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Many people question whether they should rent an apartment or house, or simply buying a house outright. I want to instill the idea that there is no right idea, and that it depends on where you are in your life, how the economy is doing, and where you are located.
The goal of this article is to simply get you started thinking about what is the right choice for you. I’ve rented most of my life, and that’s the lifestyle that suits me well and fits all of my needs. Everyone’s needs are different and we need to take that into consideration when making such a huge financial decision.
After reading, share with us your thoughts in the comments below which you think is better.
Let’s Start With An Example
Let’s say you’re faced with the choice of renting an apartment for $500 dollars a month (which turns out to be $6,000 a year), or you can buy a house at $200,000 upright.
However, you don’t have this cash on hand so you’re going to have to borrow some money. You’ve saved $50,000 for you’re down payment, so you take the remaining $150,000 as a loan.
A traditional mortgage has either a 15-year or a 30-year fixed term. Each time you make your monthly payments, some of it will pay down the interest and some of it will pay off toward the ownership of the house.
For example, let’s say your monthly loan payments are at $900 dollars a month. When you start off, most of that money might be interested owed on that loan since you’re going to owe more money on the house when you first buy it.
Gradually, as you make more and more payments, that interest amount is only going to decrease, and the larger portion of those monthly payments will go down toward paying the house.
If you have a loan at 6% interest and you have to pay off $150,000 dollars still, your interest is going to be $750 dollars per month along with another $150 dollars going toward paying off your house.
After so many years, you’ll have paid off $100,000 dollars and have $50,000 remaining on your mortgage payment. Still at 4% interest, your monthly payment is still the same, but only $250 of your $900 is going toward interest, while the rest goes toward paying off the house. This is why you usually pay it off quicker toward the end of your loan term.
Most loans, however, are interest-only loans. This means you only need to pay off the portion of your loan that is interest and you can pay off the money needed for your house as you please.
If this is the case, in interest alone for our example, we’re looking at paying $750 a month or $9000 per year.
One great thing about interest payments is that they are tax-deductible. This doesn’t mean you’re going to save all of the money that you paid toward interest, but you can deduct from your total income when paying taxes. So if you make $100,000 dollars in one year and you pay $9000 in interest, you can treat it like it’s $91,000 per year when paying taxes.
Some other expenses may come into play when owning a home. You own the home, which means you are responsible for making repairs to whatever it may be. Some examples may be plumbing, new floors, fixing a window, etc. just to name a few.
For the example we are using above, we’re just going to assume that our cost of home ownership for just upkeep is $2,000 per year. This is income you would not normally have to pay if you’re renting.
On a $200,000 house, property taxes is something you’re going to have to pay as well. This isn’t usually a very high number, but it does come into play. Let’s say that it’s at 1%, so with a home valued at 200k, you’re going to pay another $2,000 per year. So just for owning a home you have to pay an extra $4,000 per year.
This is a rough estimate of what it might be, as we could of course go into more detail about what state you live in, how much your home is worth, how much you’re willing to put into repairs and other things. Basically you’re paying for the benefit to own your own home.
2. Add It Up
Given the assumptions that we’ve made so far, what’s going out the door on an annual basis just for owning a house is your $9000 for just paying off the interest, $2,000 per taxes, $2,000 for upkeep for a total of $13,000 in annual payments.
This sounds like a scary number in theory, but what about investment value? That’s something we also have to take into consideration when buying a property.
3. Investing Our Down Payment
If we didn’t have our down payment of $50,000 and decided to rent a home instead, we can always take that money and invest. So what we need to take into account is what we could have made had we not used this money for the down payment.
Let’s say that we’re not very good investors and the interest rates on Certificate of Deposits (CD) increases and we’re getting a 2% return annually. Instead of this $50,000 being used for the down payment, we’re now getting $1,000 dollar in cash on our investment.
Normally on rent along we’d be paying $6,000 dollars a year. However, now that we’ve invested the money that we saved in order to generate a return, we can subtract this $1,000 made and treat it as if we’re only renting for $5,000 dollars a year.
What’s the difference? From the home payment above, we were spending $13,000 dollars per year. With renting, we end up only paying a total of $5,000. This is all based on assumptions from the examples that we’ve given above. Given from these numbers, it might actually make sense to rent instead of owning a home.
