Ask a person on the street what the American dream means to them, and they’ll probably tell you owning a home is at the top of the list. Most people think they’re not part of the middle class if they don’t have a mortgage.
Plus, it’s always a good financial decision to buy a home, right? After all, isn’t renting just “throwing money away”?
Well, the answer isn’t quite so simple.
Buying a home might be the best decision for you, but it might very well not be. There are a lot of factors involved…more than I can possibly cover in this blog. However, let’s take a look at some of the pros and cons of renting.
Ultimate Flexibility. Leases are usually a year or less. Plus, you can often break a lease with relatively minimal cost. Most apartments I’ve rented have given me the option to break a lease by paying an extra 1-2 months of rent. 2 months of rent may seem like a lot, but it isn’t when compared to the expenses of selling a house. This flexibility means you can upgrade or downgrade your living situation quickly and with little pain.
Short-Term Financial Predictability. When you rent, your lease is a contract, and your monthly rent cannot increase for the term of that contract. So you know exactly how much you will be paying per month, and you don’t need to set aside money for major repairs. Replacing an air conditioner or major appliance could easily derail your finances.
Long Term Financial Unpredictability. Your lease could increase quite a bit from one year to the next. In fact, you may not be able to renew your lease at all. To illustrate this, let me share something I experienced.
In my mid-twenties, I lived in a lovely apartment at the edge of a very upscale neighborhood. The apartment was $815 a month for the first year we lived there. The second year, it went up to $835 a month, which seemed like a reasonable increase. About 9 months into that lease, I received paperwork from the apartment complex saying that I couldn’t renew the lease. They were renovating all the apartments, so I had to move out when the lease was up. I could move into one of the newly renovated apartments if one was available at that time, but it would cost $200 more a month. I chose to find another apartment instead.
This type of thing wouldn’t have occurred if I owned my home. Further, at that time, many apartments in my area were being converted into condos, which also resulted in people being kicked out of their homes at the end of their leases.
Of course, expenses such as insurance and HOA fees could increase significantly from one year to the next.
Lack of Availability. You can only rent a property that someone makes available to you. This could mean that you won’t be able to rent in the an area that is convenient to your job or in the school district you desire.
Lack of Tax Deductions. If you don’t have a mortgage, you can’t write off mortgage interest on your taxes. However, many homeowners do not benefit from the mortgage interest deductions.
The mortgage interest deduction is actually one of the biggest fallacies surrounding the benefits of home ownership. In basic terms, the amount of annual mortgage interest you pay would have to be higher than the standard deduction in order for it to make sense to claim the credit. As of 2014, the standard deduction was $6,200 for singles and $12,400 for married couples filing jointly. A recent Pew Charitable Trust study found that less than half of homeowners had enough mortgage interest to claim the deduction.
Now that we’ve examined some of the pros and cons of renting, let’s look at the pros and cons of home ownership.
Customization. You can customize your place as you like and make it suit your personality and lifestyle. Many people who rent aren’t even able to paint the walls.
Forced Savings. When you pay a mortgage, you gradually build up equity in your home…unless the home value falls, as we saw in the recent housing crisis. Some people are unable to save money, and may benefit from being forced to save by paying a mortgage every month. The equity that they build can be accessed through selling the home or through home equity loans. However, both options are not easy and may incur significant costs. For this reason, I believe a home isn’t a great financial asset. Future blogs will cover this in more detail.
Mortgage Interest Deductions. You can write your mortgage interest off your taxes if it is high enough. See “Renting Cons” section above to see why this may not benefit you.
Stability. You may get flexibility with renting, but home ownership offers more stability. If you are not planning on moving for more than 10 years, buying a home may be the better option for you.
Unexpected Expenses. You might incur significant expenses if appliances break or you need a new roof. Often, multiple issues occur at once. This means that you should set aside a chunk of money every month to make sure you can address these issues when they occur.
Less Flexibility. Owning a home offers way less flexibility than renting. I know several people who had to move, but couldn’t sell their first home. They either had to do short sales (which messed up their credit) or they had to rent out the home, which usually didn’t cover the home’s monthly expenses.
Sunk Costs. Certain costs, like realtor expenses and closing costs cannot be recouped through the sale of a home. These fees are often quite expensive, sometimes equalling as much as 10% of the value of the home. So, although your home is an asset, it’s not a great one, as you can’t get the cash out of it without relinquishing a large amount of that cash.
So, Should I Rent or Buy?
I currently rent a townhouse with my boyfriend. We’re not rich, but we could afford to buy something nice if we wanted. And we hear a lot from friends and family about how we’re not making the responsible decision by not buying a home. But we’d be tying up a lot of our liquid cash in a completely illiquid asset, and we’d lose a lot of the flexibility we have now. If we find jobs out-of-state, or we want to scale up or down in our housing, we can do so without much struggle. We would lose that flexibility if we bought a home. We may still buy in the future, but it’s not right for us right now.
The decision whether to rent or buy is not as black and white as most people think. Sometimes renting is cheaper and will allow you to save more money in the long-run. Even if it isn’t cheaper, sometimes there are other benefits that make it better than home ownership for you. The New York Times has a great calculator that can help you through this difficult decision.