Rent vs. buy: finding a better bargain
This post is the first in a new series of guest contributions on Makin' Money examining all things personal finance.
This week we turn to Jim Wang, founder and editor of Bargaineering.com. He started his personal finance blog about five years ago as a twenty-something college grad who quickly realized "he knew nothing about managing his money." He's certainly learned a lot about life and personal finances since then.
On this week's episode of Marketplace Money, we covered the housing market from a number of different angles: the challenges of buying a foreclosure and some changes that could prevent you from getting a home loan. Here, Jim Wang takes a closer look at the eternal question of renting vs. buying:
For years, real estate agents have been touting the benefits of homeownership and "investing" in your home. Then we had the housing bubble, fueled by cheap mortgage, aggressive underwriting, and buyer frenzies.
These days, people are a little wary of buying a liability. The myth that home prices always go up was crushed in spectacular fashion and thousands of people are underwater on their homes. In years past, no one advocated renting. It was throwing your money away! Then housing prices sank and homeowners discovered they didn't throw their money away but it disappeared all the same!
All said, the debate on whether it's better to buy or rent still rages on. My personal approach to the renting vs. buying issue is to rent until you know where you're going to live for the next twenty years.
Buy a home for 20 years, rent for a few
As a renter, you may not be building equity but you'll have a precious commodity homeowners lack - flexibility. As a buyer, you surrender flexibility and mobility but you do build equity in your home and put down roots in the community. I rented for years until I knew where I was going to spend the next 20 years.
The biggest advantage you have when renting is the flexibility and mobility to move wherever you want. If you sign a one year lease, you are, at most, locked into a residence for one year. If you wanted to move for any reason, whether it's to go back to school or take a new job, your living situation won't make it difficult to do so.
Something's broken? Call the landlord
In addition to flexibility, renting a home means you're not responsible for repairs. One of the biggest shocks for new homeowners is how many things can break inside a home. In the five years I've owned a home, I've replaced the water heater, all the windows and sliding doors, as well as put on a brand new roof to the tune of several thousand dollars. I was fortunate to know, ahead of time, that the windows, doors, and roof would eventually need to be replaced but it didn't reduce the shock of actually paying for it.
Equity takes time to grow
As for not building equity, homeowners build very little equity in the beginning because of how amortization works. On a 30-year fixed mortgage, the vast majority of first few payments are towards interest. On a 30-year fixed mortgage at 5 percent, you pay more interest than principal for the first 16 years. The deduction you claim on mortgage interest softens the blow, depending on your tax bracket, but it's still money out of your pocket.
Own a home to put down your roots
The biggest advantage you have when buying is that you put down roots and start building equity. The amortization schedule is front loaded with interest because it'll give you a bigger tax deduction and lower the bite of homeownership. You pay the same but with front loaded interest you can deduct a greater percentage of your payment. The real treat in homeownership comes once you get closer to the end of the mortgage. Your payments stop "going down the drain" and start going into a lockbox called home equity.
While the biggest financial reason is building home equity, I found that the value in homeownership was in putting down roots, becoming part of a neighborhood, and being able to tailor your house into your home. Prior to buying a home I moved from apartment to apartment, never knowing my neighbors and never spending my time in the common areas. Now that I own my home, I'm friends with my neighbors, I spend time with them outside of the occasional salutation, and I really feel like the neighborhood is mine. It's not quantifiable but it certainly improves my quality of life.
When it comes to renting a house or buying a home, there are strong arguments for both and you shouldn't assume one is better than another for everyone. If you don't plan on spending the next five or more years in an area, buying is a mistake. If you plan on spending twenty and don't mind doing a few repairs, buying may be the right choice. Ultimately your personal situation will dictate the right choice for you.
More on renting vs. buying
Read more perspectives on the rent-vs-buy debat in our personal finance question-and-answer blog, Getting Personal.
- Q: Buy or rent in grad school?
- Q: Is a five-year stay long enough for homeownership?
- Q: Buy a house to rent it out?
- Q: Home mortgage or college for the kids?
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