How to Determine if Renting or Buying a House is Right for You

Which is better financially, to rent or buy a house?

We all dream of owning a house, but sometimes our financial situation doesn't favor the dream of having a place over which we have a right to call ours. Renting and buying are both better options, but the financial situation is sometimes unsuitable for some to buy.

Buying is and always will be preferable, but renting also has some benefits over buying if owning a house is strenuous.

Let's explore whether to rent or Buy a House: Which is the Better financial decision?

Renting vs Buying- How much money you throw: 

Renting is relatively cheaper in the short term as you don't pay the maintenance cost, you don't need to insure the house, and you avoid paying a colossal down payment. So what do you pay instead? 

  • You pay a small security deposit and sometimes pay low additional expenses. If we look at and analyze the average rent in the USA, According to Rental Market Data, it is $1,372.

  • Despite saving so much while renting a house, you won't build equity for yourself for years.

Renting vs buying- Where do you pay more taxes:

Renting wins in the game of tax payment because renters don't have to pay any property taxes. The property taxes add a significant burden on homeowners. And as the real estate taxes are increasing daily, it's good to skip the cost of renting housing if you are struggling financially.

  • On average, a homeowner pays $2,331 per year as property tax. It depends on the value of the house and the land on which it is built.

Renting vs Buying- Where what is preferable:

Location majorly determines what to prefer- renting or buying. This is because, in 45 out of 50 US cities,  renting is a more cost-effective option than buying a new house. Even though the cost is desperately rising, it is still more affordable than buying a home.

  • An average monthly living expense for a single person in the USA is $3,187,  which yearly counts to $38,266. On the other hand, the average cost for a family of four is $7,095,  which yearly counts to $85,139. 

  • Renting is suitable for those with a fixed and more-than-average income in the USA. You need to fit into this bracket to be able to afford to buy a house, especially in the metropolis cities.

Renting vs buying- What you get at the end:

This is the most important question that needs to be addressed because our decision to rent or buy ultimately decides what we will have. 

  • If we choose to rent, we save a lot of money by not paying property taxes, maintenance fees, and other additional costs; we even save some by not expensing the house in renovation. All the saved money can be utilized in other investment options like ETFs,  shares, treasury bills, REITs, or retirement funds. Even though we don't own a real estate property, we can have other investments.

  • If we choose to buy a house, in the end, we build equity and security for our generation so that they don't pay a lot to buy a new house. It doesn't mean you cannot save or invest in other options. If your financial situation is favorable, you can build a strong portfolio for yourself and also have a place of your own.

What is the 5% rule when comparing renting vs buying? 

Sometimes, you need clarification about renting or buying a house. So, how do you decide what to do? The simple rule is the 5% rule that helps you determine whether you are ready to buy a new house or not. It is a simple rule comparing three basic costs homeowners face and renters do not. The three costs are property taxes, maintenance costs, and capital costs.

Property Tax-  Property tax is levied on the value of the house, which is generally one percent.

Maintenance cost-   It is also levied on the value of the house, and it is also generally around 1%

Cost of capital-  The cost of capital equals the cost of debt + the cost of equity. It is around 3% of the value of the house.

  •  If we add all three costs, they are put into the 5% rule. If you multiply the property value by 5% and divide it by 12, you get the break-even point of what you would pay each month.

  • This will also help you to decide whether to buy or rent a house. If the cost of buying a house is less than renting, then it is preferable to purchase a new home.

What are the disadvantages of buying a house over renting a house? 

Below are some of the disadvantages of buying a house over renting.

  • High upfront cost- To buy a house, we take a loan and don't even bother calculating the upfront fee or other costs associated with closing on a mortgage. It is generally 2% to 5% of the home purchase price. The upfront cost includes property taxes, mortgage, insurance home inspection, first year of homeowners insurance, title search, title insurance, etc. It takes about five years for a borrower to recoup these costs. 

  • Building equity is not easy: We buy a house not just for security but also to create equity. However, it is essential to note that this process takes a lot of time. You put most of your money into paying interest, and equity will only be built if your area's property price increases drastically. If you want to develop or grow your equity fast, all you need is to add more money to your mortgage principal every month. This will again increase your budget, and it might be difficult for you to pay an additional amount.

  • Maintenance and other costs- You are responsible for occasionally maintaining and repairing your house. You hold the sole responsibility for maintenance. Apart from this, you are also responsible for paying property tax levied on the home's value.

Do millionaires buy or rent homes? 

Though millionaires buy a house, they prefer renting as they don't see a return on the money they have put into their homes. Many millionaires have sold their equity to purchase a few rental properties and become renters again.

  • It is also true that they support the idea of home ownership, but they also see that owning a home for some also means they take more money out of their pocket. 

  • Millionaires buy a house when they have enough money or when their passive or active income is enough to fund the cost of the mortgage, property taxes, and other costs.

Conclusion

Owning a house is indeed beneficial for many homeowners as, in the long run, they acquire equity in their homes. On the other hand, renters end up having no tangible assets at the end. But this doesn't mean renting is a bad idea because you don't have equity. By renting, you save the cost of property taxes, maintenance, renovation, etc, and by keeping the money, you can invest in other options like ETF, treasury bills, shares, or even REITs.

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Win Harrison 09 Nov, 2023

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