Renting vs. Buying: Why renting isn't just "throwing money away"
Renting Vs. Buying: Home Ownership isn't always the best choice
Chances are that at some point in your life, you've heard someone say, "Renting is just like throwing your money away!" In this school of thought, renting is a poor financial decision, because your monthly housing costs are not contributing to a build-up of equity. The people who throw this phrase around see a home as an investment, and renting as a black hole for your hard-earned money. For them, the American Dream is owning your own little patch of green with a white picket fence.
However, in reality, choosing home ownership over renting is not always the best choice. For some, the dictates of lifestyle, financial considerations, and the housing market make renting a preferable option. Moreover, overly enthusiastic proponents of purchasing property sometimes forget to take into account the hidden costs of home ownership. While owning a home can be a great investment, it is one that should be entered into with a full understanding of the pros and cons, the extra expenses, and reasons why, in some cases, renting is actually a better option.
The hidden costs of home ownership
Depending on the housing market, it's possible to find a home with principal and interest payments lower than what you'd pay in rent. However, with a home, you'll also have to pay taxes and insurance. These additional payments can add up to thousands of dollars. This money isn't being ‘thrown away;' it serves a purpose. All the same, it's not going towards building equity. When you rent, you won't have to worry about taxes, and you won't be responsible for insuring the premises you occupy. Any insurance you pay on your belongings will be a fraction of what you'd pay for homeowner's insurance.
Another important consideration is the amortization schedule on a mortgage. Your ‘principal and interest' payments will be heavily skewed towards ‘interest.' For instance, if you took out a 30-year loan for the amount of $150,000 at an interest rate of 6.75%, your monthly principal and interest payment would be $972.90. Of that nearly $1000 monthly payment (and remember, that doesn't include taxes and insurance), you won't see $200 going towards principal until your 79th payment- that's six and a half years into your mortgage. And all that money going towards interest isn't working any harder for you than if you'd spent it on rent.
The decision to buy a home needs to also take into account the costs of maintenance. When you're renting, if the water heater leaks or the AC freezes up, you just put in a work order and wait for the problem to be fixed. When you own your own home, you're going to need the cash on hand to pay for parts and labor. And while a simple service call every once in a while might not put you out, you need to be prepared for the worst: what if your roof needs to be replaced? What if there's a major water leak in your home? What if a major appliance stops functioning and needs to be replaced? Will you have hundreds, or even thousands of dollars to complete these crucial repairs? Experts recommend that you budget at least 1% of the selling price of your home towards yearly maintenance costs. These are expenses that you wouldn't need to worry about if you were renting.
There's also an upfront cost to home ownership: even if you qualify for a 100% financing loan with no down payment, you'll still see as much as several thousand dollars in closing costs at you time of purchase. None of this money will be applied to your home's equity, so it won't be doing you any better than your monthly rent.
Gathering moss: home ownership ties you down
Another crucial consideration in the decision to buy versus rent is the amount of time you can commit to one place. You need to ask yourself the following questions:
• What the chances that I'll be transferred unexpectedly?
• Is there any foreseeable chance that family events might occur that would necessitate a move in the near future (for instance, an ailing relative you may want to move closer to, or the birth of a niece/nephew/grandchild that might tempt you to move closer to family)?
• Will this home be able to fit your needs, not only at the time of purchase, but also for years in the future?
• Will I be able to stand living here if my neighbors have loud parties at night, or I start noticing graffiti around the neighborhood, or there's a rash of car break ins on the block?
Home ownership is a great way to put down roots; however, the flip side of having roots is, well, that you are rooted! While you can pick up and move at the end of a lease with no consequences, there's a lot less flexibility with a home. To move, you'll need to find buyers or renters, processes that can sometimes take many months. If you need to move quickly, you may find yourself paying both a mortgage in your old home, and rent or a second mortgage at the same time while you try to sell or rent your home. If you don't have a significant cushion of savings, this situation could be financially devastating.
Another, very important reason why home ownership ties you down is that the cost of selling a home that you've occupied for less than a few years can be substantial. As the seller, you'll be responsible for paying a total of 6% of the selling price in commission to the buying and selling agents. You can expect an additional 2-3% extra in miscellaneous closing costs as well. So if your home hasn't appreciated in value by at least 9% (which it's not likely to do in less than a few years, particularly now that the housing bubble has deflated) you'll be looking at a loss on your ‘investment.'
Money invested in real estate is relatively non-liquid
The liquidity of an asset refers to how easily money can be accessed from it. Checking and savings accounts, obviously, are as liquid as you can get, since funds are easily accessed through a withdrawal. Stocks and matured bonds are considered fairly liquid because they can be sold or cashed with a minimum of difficulty and turnaround time. Real estate, on the other hand, is considered illiquid. The money you have invested in your home's equity, while certainly an asset, can't be easily accessed in case of an emergency. So, if you invest the bulk of your savings in a down payment on your home, you could find yourself in severe straits when an unexpected emergency comes around and you haven't got any liquid funds to access.
To rent or to buy: a final word
In this article, I've tried to present a compelling argument for why buying isn't always a better choice than renting. That being said, however, there are many situations where buying a home is a sound investment. It's important that as an individual or couple, you consider all the aspects of your financial situation, without being influenced by peer pressure or making a hasty decision. For some people, paying rent is not a waste of money: it's a sound financial decision.
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