Again, you have to take into consideration where your numbers lie. If your interest rate on your home was lower, your out-of-pocket costs might be different. This also depends how much you decide to put toward paying off your house each month. I recommend writing everything down on paper and trying to analyze everything you can.
4. Let’s Think About The Intangibles
When buying a home, there are quite a few benefits that you have.
1. You have stability. If you rent a home or apartment, when the lease is up and the landlord happens to need that space for themselves or someone else, you’ll be forced to move.
2. Another reason that you might want to buy is because rents can sometimes be unpredictable. Rents can increase, just like housing prices. When you own a house, you don’t have to worry about this fluctuation. With big cities like Manhattan, you never know how much your rent will change from one year to the next.
3. The last benefit we’ll mention here of owning a home is that you have a choice in what you want to change. When renting, you can’t simply change the color of a wall because you don’t like it or drill something into the wall. You have to either get permission or wait until you move into a home.
The benefits aren’t always on the buy side. Let’s take a look at the rent side.
1. Flexibility. Maybe you just moved into a new area and want to scope out the best neighborhoods to live in. It could be that if you really dislike the city, you have the option of leaving without too much commitment of staying in one spot depending on the length of your lease.
2. Costs. Just the transaction of buying a house can be expensive, let along the upkeep and other costs that we mentioned above. There are also brokerage fees and other minor costs that all add up. Sometimes we also have housing bubbles like in 2007 and 2008 where housing is overpriced relative to rent.
The big idea that we’re trying to make here is that you need to analyze the decision for yourself and weigh the pros against the cons when considering renting vs. buying.
It might be that time in your life when you’re “supposed to buy a home. Now there is a lot of societal pressure to buy a home. When I tell my friends that I’m renting, I mention that I do so by choice.
For me, I tend to move around a lot, enjoy new settings, and don’t want to deal with the maintenance of owning property when I can have someone else do it.
Real estate agents want you to buy, your friends and family wants you to buy, so there seems to be this adage that buying is always better than renting. The idea is that when you make a monthly payment, when owning a home the money is actually going toward something and when renting the money is just being thrown away.
Again, whether this is true or not depends on how much you’re spending on your house, your interest payments, and all other costs associated with owning a home.
Let’s give another example and say that you have two choices:
- Rent a home at $1,500 dollars per month.
- Buy a home for $500,000 dollars.
If you only put $100,000 dollars down on your house, you’re still left with $400,000 dollars to pay off the house. If we decide to rent, let’s say we can get a good return on our investment at 4% from our $100,000 that we decided to save. This means we’re going to get $4,000 for the first year.
This money is also going to continuously compound. Year 2 you’re going to have $104,000 and make $4,160 in returns, and then Year 3 roughly $4,350, etc. This money is going to increase.
If you were to take that $100,000 and invest it to generate a return over 30-years (the same length as a lot of mortgages), in the end you’re going to have made $224,000 dollars. When you start out owning a home, most of your monthly payments are going to go toward paying off interest.
And that’s where you have to decide. If after taking all costs into account and making tax deductions on your interest, is your house going to increase by $224,000 dollars in value over a 30-year span? Again, it may depend on the housing bubble during that time, climate change, natural disasters and other things that we might not be able to predict during that time.
On the rent side, even if you did invest there’s always the factor that your money could become worthless due to increased inflation. Hopefully this helps give you a better idea on whatever one is better, but in general I would say it’s best to diversiy your assets as much as possible.
Owning a home is tough decision and can also be a personal one, especially if you’re moving with a family. However, don’t rule out the fact that sometimes renting can be better.
After all, even if you do have to change places, moving furniture and reorganizing it only takes up only a few days of your time. When owning a home, you could be spending days if not weeks on repairs depending on the amount of damage done. This can also create a lot of stress – there’s no landlord to maintain your property (unless of course you can hire someone).
I would like to thank Khan Academy for helping me come up with ideas for this article. I highly recommend that website as an academic resource or any general knowledge questions.
I’d love to hear some feedback about whether you think it’s better to own a house or rent one. Please leave your thoughts in the comments below. Thanks for reading and happy frugaling!