When Renting Is Smarter Than Buying
You’re not necessarily throwing your money away when you rent.
I’ve been a happy renter since I moved to Washington, D.C., seven years ago. Neither of my apartments has been luxurious. But in an expensive city with limited housing, I paid below market rate for my first place (my roommate and I had our own bedrooms, thanks to a makeshift wall). Later, when I wanted to live alone, I landed an underpriced studio in a rent-controlled building. But as more friends purchase shiny condos or casually speculate about future plans to buy, I wonder whether buying is something I should consider.
The nagging feeling that buying is something you should do is one big reason that millennials choose to buy, says Bill Nelson, a certified financial planner and founder of Pacesetter Planning near Boston. We've also been told that buying is an investment, and renting is "just throwing money away."
Adding up the costs. Many experts recommend buying only if you expect to park yourself there for at least five to seven years. What if you like your city and current situation but also have no idea where life will take you in the next five to seven years? Sometimes, "the most you can say is 'I plan to stay in the same spot, knowing everything about my circumstances, career and family today,'" says Jeff Tucker, an economist at home-price site Zillow.com.
An online rent-or-buy calculator, such as those from SmartAsset.com or Zillow, can run some quick calculations after you enter your location, rent, target home price, size of down payment and other factors.
Don't underestimate other costs associated with buying a home. Closing costs, including the appraisal fee and loan origination fee, typically cost 2% to 5% of the purchase price of the home. Increases in ongoing expenses such as property taxes can blindside new homeowners, says Nelson.
Eric Simonson, a CFP and owner of Abundo Wealth in Minneapolis, advises clients to plan on spending 1% of the home's value each year for maintenance and upkeep. Finally, if you put less than 20% down, you'll need to sink even more money into private mortgage insurance.
When Simonson speaks with clients who want to buy a home, he asks them how much they pay in rent and pulls up several properties where they would pay the equivalent after factoring in monthly mortgage payments, taxes, insurance and upkeep. "More often than not, they find they aren't getting such a bad deal renting, especially if they live in areas where the cost to purchase is very high," he says.
In some locations, renting can be cheaper than buying, depending on the size of your down payment and the length of time you stay in the home. Zillow found that renting beats buying in San Jose, San Francisco, Honolulu, Oakland, Seattle, Salt Lake City and Anaheim, assuming you put down 10% and stay in the home for five years. Even if buying comes out ahead, renting allows you the flexibility to make big life changes and affords you the time to save up for a down payment and the cash needed to cover up-front and regular expenses.
Renters could, on average, accumulate more wealth than homeowners if they invested the equivalent of a down payment plus the difference between a monthly mortgage payment and rent in a diversified portfolio, according to Eli Beracha, coauthor of a study on homeownership in the Journal of Housing Research. Most renters don't do this, and for most people, buying is a better financial choice in the long run. But don't rush. "I've never met with someone and said, 'The problem with your finances is that you bought a home way too late,'" says Nelson. "But I've seen plenty of people who have messed up their financial situation by buying a home too early."