Am I better off renting or buying a house? – This is a very old question. Before you decide, you need to answer the following:
1. How often do you expect to move in the future?
- More than once a year
- Once every two years
- Not for at least 5 years
If you expect to be moving a lot (every couple of years or more) then you probably shouldn’t buy your own home. Every time you buy or sell a home you incur significant costs (selling commissions alone average 6 %). Unless you get lucky and the value of the home you purchased goes up by at least 10%, you’ll be losing money.
2. How stable is you employment situation?
- Very stable
- Probably stable
- Not stable at all
If your employment is not stable, you probably shouldn’t be considering buying your own home. Home ownership requires a number of regular payments – the mortgage, property taxes, utilities, maintenance, insurance, etc. Missing any of these payments can trigger dire consequences for a homeowner. Until your employment is stable, your answer to the renting vs. buying a house question should be “renting”.
3. How much can you afford to pay for housing?
To answer this question you need to prepare a detailed monthly household budgeting plan. As a guide, most mortgage companies will only allow your housing costs to equal 33% of your gross income. Housing costs may include your rent or mortgage payment, property taxes, utilities, and 50% of condo fees if applicable. In addition, if your total debt servicing costs (housing costs plus all of your other monthly debt payments) exceed 40% of your gross income you won’t qualify for a mortgage.
As a guide, how much rent are you paying now? What is the maximum amount you are willing to pay?
4. Are you able to save money every month?
Once again, we need to take a look at your budget. As a renter, are you able to save money every month? How much do you currently have in your savings? If you buy a home its important to have some money set aside for “emergencies”. You may not be able to save as much money as a homeowner as you did when you were renting, but its important that you leave some room in your budget to save something. If you have to stretch your budget to the point that there is no room for any savings, you are probably stretching your budget too far and you should definitely reconsider your home purchase.
5. Is it important to you to own your home?
Some would argue that this is the first question you should ask yourself. Another way to phrase it might be, “how badly do you want to own your home?” Home ownership, like everything else, is a matter of choice. Only you can decide whether or not home ownership is important to you. People born in the ’60s or earlier, had home ownership drilled into them – to be a real person you had to own your home. Today, that’s not necessarily true.
Take a look at your budget (again). If home ownership is important to you then you may want to re-assess how you spend your money every month. For example, perhaps your budget includes going to the movies once per week. If you really want to buy that home, you may have to change your spending habits and only see one movie a month. Maybe you have to quit that health club, or buy fewer trading cards.
The point we’re trying to make is that you have the ability to decide what’s important and what’s not. If buying a home is important to you, you may need to limit some of the other things that you do.
6. Finally – here’s the math
Let’s compare the rental of a townhouse versus the purchase of the same townhouse.
The rental example: 1000 square feet, you pay your own utilities. The rental charge is $850 per month and utilities on average cost another $150.
To purchase the same house: selling price $90,000, mortgage at 8%, with a 10% down payment, property taxes of $100 per month, condo fees of $150 per month, utilities are the same as above.
On the surface, it looks like there’s very little difference between renting and buying a house, but the model only shows half of the picture.
As a renter, you aren’t responsible for maintenance. As a homeowner, you are. Depending on the age of the home and the type of features that it has, maintenance can be minimal or significant. Generally, the older the home, the higher the maintenance. A good rule of thumb is to estimate maintenance costs to be 2% of the value of the home value per year. In this example that would be $1,800 (2% of $90,000) or another $150 per month.
In addition, when you buy, there are “closing costs” that have to be paid. They include legal fees, land transfer taxes, and other miscellaneous expenses that you don’t pay if you are renting. A good rule of thumb is to assume 5% of the purchase price on the home. In our example that would be $4,500 (5% of $90,000).
And finally, when you buy a home you need to make an initial downpayment. In our example we used 10% or $9,000. If you remained a renter, that $9,000 plus the $4,500 you paid in closing costs could be invested and earn income. At a conservative rate of 7% per year, the $13,500 would produce $945 per year or $78.75 per month in interest income.
On the positive side, when you buy a home, a portion of your mortgage payment goes to pay-down your mortgage, increasing the percentage of your home that you own. In our example, in the first year of home ownership your mortgage payments would total $7,680, of which about $1,000 would go towards reducing the mortgage. The rest ($6,680) represents interest â€“ the cost of borrowing the money to buy your home.
Lets revisit our example:
|Cash outlay per month||$1,000.00||$1,190.00|
The cash outlay line is the one that’s most important – it represents the payments you will have to budget for every month. In our example, it costs you about 20% more per month to own your home. If the interest rate of our mortgage was higher, say 10% then it would have been 30% more. Similarly, if interest rates were lower, say 6%, it would have been only 10% more.
Let’s summarize. From a purely financial standpoint, whether you should rent or buy comes down to your monthly budget and the cost of borrowing. If you have the down payment and interest rates are 5% or lower, it makes very little difference whether you rent or buy. At interest rates above 8%, buying will cost you 20% or more than renting.
Assuming that you can afford the increased costs of owning your home, the question of what’s better, renting or buying a house, again becomes one of personal preference. There is a certain satisfaction in owning your own home, but only if it’s important to you. Take the time to read through our first 5 questions again. This a big decision and it shouldn’t be made hastily.