A question often posed by folks discussing personal finance is whether renting or buying is “better.” Here, I will give you the typical lawyer answer: It depends. To determine which is better for you, you need to first look at the pros and cons of renting, then explore the pros and cons of buying (and all that home ownership entails), and finally consider what “better” even means.
What are the major pros and cons of renting?
Renting is more straightforward. When renting, you sign an agreement with a landlord to pay a certain amount of rent per month in exchange for occupying agreed-upon premises for a specified period of time. At the end of that period of time, you can either move elsewhere, renew the lease for another period of time, or become a month-to-month tenant.
What does it take to rent? Research available listings in your desired location, visit your top choices, and submit an application to lease. Your landlord will pull a credit report and perhaps run a background check. (You will usually have to pay an application fee to cover these costs.) If your application is approved, you pay a security deposit plus the first month’s rent, move in on the agreed-upon date, and pay rent each month afterwards. Before the end of your lease term, you give advance notice of your intent to vacate or renew, and keep repeating this process until you eventually move out. After you move out, you receive a refund of your security deposit.
The amount of the security deposit can vary widely depending on state and local law. In some places, the security deposit is equal to an entire month’s rent, and you must pay the deposit, first month’s rent, and last month’s rent before you can move in.
State and local laws vary in how quickly your landlord must refund your security deposit, and whether (and how much) interest accrues while it is held. Additionally, if your security deposit is not refunded in full due to damages beyond normal wear and tear, the landlord must provide an itemized statement of charges by the deadline to refund your deposit.
The end of the lease term is perhaps the biggest “pro” of renting. You are not locked in beyond the length of the lease. If you want to move when the lease expires, simply give advance notice—check your lease for how much advance notice is required—and move out. Simple.
The other big “pro” of renting is that your landlord is responsible for repairs and maintenance. (Renters are usually responsible for day-to-day stuff like changing light bulbs and mowing the lawn.) Water heater on the fritz? Call the landlord. Air conditioning not working? Call your landlord. Beyond the very day-to-day basics, you do not need to budget for home maintenance because you are only responsible for normal wear and tear. In this respect, renting is carefree. When renting several years ago, there was a problem with our refrigerator. We just called the maintenance number for our apartment complex rather than trying to figure out the issue or identify whom to call. Our apartment complex also chose not to diagnose the problem and simply replaced the appliance.
The cons? Sometimes you get a landlord that drags their feet when making repairs or is otherwise difficult. (There are various remedies available under state and local law if that happens.) The cost of rent usually goes up each time you renew your lease; depending on the local market, the increase can be quite substantial. You cannot make modifications to your living space (such as paint or wallpaper) without approval. And the biggest one for folks keen on personal finance: You do not build up any equity. When you move out, the only asset you have is your security deposit, and you will need to pay a new deposit when you move into your next rental.
What are the major pros and cons of buying?
Home ownership is a completely different lifestyle than renting. You will still research available listings and visit your top choices, but that is where the similarities end. Rather than submitting an application to rent, you submit an offer to purchase along with an earnest money deposit—the amount varies according to local custom and the offer price—to show that you are serious. Most folks use a real estate agent to help them with the process. (In several cities, real estate agents also help people with their search for rental properties.) There might be back-and-forth counteroffers. If your offer is accepted, you go through the process of applying for a mortgage, obtaining an appraisal and home inspection, and performing other due-diligence items. You will finally “close” the sale—i.e., sign the purchase paperwork and officially become a homeowner—typically 30 to 60 days after your offer is accepted, if all goes well.
I include the “if all goes well” caveat because the train could get derailed at several steps along the way. If your mortgage application is denied, you will be left scrambling to find another lender before the financing deadline. If the home inspection reveals a mold infestation, a cracked foundation, or other problems, you might want to rescind your offer by the inspection deadline. If your review of the condo documents reveals an oppressive homeowners association, you might consider backing out by the due-diligence deadline.
Life is grand. As a homeowner, you are in control. Want to repaint the walls? Head down to Home Depot to pick up paint and supplies. Fancy a remodel? Call some contractors, get quotes, and hire one to do the job. Invite your friend or significant other to move in? It is your place!
