At some point, most everyone has asked the question “should I buy house or rent?” Buying a home is often considered a key component of the “American Dream.” But for many, it became the American Nightmare during last decade's Great Recession. According to a recent article on CNBC “more than 6.5 million homeowners are still underwater” meaning they owe more than their home is worth (a.k.a. negative equity).
I've had conversations with some who have vowed to never buy a home again. On the other hand, I've had conversations with people who have been through short sales and foreclosures and they are counting the days until they're eligible to apply for another mortgage. In addition, there is an entire younger generation who witnessed the real estate crash and subsequent financial crisis who are leery of the risks.
The debate between renting versus buying has existed for years and my guess is it will continue forever. That's because there simply is no right or wrong answer. There are just too many variables to come to a simple conclusion. Rather than attempting a general conclusion for all, we're better off focusing on our individual circumstances. This will help answer the question “Should I buy a house or rent?” Let's explore some of the pros and cons of buying a house or renting.
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Should I rent a house? Advantages of renting:
Easier to relocate: As a renter, it can be easier to relocate if necessary. If you have job change or simply want to move to a better neighborhood, it is much easier when you're renting. Let's say you move into a neighborhood you love, but your neighbors leave much to be desired. As a renter, you're only obligated for the term of your lease. After that, and in some cases before the lease is up, you can move on and leave the crummy neighbors behind. The same goes for taking advantage of a new opportunity. You have greater flexibility to move and change your situation.
Lower maintenance costs: When something breaks, it may be an inconvenience, but at least you won't be on the hook for the costs. Anyone who has been in a home for a reasonable length of time knows that things break and break often. This can range from smaller things like appliances to big things like plumbing, electrical, and heating and air systems. Some maintenance costs are minimal, others can easily run into the thousands. As a renter, while you may be inconvenienced by the timing or schedule of the repairs, you won't be on the hook financially.
No down payments: The biggest financial hurdle to closing on a lease is coming up with the deposit which is often around the same amount as one month's rent. Let's assume you're about to rent a home worth $270,000 with a deposit of $1,500. If you were a buyer of that house, assuming a 10% down payment, you'd need to come up with $27,000 at minimum.
No market risk: Once you rent your house, you can breathe a sigh of relief because if the real estate market drops, that's really your landlord's problem.
Should I rent a house? Disadvantages of renting:
Lease renewal: When the lease is up, will it be renewed? Maybe the landlord plans to sell the house. Will your rent increase? Unless you're in an area with rent controls, you should assume that your rent will increase over time.
Less freedom: As a renter you need to get permission to make changes to your home. Not all landlords are the same and some allow tenants more leeway than others. But at the end of the day, you're living in someone else's house and they can decide whether to allow pets, smoking, renovations, and whether others can live in the home.
No tax advantages: Renters miss out on the tax deduction that homeowners receive for mortgage interest. This deduction can significantly reduce taxable income.
No equity: Renters miss out on the potential for equity which comes from increasing value and a steadily decreasing mortgage balance. In normal conditions, home equity is gained slowly over time. Without it, a renter must rely on other investments to build long term wealth.
Should I buy a house? Advantages of owning:
More freedom: Do you love lime green carpet and camouflage wallpaper? Have at it! Within limits set by homeowners associations and local CC&Rs, homeowners have the freedom to do as they see fit. From pets to remodeling, you have the freedom to choose.
Tax benefits: The mortgage interest deduction is probably the most well known deduction around. For most people, it is the largest deduction having the biggest impact on a tax return. But the tax benefits aren't limited to mortgage interest. You can also make sizable reductions in your taxable income by deducting your property taxes.
Help establish and maintain credit: According to Credit.com, a mortgage loan on your credit profile shows you can handle the cost of housing. In addition, because mortgages are typically for 30 years, you are more likely to have a consistent credit history. Some people mistakenly believe having zero debt and no monthly payments is good for their credit rating. In fact, it has the opposite effect on your credit.
Potential appreciation: It's no sure bet, but you can benefit from potential appreciation of your home's value. Most people can't afford to pay in full so a mortgage is the most likely way to buy a home. It not often discussed in this light, but what you're really doing when you get a mortgage is using leverage. If a home is $300,000 and you put 20% down, you're buying a $300,000 asset with $60,000. If that home increases 10% in one year, you've gained $30,000 which is a 50% return on investment. Now for the record, I don't believe a personal residence should be viewed as an investment. But, even assuming 4% average return over 20 years, that $300,000 home could be worth $657,000.
Should I buy a house? Disadvantages of owning:
Difficult to relocate: Owning a home can make it difficult to relocate. Changes in the real estate market can seriously affect the length of time it takes to sell a home. Even worse, what happens if you buy a home and two years later, prices are significantly lower than when you purchased? If this occurs, you might be stuck. When you owe more than what your home is worth, you have negative equity (a.k.a. underwater) and this significantly limits your options if you're looking to make a change.
High maintenance costs: Keeping up with the maintenance not only takes time, but it takes money. From yard work to appliances and from carpets to toilets, the to-do list can go on forever. If you're not prepared for the time involved and hit to your wallet, you will be in for a rude surprise.
High taxes: For the privilege of owning a home, you get to pay property taxes. Tax rates vary significantly between locations. Some areas have Mello Roos taxes that are in addition to property taxes. These taxes are used to fund the building and maintenance of schools and other projects that are primarily used by members of the community.
Potential loss in value: There are no guarantees and you only need to look back at the last recession to see what happened to real estate values. Booms and busts are a typical part of economies over time, but they are difficult to predict. The extent to which a decline in a home's value will affect one's financial situation depends on many factors. If anyone tells you “real estate prices will never go down” or “real estate is a safe investment,” take it with a grain of salt.
Conclusion: Should I buy a house or rent?
To own, or not to own, that is the question. When you ask “should I buy a house or rent?” there isn't a cut and dried answer. There are simply too many variables and much of the decision making has to do with personal preference. Do you value flexibility and prefer to avoid financial risks? Or, do you place an emphasis on being more in control and having the potential for financial gains? Buying a home is a major commitment. Check out this home buying calculator from Bankrate.com to see what you can afford. While home ownership has its merits, it's not for everyone. Proceed with caution.
Have you ever asked “Should I buy a house or rent?”
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