The rent versus buy debate for housing is an emotional one with passionate advocates on both sides. From the perspective of a financial advisor, which is better? As with many things in financial planning, it depends on the circumstances of the individual or family. Having both rented and owned, we thought it would be worthwhile to share what we see as the pros and cons of both options. While certain factors are purely financial, other (equally important) considerations are more qualitative in nature.
The True Cost of Ownership
A common argument against renting is the idea that you are “throwing away money.” While it’s true that renting does not build equity, people often neglect the non-mortgage costs of owning a home. The largest of these costs is property taxes, which can range from less than 0.5% to greater than 2.0% of the home value. Maintenance is another significant cost. The upkeep you don’t have to worry about as a renter (landscaping, lawn care, snow removal) falls on you as an owner. These costs tend to range from 1.0-2.0% annually. Add in homeowner’s insurance and association fees, and you realize the true annual cost of ownership is much higher than your mortgage rate. This illustrates why comparing rental yields to mortgage rates is an apples-to-oranges comparison. It’s also worth keeping in mind that, under the new tax law, fewer people benefit from the tax advantages of mortgage interest and property taxes.
The Softer Side of Things
In addition to the quantifiable costs of owning a home, there are qualitative factors to consider. Houses are illiquid assets that carry high transaction costs. Renting offers greater flexibility, both in a life sense (peace of mind knowing you aren’t responsible for the furnace when it breaks) and in a financial sense. Part of financial planning is maximizing the benefits of the resources you have, and you must consider alternative uses of money that would be used for a down payment (such as investing or paying down high-interest debt). Another thing to consider is your attitude toward debt. A house is one of the largest purchases people make in their lifetime, and the debt load that accompanies the purchase can be uncomfortable for some. When weighing the two options, don’t forget to factor in the softer elements.
The Case for Owning
So, if there so many negatives to owning your home, then why are more than half of Americans homeowners? For starters, during a typical environment and over a sufficient period of time, the numbers tend to work in favor of owning. U.S. residential real estate has historically appreciated faster than inflation, so it produces a return. Furthermore, the process of paying down a mortgage builds equity. There is also the intangible benefit of owning a home. Many people still consider home ownership the American Dream and there’s a sense of accomplishment and pride that accompanies owning your own home.
Putting it all Together
Overall, it’s important to understand when it does and does not make sense to own your home. If you are in a stable career and life situation and know you will live in the home for an extended period, then it often makes financial sense to own. While the numbers vary depending on what is happening in the real estate market, on average, we find it typically takes at least 3-5 years before the cost-benefit equation begins to work in favor of owning. For some people, owning may simply be out of the question and renting for a period provides the opportunity to save for a down payment, grow income, and eventually purchase a nicer house than would have been possible initially. For others, it may be the right option. The key point we want to make is that the decision is not black and white, as some people might lead you to believe, and it really depends on the specifics of your situation.
About MD Wealth Management: We are an Ann Arbor financial planner that specializes in providing financial planning for physicians and retirees. We are CERTIFIED FINANCIAL PLANNER™ professionals and fiduciary financial advisors who operate on a fee-only basis, which means we do not sell financial products or collect commissions. As an Ann Arbor financial advisor, we enjoy working with clients both locally and remotely.