Is It Better to Buy or Rent a Home?
The decision will depend on your finances and personal circumstances
When it comes to deciding between renting or buying a house, the answer is not all that clear-cut. Some people may not be ready for homeownership for a variety of reasons, and financial calculations do not always favor renting or buying. Before taking the plunge into buying a house, you should consider homeownership costs as well as your personal circumstances.
Upfront Homeownership Costs
There are upfront costs associated with buying a house that you will need to consider. Most importantly, you will need to get a mortgage, which will require a down payment of at least 20% of the purchase price if you do not want to pay for private mortgage insurance (PMI). In other words, you save more money if you are able to put more money down at the beginning.
As an example, let us say that you are willing to pay for PMI, so you put down 15% of the house purchase price. If the house is valued at $285,000, the down payment would be $42,750. The calculation, however, does not end there. You would also need to keep in mind closing costs, which would include PMI fees, to finalize the purchase. These costs can add another 2% to 4% to what you have to pay for a house: $5,700 to $11,400 respectively.
Long-Term Homeownership Costs
Your long-term homeownership costs will be determined by your mortgage rate, home maintenance costs, property taxes, and insurance costs.
The mortgage rate will be affected by the following two calculations:
- FICO score. You are not going to receive a good rate if your FICO score is below 620. You should try to fix your credit before applying for a mortgage. You can order your credit report for free online if you are not sure where your score stands.
- Debt ratio. Lenders consider two types of debt ratios when approving a mortgage: front-end and back-end. The front-end ratio is your mortgage payment plus taxes and insurance (PITI) divided by your monthly earnings. The back-end ratio adds your other monthly debt payments to your PITI payment before dividing that total figure by your earnings. Evidence indicate that borrowers with higher debt-to-income ratios are more likely to have trouble meeting monthly payments.
In addition, all homes require maintenance, and not everybody has the wherewithal—much less the desire—to tackle home repair projects themselves. You should make sure that you have enough money to pay for these repairs.
A good rule of thumb is to set aside between 1% and 3% of the house purchase price each year to cover maintenance.
There are numerous online mortgage calculators that can help you get a good idea of the monthly costs of a property you are considering to buy. Basically, you have to add your mortgage payment, including principal and interest, your homeowner's insurance premiums, private mortgage insurance if applicable, your property taxes, and a fudge factor for maintenance costs.
Your Personal Circumstances
Buying a house is a big financial decision, and you need to make sure that it is the right choice to make in light of your personal circumstances. You should take into account the following before you commit:
- Job stability. You need to have enough money to be able to pay mortgage and maintenance costs. How secure is your job? Is there any possibility of a layoff in the future? How hard would it be for you to get another job immediately after a layoff? Unemployment compensation is rarely enough to cover mortgage payments.
- Possibility of relocating. Are you likely to be transferred to another city within the next two to three years? Your property would need to appreciate enough to cover the cost of selling if you are forced to move that soon. You should plan to stay put for a while when you buy a home. Additionally, there is an added benefit if you do intend to remain in the residence for a considerable period of time. Your home will gradually appreciate, so you will ultimately own an asset that is worth more—perhaps considerably more—than what you paid for it.
- Trade-off for freedom. Unless you purchase in a community with a homeowners association (HOA), you will be able to do anything you want with your own home. If you value your freedom, buying might be the better option from an emotional standpoint. But, your freedom will come at a cost, since you will be solely responsible for all the issues that arise from your home.
There will be no landlord you can go to for resolution of these issues. You are the owner of your home, and you have to be comfortable with that.
When Renting Costs Considerably Less
It may not make financial sense for you to buy if you mortgage payment would be triple the amount or more than what you would pay for rent. Do you really want to pay $48,000 a year to own a home that would cost you $2,000 a month or $24,000 a year to rent?
You will also have a locked-in monthly cost if you rent, at least for the term of your lease. This is something you might not enjoy if you have a variable rate mortgage, although even in such cases rates do not tend to go up literally overnight.
Your insurance costs will be less as a renter, if you have to carry any at all. Generally, you need to only insure your own property within your rental home and only if you want to (although some complexes run by development companies require that you also carry minimal liability insurance on your unit).
At the time of writing, Elizabeth Weintraub, DRE # 00697006, is a Broker-Associate at Lyon Real Estate in Sacramento, California.