You hear it all the time–renting is just throwing money away and homeownership is everything: equity, no landlord, tax deductions, buy it for x and sell it for y because it’ll be the best investment you’ll ever make. But what if it turns out buying a home isn’t always better?
When evaluating buying vs. renting it’s easy to only compare the mortgage payment to rent. But this ignores many other costs of owning a home. The true cost comparison looks like this:
This doesn’t even begin to cover that kitchen or bathroom remodel you want in your new home. Factor in that most buyers will stay in their house for over 10 years, and owning starts to look a little less rosy.
Take The Test
Owning your own home is not a fail-safe solution to financial success, and yet neither is renting. There isn’t a one-size-fits-all approach. But a good way to determine what your best course of action might be is to weigh three important tests:
#1 – Permanency
What if you or your spouse get an incredible job offer in another city or state? What if you decide you want to live in Spain for a year – just because?
If you’re already a homeowner, you either have to become an accidental landlord or be forced to sell when you may not want to (at a below-market rate if the housing market is bad). Buying and selling a home is a complicated, lengthy process than can last weeks, months, and sometimes even years.
If you’re not certain you or your spouse are going to be in the same house for at least the next 10 years, the inflexibility of buying a home puts you at risk of having to take a significant loss just to get out of it quickly.
#2 – Total Cost
A house costs more than just the mortgage and tax payments. There’s much uncertainty in maintenance, landscaping, the emotional cost of whether you dislike your neighbors, etc. After adding in all the other costs that arise, could you afford to rent a comparable house for less? Because if you can afford to rent for less than or the same cost of your target home’s mortgage payment, property tax, and maintenance costs combined, then you’re better off renting and keeping your flexibility.
#3 – Current Lifestyle vs. Future Lifestyle
Are you single or married with no kids? If so, you have no idea what kind of house you’re going to need if and when you start building a family. If you’ve never been a parent, how do you know what features will be important to you? How much space will you need? What kind of layout would make sense?
You could very well outgrow your house before you’ve been in it for even two years. Not to mention all the time spent having to be your own head of maintenance when pipes break or fences need repairing. Parent or not, no one has time for that.
If your target home will work for future you (think you 5–10 years from now), then it may be a good move.
Buying a Home for the Wrong Reasons Can Cost You
Though it can be a great purchase over time (and valuable for reasons outside of finances), buying for the wrong reasons can end up costing you a lot more than any tax write-offs could ever offset, even affecting your retirement. Here’s why: home-buying means a lack of asset diversification.
Often times, a home is the only investment someone has ever made. When you make a down payment, you’re taking a chunk of money from other (and likely far more diversified) investments and placing it in one, highly illiquid investment.
Though it might feel like an acceptable risk to put so many eggs in one basket, think of the thousands of companies, countries, industries, and sectors you could be investing in instead through mutual funds. If you could invest more broadly the difference between your rental cost and what you would have spent on a set of home mortgage payments, your financial return, in the long run, may be greater.
If You Decide To Buy, Timing Is Everything
If you do become a potential buyer, be calculating and make sure your overall risk profile (age, time horizon, job stability) is in sync with your goals. Professionals who are in the early phase of their careers, and who have a high tolerance or capacity for risk, may be better off renting so they can keep their excess cash available for higher-return pursuits.
At some point, saving your surplus income annually into more “traditional” and liquid investments puts you on track to meet long-term life goals. When that happens, owning a home may become a cheaper long-term option. The lower return you achieve on your freed-up cash, the more it makes sense to buy.
If you’re in a committed relationship with your career and company and have no plans to raise a family, it’s fair to say you could commit to keeping a new house for at least 7 to 10 years. This would allow for enough time to cover all the transaction costs and broker commissions that result from buying/selling.
Finally, if you get into the market and find there are no homes that match your criteria of geographic location, price, and size due to a thin market inventory, be patient and take your time. Because now you know that renting isn’t the waste of money it’s made out to be, and that will let you make the best choice going forward.
Your personal situation should always be evaluated before deciding which living arrangement is right for you. Knowing how long you want to stay in an area, what your job prospects are, how your family may shrink or grow, and how likely you are to be a disciplined saver are all factors that must be weighed prior to making the choice to rent or buy. Schedule an appointment with an Abacus advisor today to get more in-depth support that will help you live to your fullest.