Additionally, as you continue to pay the mortgage, your home equity rises—slowly at first, but more rapidly as time goes on and a greater portion of your payments go toward the principal balance. After the mortgage is paid in full, you still have the home without the payment! If you sell your home before the mortgage is paid, you get to pocket the equity after paying selling expenses. Building up equity is the biggest “pro” that people cite regarding home ownership.
“Equity” refers to the market value of your home minus the amount of your mortgage and other home debt. (In other words, assets minus liabilities.)
Because of the extra expenses involved with both purchasing and selling (i.e., closing costs), you should not purchase a property if you are not going to own it for at least seven years. This does not necessarily mean you should not purchase a home you do not plan to live in for seven years, if you purchase a home that you would keep as a rental property after you move out.
In the meantime, unlike your monthly rent, your mortgage payment stays the same. If your mortgage includes an escrow account for property taxes and insurance, that portion will increase as your property tax and insurance rates rise; once the mortgage is paid, you will be responsible for making those payments directly.
But also in the meantime, the water heater fails, the air conditioner stops working, or the window leaks. It is not a question of if, but when! Rather than call your landlord, though, you either call a contractor or fix it yourself. This is the flip side of the “you are in control” coin: You are responsible.
A word of caution: Do not attempt to perform repairs and improvements if you lack the skills. You will end up causing a bigger problem, which will just cost more money to fix than had you hired a pro in the first place. Even if you have the skills, it might still be worth it to hire a contractor that can do the job better, in much less time, and without the hassle.
Another word of caution: While calling a contractor sounds like a simple solution, there is the mental load of finding a good contractor in the first place. It is a good idea to have an idea of whom you would call before the need arises. Find good contractors by asking friends and neighbors for recommendations, perusing online reviews, and obtaining quotes before hiring.
You can mitigate the impact of unexpected maintenance costs by setting aside a certain amount each month so that you will have the available funds when the need arises. Perhaps the easiest rule of thumb is to set aside 1–1.5% of the purchase price each month, but you should take into consideration the various unique aspects of your property, potentially adopting a CapEx approach if you have numerous unique characteristics in your home. Other methods to calculate expected average annual maintenance costs focus on square footage or a percentage of your housing costs.
Which is better?
This overview is just that—an overview. There are many nuances involved, and several additional considerations that might apply to your situation, that could each be explored in greater depth.
Do not fall into the “fear of missing out” or “keeping up with the Joneses” and rush to buy if it is not a good time for you, financially or otherwise. There is a huge bias towards buying a home because many individuals and families use their home’s equity as their main source of building wealth. Do not buy simply because you think home ownership is a good long-term investment. Unless you have many children and a six-bedroom home that you plan to sell to purchase a one-bedroom condo when the kids become adults, building the majority of your wealth through home equity is not a great plan to financially support yourself in perpetuity since your equity is not liquid. Accumulating some of your wealth in the form of home equity is fine diversification of your portfolio, but it is worth waiting to buy until you also have other investments.
You can get a home equity line of credit (HELOC) to use your home equity to make purchases, but this generally comes with high interest rates, additional years of paying a mortgage, and the risk of losing your home if you stop making payments.
Reject the notion that when you are paying rent, you are simply throwing money away. When renting, you get a place to live and the freedom to live elsewhere without the hassle of selling your home, becoming a landlord yourself, or paying for multiple homes simultaneously. Ramit Sethi, author of I Will Teach You to Be Rich, famously prefers renting because he gets value out of the efficiency it provides him since he does not need to personally address problems that arise with his home. Despite his lack of equity, his net worth is doing just fine.
When you are ready to diversify your wealth through the purchase of real estate, a home can be an avenue to grow your net worth over time through the accumulation of equity. Typically, the value of homes rises over time. While this is usually true, it might not be in your situation. That is okay, too—after all, like with renting, you are still getting a place to live.
As a gross oversimplification, renting offers you flexibility, whereas home ownership offers you stability. Home ownership can also provide an avenue to grow your wealth, but this is not always true. It is perfectly fine to prioritize different factors at different times. Just make sure you know why you are pursuing a particular path, and live your best life.
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