on January 20, 2019
Renting There comes a point in life where people have to decide between renting and buying. A decision about housing usually holds significant weight. If you came to this article expecting a clear-cut answer, then you’re here for the wrong reason. This article is going to unpack some of the questions that need to be asked while you’re going through the process.
Why Would Someone Choose to Buy Over Rent?
Renting vs. buying has been a hotly debated topic for decades. I asked Luke Hougland, a Mortgage Banker in Overland Park, KS, a few questions about the issue. Despite his natural bias for buying, Hougland has some convincing points.
“The main reason someone would buy instead of rent is the investment opportunity. With renting, money is going down the drain; there will be no return on investment in the end,” Hougland said. “There’s also a sense of pride that comes with owning a home. Although that’s not necessary, it’s definitely a perk.”
I also had the opportunity to speak with Kate Place, a real estate agent/landlord with experience on both sides of the market. Place said, “owning a home is a proven way of growing equity and diversifying your portfolio.”
To illustrate the idea of buying a house as an investment, let’s crunch some numbers.
For this example, imagine that two identical properties cost the same amount whether renting or buying. House A (3 bedroom/2 bathrooms) costs $1,200/month in rent, and House B (also a 3 bedroom/2 bath) requires $1,200/month in mortgage payment.
When it comes to that simple view of the two options, House B is the obvious choice. By buying, you’d essentially be paying yourself rather than paying someone else’s mortgage.
I also had the chance to speak with Sarah Jo Brown, a real estate agent and team lead for Platinum Realty. Brown says, “the decision to buy should not be made 30-60 days before you renew your lease.” Emotional purchases will cost more than thoughtfully planned investment purchases. That’s why you shouldn’t rush out with a fistful of cash without a plan.
What Other Costs Do Potential Buyers Need to Consider?
People tend to think that the mortgage is the only expense, so they end up rushing into something they shouldn’t. First of all, you can’t buy a house without a loan (unless you’re extremely wealthy), and you can’t get a loan without a down payment. The most common loan type is the conventional loan, and the minimum down payment is 3%. Although 3% seems small, that’s $7,500 for a $250,000 house. Different types of loans have different requirements, but 3% is the lowest down payment you will find.
In most scenarios, your mortgage lender will walk you through the different loan types and help you decide which one is best for you. The different types of home loans are meant for different types of situations. Most depend on a person’s financial situations, as well as how they have handled their credit. Along with that, there are certain loans that are meant for certain people. The infographic below provides some more information on the varying mortgage options.
If you choose to pay the minimum down payment, you will be forking over extra money. Lenders prefer a down payment of 20%, but they know that’s not always possible. When a person has a down payment that’s below 20%, they are required to purchase a private mortgage insurance (PMI) policy. This type of insurance protects loan issuers if the borrower defaults on their mortgage.
Investopedia says that PMI costs between .5% and 1% of the loan annually. Imagine paying an extra $2,500/year for insurance on the money you are already paying the bank. $2,500/year is an additional $208 you are spending a month.
On top of that, you’ll need to add various closing costs and a home inspection. A home inspection can cost anywhere from $200-$400.
If you are going to be a first-time home buyer, you are likely going to need stuff to fill the house. You might need a new couch, a new table, a new refrigerator, and maybe even a new lawnmower. Furnishing is another expense that people don’t consider when they are going through the buying process. Hougland estimates that a person should set aside around $3,000-$4,000 for furnishing. Despite that, there are ways to furnish on a budget.
On top of furnishing, people forget about the amount of work that owning a home requires. As a homeowner, you are responsible for all of your own repairs, yard work, snow removal, and more. That might not seem so bad to some people, but what about when a hot water heater breaks unexpectedly? Do you have the money saved for that type of situation? Kate Place suggests that a new homeowner should have $5,000-$6,000 set aside for house repairs and upgrades.
Once you start owning a home, you will begin to pay property taxes. The property tax rate varies in different locations, but the average property tax in Kansas is 1.4%. On a 250,000 home, that’s another $3,500/year, or $292/month.
