Rent vs. Buy: the Real Costs of Homeownership

Many claim that buying is a great investment while renting is just throwing money away. That logic, however, is questionable — is paying month-to-month for a place to live really a waste of money? Beyond that, there are other facts that affect whether or not it’s better to rent or buy. The honest answer is that it depends on your personal circumstances.

On the Many, Many, Many Expenses

Buying a house is a great way to grow wealth, but it’s critical to understand how many expenses go into owning a home that doesn’t actually build equity. Right off the bat you have to pay a pretty large sum into closing costs or fees to your lender that typically fall between two-to-five percent of the purchase price.

A large portion of the mortgage itself goes into non-equity-building interest payments, especially early in the loan. On top of that, there’s homeowner’s insurance and property taxes, and if you put less than 20 percent down there are additional costs for mortgage insurance. To add insult to injury, utility costs in a home are likely to be much higher in a house than in an apartment, even before considering upgrades, repairs, and renovations, all of which you’re responsible for as the homeowner.

“You need to be brutally honest with yourself about your ability to undertake those things, and how much time and money it will take,” Jim Lapides, a spokesperson for the National Multi Housing Council, said to HSH.com.

Breaking Down the Math

To make the right decision, you need to really look at the financial considerations of renting vs. buying. Let’s take a look at what this is in practice and compare the costs of renting an apartment for $1,000/month compared to purchasing a modest $200,000 home.

The calculations for a rental are simple: $1,000 each month for an entire year brings the total to $12,000 (assuming the landlord never raises the rent and the price includes utilities).

To buy a house, you could put down 10 percent ($20,000) and choose a mortgage with four percent interest for the remaining $180,000. We can also assume there’s 0.5 percent mortgage insurance, $1,000 per year in homeowner’s insurance, and $2,400 in annual property taxes and bundle those into the mortgage payment.

Altogether on a standard 30-year mortgage, the monthly payment would come to $1,217.68 and then drop to $1,142.68 after five and a half years when 20 percent equity is reached and you can ditch mortgage insurance. That’s not much more than rent and you get a house out of it.

However, owning a home means you’re on the hook for the upkeep, which is often estimated at one percent of the cost of the home per year. In this case, it comes to about $2,000 per year.

Over 30 years, those figures mean you’ll shell out nearly $500,000 total for that house: $463,465.11 in down payments plus mortgage payments and then an estimated $60,000 in upkeep. You could have rented for much cheaper — $360,000 over 30 years — but you wouldn’t own a $200,000 home.

This is just an example of the general things to consider in renting vs. buying. Compounding, real estate appreciation, tax policy, and the general state of the economy also come into play here — it gets very complicated.

Short- and Long-Term Horizons

There are many other variables that come into play, such as a tax break for mortgage interest, inflation increasing the house’s value, or a recession doing the opposite. Local housing markets vary widely. Since you can’t predict the future, you just have to make the best decision based off current information you have.

“If this is not the time for you, there will be a time in the future, there will be a property, there will be an appropriate mortgage product,” Amy Tierce, regional vice president at Wintrust Mortgage, said to Forbes. “Do not try to time the market. Time your purchase around your life.”

In the long term, buyers generally come out financially ahead, assuming they can make all the payments. The more years you stay in your house, the greater the difference. Over shorter time periods, however, renting can be the savvier move. You can use the money you’re not putting into closing costs, repairs, and interest payments to make other investments.

“If you’re planning to stay less than three years, it’s likely that buying a home will prove to be a financially questionable decision,” cautions Adheesh Sharma, a vice president at Fidelity’s Strategic Advisers. Other advisers go even further, suggesting a minimum five-to-seven-year horizon before you think about buying.

The Final Factor: Your Personal Psychology

There are other non-financial factors to consider based on your personal values and preferences. If you want to live downtown in a major city, for example, you may find more value in renting, whereas suburbia is geared more toward homeownership.

A house will usually provide more space indoors and out. Plus, you can modify it as you see fit. An apartment, however, gives you the peace of mind of calling the landlord if something break. If you own a home, you’re on the hook for those repairs. If you need to move to another city for a job or fun, it’s a lot easier if you’re renting. If you value your flexibility, any extra costs you pay to rent may be worth it.

“Even if you can afford the costs of homeownership, you should think about how ‘settled’ you feel in your life,” notes Rent.com. “If homeownership makes you feel like you are a slave to a mortgage and that you can’t pursue dreams that will bring you real happiness, it probably is not right for you.”