Is It Better to Buy or Rent a Home?
It can depend on your finances, your goals, and your plans for the future
When it comes to the question of renting versus buying a home, the answer isn't all that clear-cut. Some people just aren't ready for homeownership for a variety of reasons, and the financial aspects don't always favor either renting or buying. Even if you think you're ready for the American Dream, consider the current market, your financial circumstances, and your plans for the future when deciding whether to rent or buy your home.
The general rule of thumb is that you'll need three times your monthly payment in upfront, move-in fees if you lease. Plan on spending about $3,750 if the lease payment is $1,250 a month. This includes a security deposit, among other rental-associated costs.
Getting a mortgage requires a down payment of at least 20 percent of the purchase price if you don't want to pay for private mortgage insurance (PMI). But let's say you're OK with paying PMI, so you put 15 percent down. That's $42,750 on a $285,000 home. And don't forget closing costs—including those PMI fees—to finalize the purchase. These can add another 2 to 4 percent: $5,700 to $11,400.
Owning a home is a big financial commitment, not just in the long term but even to just get out of the starting gate.
What If You Have Poor Credit?
You're not going to receive a good interest rate on a loan if your FICO score is below 620. In fact, that kind of score could dump you into the hands of a predatory lender. You should work on fixing your credit before applying for a mortgage. Four late loan payments are enough to disqualify you from obtaining a loan.
You can order your credit report free online if you're unsure where you stand. You might want to rent for a while if your credit is less than good, giving yourself some time to repair it.
You Have a High Debt Ratio
Lenders consider two ratios when approving a mortgage: front-end and back-end. The front-end ratio is your mortgage payment plus taxes and insurance (PITI) divided by your monthly earnings. The back-end ratio adds your other monthly debt payments to your PITI payment before dividing that total figure by your earnings.
A 50 percent debt ratio is high, and a high debt ratio means you might not qualify for the loan. But if you should find an unscrupulous lender that's willing to fund such a loan for you, you might not be able to afford to feed yourself after making that note each month.
Job Instability or Relocation
How secure is your job? Is your company laying off? Could you be fired; if so, how hard would it be for you to get another job right away? Unemployment compensation is rarely enough to cover mortgage payments.
Are you likely to be transferred to another city within the next two to three years? Your property would have to appreciate at least 10 percent to cover the cost of selling if you're forced to move that soon. You should plan to stay put for a while when you buy a home.
But there's an added benefit if you do intend to remain in the residence for a considerable period of time. Your home will gradually appreciate, so you'll ultimately own an asset that's worth more—perhaps considerably more—than what you paid for it.
How Much Do You Value Your Freedom?
You're beholden to your landlord's wishes when you rent. She'll certainly have rules by which you must abide, and you'll have to seek approval for any unusual occurrence, such as adopting that homeless puppy who stole your heart at the pound.
You can do anything you want with your own home unless you purchase in a community with a homeowners association that will tell you, for example, what color you can or can't paint your mailbox. If you value your freedom and independence, buying might be the better option, at least from an emotional standpoint.
All homes require upkeep and maintenance, and not everybody has the wherewithal—much less the desire—to tackle home repair projects themselves. But many first-time homebuyers can't afford to hire a professional to fix things when they break. Experts suggest that you set aside 5 percent of your home's purchase price to cover maintenance and repairs when you buy a home.
And if you decide to rent instead? Your landlord will take care of most issues at no extra cost to you unless you've actually caused the problem that requires fixing. That septic tank isn't your headache.
When Renting Costs Considerably Less
If your mortgage payment would be triple the amount or more than you would pay for rent, it might not make financial sense for you to buy. Do you really want to pay $48,000 a year to own a home that would cost you $2,000 a month or $24,000 a year to rent?
You'll also have a locked-in monthly cost if you rent, at least for the term of your lease—something you might not enjoy if you have a variable rate mortgage, although even in this case rates don't tend to go up literally overnight. Your insurance costs will be less as a renter, if you have to carry any at all. Generally, you need only ensure your own property within your rental home and only if you want to, although some complexes run by development companies require that you also carry minimal liability insurance on your unit.
Do the Calculations
You can find numerous mortgage calculators online to help you get a good idea of the monthly costs of a property you're considering buying, including property taxes and insurance. But the equations are pretty basic.
Add your monthly rent times 12 months, insurance premiums if applicable, and the amount of your security deposit—which in most cases is refundable—to come up with an idea of how much it will likely cost you to rent for a year.
Now add your mortgage payment, including principal and interest, your homeowner's insurance premiums, private mortgage insurance if applicable, your property taxes, your down payment, your closing costs, and a fudge factor for maintenance costs. This is how much it will cost you to own your home for a year.
Only you can truly say if the difference is worth it.
At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.