Add your usual utilities and insurance expenses, suddenly that $1,200/month payment is closer to $1,900 or $2,000. Whereas renting that same property will total out around $1,400 to $1,600.
Although small, it’s possible you will be on the hook for Homeowner Association fees. A Homeowner Association (HOA) is a community or group of houses built with the neighborhood in mind. HOA membership is often required when you move into a new area.
To help you picture all of this, here are the pros and cons of buying and renting a house or apartment.
Renting vs. Buying
Factors to Consider Before Buying a Home:
If you are debating whether or not to purchase a home, you should put the following factors into serious consideration.
Money
Can you afford to buy a home? Before you even begin to consider purchasing a home, you need to decide whether or not you have enough money for a down payment. If you don’t have any savings, you’re better off renting.
Next, you need to consider the monthly mortgage. You should use an online mortgage calculator to get a ballpark amount that you might be paying. Don’t always trust those online mortgage calculators. Oftentimes they aren’t including all of the other costs that we listed above. Here’s the best calculator that we found online. Speak with an expert about the expenses you need to consider.
You never want to be housebroke. If you are pinching pennies and living paycheck to paycheck because you bought a house, you are going to regret your decision. Hougland says that if you can afford all of the home ownership costs and still afford to grow your savings, it’s a good indicator of a risk-averse investment.
You’ve probably heard this before, but a good rule of thumb for housing is that it shouldn’t exceed 30% of your monthly income. This rule can be different for everyone, but it’s a good benchmark to keep in mind.
Sometimes the line between being able to afford and not being able to afford a house is slim. If you’re set on buying a house, aim a little cheaper. Just because you qualify for a loan doesn’t mean you have to borrow the maximum amount.
Credit Score
Mortgage lenders usually won’t lend to anyone with a credit score below 620. If your credit score is below that threshold, your interest rates can skyrocket. If you do have a poor credit score then check out how you can rent an apartment with bad credit. Rather than jumping into a long-term loan with a high-interest rate, it’s better to focus on raising your credit score and building up your savings. If you’re renting, you can utilize something like Digs. Digs is a home savings app that matches the money you put towards a home.
Time
Owning a home will only take up more of your precious time. The moment you sign on the dotted line, you’re on the hook for all of the upkeep and repairs on your home. Along with your house itself, you will be required to take care of the entire property, including the lawn, trees, bushes, and sidewalks. Owning a home takes constant work, versus a rental where all of that is done for you.
If you aren’t willing to do the work, then you better be willing to pay. Many Homeowners Associations require that a lawn is kept to a certain standard. So you’ll be doing the work, or you’ll be paying someone to do it for you.
How Long Do You Plan to Stay?
Stop and think about how long you’re planning to stay in your city. Will your job take you somewhere else? Do you have plans to move somewhere else? Plans of spending time abroad?
Another good rule of thumb in these scenarios is to plan to be in your house for at least five years. Depending on the work you put into it, that’s generally when you will see a return on investment (ROI) from your house. On top of the potential ROI, homes can take a while to sell, making a possible move more difficult in the future.
Five years isn’t a set number. Plenty of people buy a house then turn around and sell it in a year. It’s just a good thing to consider before committing to an investment. If you see yourself sticking around indefinitely, buying is a great option (as long as you can afford it).
What Does the Market Look Like?
Is it a buyer or a seller’s market? Spend some time researching market predictions. Keep an eye on MarketWatch for the latest housing trends. Perhaps even reach out to someone you trust and get their opinion.
Do You Want to Have Control of Your Property?
If you want to customize and renovate your space, you won’t want to be renting. Renters don’t have a lot of freedom when it comes to customizing their space. This concern should sit towards the bottom of the list. Before you renovate a home, you need to able to afford it. Check out ways you can customize your rental to make it feel more like home.
Look, I’m not saying that buying a home is a bad thing. I look forward to the day when I can buy a home myself. I listed a ton of cons for buying, but there are cons for renting too.
This article isn’t meant to persuade you one way or the other. Every situation is different. I hope this helps you ask yourself the proper questions when you’re deciding whether you want to rent or buy. Evaluate your circumstances, seek guidance, and enjoy your new home (whether it belongs to you or someone else).
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