There are many financial "traditions" that we all simply accept as true. One of the things I have done as a financial writer is to question many of these traditions to see how valid they really are today. This article will attempt to address the dozens of emails that I receive every month on the question of whether or not it is better to rent or buy a home. Right now, with the millions of empty homes on the market, rent is cheap. I would not venture out and even consider buying a home unless you have a minimum of a 10 to 15% down payment.
Home buying - The new paradigm
There was a time when this was not really a question at all. My parents purchased their first home in a southwest suburb of Chicago for less than $4,000. Due to inflation, the cost of buying a home seems to have no relationship with today's income levels. This is why the housing boom that took place in the early 2000's was accompanied by creative mortgage financing. The truth is that there are a lot of people that should not buy a home. This may be due to lifestyle issues (such as needing to move frequently), but for many people it is simply not the most affordable option.
The video below is a little dated, but the mathematical process is sound.
Does it make sense for everyone to own a home?
Everyone needs a place to live, right? Unless you are living at home with your parents rent-free, you are like the rest of us and need a place to lay your head on a pillow each night. So what it comes down to for most people is a rent versus buy decision. In my view, renting is no longer simply for the poor and uninitiated. There was a time, not too many years ago, when owning a home was a prerequisite to being considered responsible contributing member of society. I think people are far more open-minded today to the possibility of renting.
One of the premises of the notion that everyone should buy a home is that the value of residential real estate will always rise. Using this argument, one would be foolish not to buy a home if values were, in fact, doubling every 12 to 15 years. Of course, in recent years we've not only not seen this kind of growth, we have had a steep decline in home prices. One radio commercial playing frequently these days is from Quicken Loans. They use the example of a person that owns a home worth $150,000 and has a $300,000 mortgage. They tout the fact that under a new government program a person in such a predicament may still be able to refinance at a lower interest rate. This tells you just how many people are out there in so-called "under water" houses. Some may dismiss the current real estate recession as being temporary, but many experts believe that it could be decades before real estate values return to the level they were in 2005.
Peter Schiff shares how people laugh at him for renting vs. buying
Are you better off renting?
If you are unsure that you will be living in your current city for at least five years, I would definitely not buy a home. The five year rule is a rule of thumb that many financial writers use, but I might even go further with that rule today and stretch it out to seven years (or longer). I know that there will be a lot of people that disagree with me, but with the current volatility of home prices I think you really have to be a long term player to take on the risk of buying in this market. Of course, this is very general advice and would not apply to all real estate markets in the country and each person's financial situation is unique.
Even if you do plan to be in your current location for the foreseeable future, it may simply be a better deal to rent. One way to analyze this is to go and get pre-qualified for a mortgage and find out what your payment would be on the size house you are considering buying. Compare that payment to the going rent prices for that same size home (be sure to included taxes and insurance and money for maintenance as well). One rule of thumb used frequently within the world of rental real estate is the rule of 1%. You can take the value of a home and use 1% to determine what the monthly rent should be. For example, a $100,000 home 'should' rent for about $1,000 monthly. If you can rent for less than this amount, renting is likely a better option. Renting is a better option than buying in many major metro areas of the United States and will likely continue to be for years to come. Where I live in Palm Coast, FL a nice four bedroom home (10 minutes from the beach) can be rented for less than a $1,000 monthly!.
I found a rent vs. buy calculator on Yahoo finance that looks interesting (although I have not run it through the paces) and it might be a useful tool in your own analysis.
One Big Reason Not To Buy
With the current financial crisis that many local and state governments are facing, property taxes represent a ready source of cash that politicians simply can not resist. A friend of mine recently moved from Chicago mostly due to rising property taxes. One of my relatives that lives in Chicago shared with me that he pays more than $10,000 yearly just for his property taxes. With property taxes at this level, do you really own your home or are you simply renting it from the government? Some may argue that landlords build in the cost of property taxes into the monthly rent. I am sure that is true to some extent, but in many cases market forces simply don't allow them to do so.
Most Affordable Real Estate Markets To Buy A Home
Indianapolis (IN), Dayton (OH), Lakeland (FL), Modesto (CA), Grand Rapids (MI), Buffalo (NY), Ogden (UT), Syracuse (NY), Akron (OH), Cincinatti (OH) (source: CNN Money). There are also bargains to be found in top foreclosure areas like Las Vegas. While there is not always a direct correlation between low home prices and low rents, there usually is.
There is also a very widespread misconception that there are no 'nice' rental homes. This may have been true in the past, today you can find homes to rent every bit as nice as new model homes.
Top websites for searching rentals:
Doesn't a home represent a retirement investment?
This is another clear misunderstanding that many people have about home ownership. I am not sure why anyone would consider a home tantamount to a retirement plan. You will still need a place to live during retirement, so you will not be able to cash in your house and use those funds as part of your nest egg. The exception to this would be those that sell a large home and buy a smaller home and pocket the difference toward retirement. In my view, for most people, the value of your home should not be included in your retirement savings.
While I am personally not persuaded that retirement is a biblical concept, I know that many look forward to the day when they can at least cut back on their work schedule and make time for things they could not do during their working years. I have no problem with this perspective at all. I do believe, however, that one can be a renter and still save and accumulate money for their latter years. In many cases the amount of available money you have to direct toward long term investing may be substantially more if you rent rather than buy a home.
You are not a financial failure, unambitious, or stupid if you are a renter. In fact, you may turn out to be smarter than those of us that have purchased homes in the end. The bottom line on renting is that it should always be considered at least with equal weight to buying, especially in this real estate market. Another article of mine you may find of interest in on the concept of lease purchasing (or lease optioning), the middle ground option that works well for many.