You have probably heard that buying a home is the better option because you are building equity, and, what follows, wealth that way, and renting is just throwing your money away. However, making the right decision may depend on your individual circumstances and priorities. Here are some points to consider when solving the dilemma of buying versus renting a home.
Pros of buying a home
Buying a home has many advantages, especially when you are ready to settle down and put your roots down somewhere, and when you have your finances in order, so you can easily afford the transition to home ownership.
Stability
Owning a home, especially in a desirable area, offers stability and a peace of mind that is hard to achieve when you rent. When you own your home, you have the certainty that nobody will ever make you leave. The stability increases when you are satisfied with the area; there are good schools for your children around, it is a convenient commute for you and your spouse and there are facilities and amenities around that are compatible with your lifestyle.
Renovations and customizations are easier
When you own a home and especially when you plan to live in it long-term, you have an incentive to truly make it your own. You can finally have that dream library built with shelves going all the way up to the ceiling, because it is your own property. What that means is that the renovation costs are recoverable in case you want to sell it down the road. Also, when you own a property you do not need anyone’s permission to make improvements to the property, unless you live in a condo or a townhome. Condos and townhomes may have specific rules as to renovations. It is worthwhile to inquire about these before you buy a property to avoid a nasty surprise. For example, some condos only allow work to be done Monday to Friday between the hours of 8 a.m. and 4:30 p.m. It is a considerable inconvenience, as you often need to take time off work when you want to put a few pictures on the wall.
You do build equity
Owning your home and living rent-free can be a great prospect, but in reality, it usually takes decades to achieve it for most people. However long you plan on living in your property, you still may take advantage of the increase in its value. Youmay be able to sell it at a profit to invest it elsewhere. With every mortgage payment you own a bit more of your home. That cannot be achieved with paying the rent.
Building equity is not always so straightforward, however. It depends on the economical climate of a period. Say, you buy a home when the interest rates are very low. You are very comfortable making your mortgage payments even though you bought an expensive home, because the interest you are paying is minimal. And then the interest rates increase and your payments double. You are not so comfortable paying off your home and you find yourself in a position where you may have to sell your home at a lower price without much profit.
That is why, it is always a good idea to buy a home you can easily afford, so you don’t depend on the financial market. Even if your mortgage payments increase a bit, you can still easily make the payments and you don’t have to sell at a loss.
Cons of buying a home
Buying a home also comes with a few cons. Here is a breakout of the disadvantages:
Higher costs
Owning a home usually means higher costs of living. On top of mortgage payments, there are extra utilities, property tax and maintenance costs. If you own a condo or a townhome, you will also have to pay monthly condo fees. Condo fees vary greatly depending on the age of the property, heating type and area. They can be quite high in older buildings.
It is always a good idea to play around with the numbers to know the exact costs of home ownership. Using mortgage calculators makes that process much easier.
Less flexibility
If you own a home, you have less flexibility when you want to move cities or even countries. You cannot just pack and sell every time you need to move for work, because you will lose money. For example, real estate agent’s commission cost and transfer tax are unrecoverable when you sell. That is why you need to make smart decisions beforehand.
Renting a home
Despite the obvious downsides, renting a home can make a lot of sense in the following situations:
- When you have to frequently move for work and stability is not high on your priority list
- When your rent is considerably lower and you use the extra money to start a business, go to school, pay off debt or invest
- When you have a life situation when you need the extra funds (for example, you are taking care of a sick spouse or parent)
If you need the extra funds for something, it is important to strategically plan your spending as not to squander the money. You can use SMART goals to match you life goals with finances.
The 5 % Rule
To determine whether to rent or to buy, you need to compare the unrecoverable costs of renting and buying.
The unrecoverable costs of renting is the amount you pay in rent.
The unrecoverable costs of buying are threefold. They consist of:
- The property tax
- The maintenance cost
- The cost of borrowing (mortgage interest and opportunity costs)
Roughly speaking and following the explanation of Benjamin Felix, the unrecoverable mortgage costs amount to 5% of the value of your home.
To determine whether to buy or rent, take the value of the home you are considering, multiply it by 5%, and divide it by 12 months. If you can rent for less than that, renting may be a sound financial decision.
