fact, “American Dream or American Obsession?”—a 2010 Business Review report—analyzed U.S. real estate over nearly 35 years, from 1975 to 2009, and found the actual rate of return was below 0%.
The decision between renting and buying is a personal one that should account for the pros and cons of each. The following is a list of pros and cons according to Quicken Loans:
Renting Pros and Cons
Pros
o Flexibility to move
o Little to no maintenance fees
o No expensive closing costs
o No fluctuation in monthly housing expenses
o Ability to live in different spaces with different layouts and amenities
Cons
o You are not building any equity
o Customization limitations
o Potential increase in rent over time
o Landlord could decide to stop renting or sell the property
o Little sense of permanence
Buying Pros and Cons
Pros
o You are building equity
o Value of the home could increase over time
o Potential tax benefits
o Unrestricted freedom to customize the space
o Feeling of stability and permanence
Cons
o Expensive closing costs
o Maintenance costs
o Less flexibility to move
o Value of the home could decrease over time
o Tax benefits could be affected due to the recent changes in the tax laws
Points to Consider When Deciding to Rent or Buy
How long do you plan to live there?
If you are planning to put down roots and stay in the home for at least five years, it could make sense, financially and emotionally, to buy. Purchasing a home and living there for only a short period can be cost prohibitive due to the initial closing costs and moving costs when purchasing the home, the closing costs when selling the home, and any repairs or maintenance that may have been done in the meantime.
How much will it cost?
A new NerdWallet analysis shows that is it 33%–93% more expensive to own a home than to rent one in all 50 states—meaning that on a month-by-month basis, it is cheaper to rent.
Purchasing a home comes with expenses that renting does not: down payment, closing costs, renovations and home repair, insurance, and property taxes. Plus, if your down payment is less than 20%, primary mortgage insurance will be added to your monthly mortgage payment. Renting can provide a way to live at a lower cost while saving money to buy a house.
On the other hand, homeownership comes with advantages that renting does not: security, stability, tax deductions, and equity building. Over the long term, in most areas purchasing a home can be cheaper not only because you are building equity but also because the home can appreciate in value, allowing you to make a profit when you go to sell your home.
According to a National Association of REALTORS® report, a homeowner’s mortgage payment is less than that of a renter after six years, assuming that the renter has a 5% increase in rent each year and that the homeowner’s mortgage is a fixed monthly payment.
The following chart from BestPlaces shows the costs of renting in Houma, the Houma-Thibodaux Metro Area, the state of Louisiana, and the United States. As you can see, the Houma-Thibodaux area is slightly less expensive than other rentals of the same size throughout the country.
According to BestPlaces, the median home price in Houma is $160,200. This is more expensive than the state average of $143,600 but is considerably less expensive than the national average home price of $231,200.
Say you are a Houma homebuyer and you purchase a house for $160,200, pay a down payment of 20% to avoid the additional expense of primary mortgage insurance, and are approved for an interest rate of 3.75% (which depends on your credit). You will pay approximately $852 per month toward your mortgage, insurance, and property taxes.
When compared with paying $895 per month for a two-bedroom rental, homeownership comes out ahead.
According to the NerdWallet Rent vs. Buy Calculator, assuming a 20% down payment and 4% buyer closing costs, the breakeven point is three years—meaning that as long as you plan to stay in the home for three years, it is cheaper to buy than rent.
Are you ready to put down roots?
Before purchasing a home, it is important to evaluate your circumstances. What life stage are you in? Are you anticipating any major changes, such as relocating for the dream job you applied for? Are you going to be expanding your family soon?
Evaluating your life stage and anticipating potential changes in the future can help guide you to make the right financial choice, rather than jumping into purchasing a home only to have your situation change sooner than you anticipated.
What are the risks?
No matter if you decide to rent or buy, there will be risks associated with your decision. As a tenant, you are not building any equity, and your rent could increase at any time. Being at the mercy of a landlord may cause some uncertainty and unpredictability, such as being asked to move out or having your maintenance request delayed.
Homeowners face numerous financial risks even though they are building equity in their home. If there is a downturn in the local real estate market, your home could be worth less than what you paid for it.
If you sell your home sooner than anticipated, you may not be able to recoup what you spent in closing costs, renovations, or maintenance. All maintenance expenses—expected and unexpected—fall on you, including landscaping, plumbing, and air conditioner repair.
Can you afford it?
It is important to be realistic about your financial situation and what your budget allows when deciding to rent or buy. As a renter, you need to ensure that you can afford the security deposit, first and last month’s rent (if applicable), monthly rent, and any other household expenses related to living there.
As a homeowner, it is not enough to just account for being able to afford your mortgage payment. The down payment, property taxes, insurance, maintenance, and other household expenses must also be factored into your budget.
As a potential renter or homebuyer, you should be aware of the 28/36 rule. This rule states that your household expenses, including your rent or mortgage, should be no more than 28% of your monthly gross income, and when factoring in your total debt, such as credit cards and car loans, should not be more than 36%.
Using these guidelines can help provide a framework when deciding how much of your monthly income you should budget toward your home.
Key Takeaways
Understanding your budget, lifestyle, and phase of life can be essential in making the decision to rent or buy, whether that’s in the Bayou region or elsewhere.
Also keep in mind that having a reasonable rent or mortgage payment opens the possibility of investing in something other than real estate. For instance, real estate investments between 1975 and 2009 had a rate of return less than 0%, whereas the stock market averaged 3.375% annually after accounting for taxes and inflation.
While this time period accounts for some of the worst times in the stock market and in the economy, it demonstrates the risk of homeownership when reviewed as an investment and the potential benefits of diversifying into other investments, like stocks.
There are numerous trade-offs you must consider as you navigate different phases of life. Working with a financial planner can help create the necessary context around some of life’s major inflection points to increase the odds that you meet your long-term financial goals.
If you are contemplating a major life decision such as buying a home, consider meeting with a financial planner to determine how this decision may impact other financial goals you may have.
Our Houma advisory firm works with clients to make informed decisions about buying vs. renting as part of our ongoing financial planning. Consider working with a fiduciary, fee-only financial advisor so you can feel confident that their advice is in your best interest.
Schedule a complimentary 30-minute discovery call with a fee-only financial advisor to discuss your financial situation.