When Its Smarter to Rent than Buy
Renting gives you flexibility and freedom.
Despite the bruising US housing market crash of 2008, home ownership still ranks up there with a successful career and happy family life as a key pillar of the American Dream. In fact, a recent survey found that 71% of adults say that purchasing a home is a top personal goal.
Buying often makes financial sense, which is why phrases like “renting is just throwing money away” and “it’s better to buy than to rent” have likely been drummed into your head.
“Historically, buying has been the way to go,” says Certified Financial Planner (CFP) Jennifer Lane, founder of Compass Planning Associates. “Members of the Baby Boom generation settled down young and usually worked for a single employer with a pension.” But these days, the old rule doesn’t necessarily apply. “Now, it’s important to be mobile for your career,” adds Lane.
The fluid nature of today’s work world may in part explain why renting is on the rise. According to the report, ‘From Own to Rent’ by real estate information site Trulia, the number of tenants jumped from 39% to 43% between 2006 and 2014. But a host of other circumstances also make writing a monthly check to a landlord a smarter course of action. Before you hit the open house circuit, find out the eight times renting is the wiser strategy.
1. If You Might Move in the Next Five Years
It takes about five years for your investment in a home to earn money, so if you suspect you’ll want to move before then, beware. Not only will you have to shell out serious cash for a down payment, selling can be pricey, too. In addition to the average Realtor’s commission of about 5%, you’ll pay transfer and capital gains taxes, escrow fees and moving fees””plus the potential cost of improvements to bring your house up to code and have it staged to make it attractive to potential buyers.
“You want to stay in the home long enough for the equity you get from paying off the mortgage to outweigh those additional costs,” says Ralph McLaughlin, chief economist at Trulia. “When making the decision about whether to rent or buy, the single most important consideration is how long you think you’ll be there.”
Even if you’re planning on staying put after you buy, take an honest look at how secure your life situation is. “If you don’t have a solid career path, dislike your boss or have a gut feeling that the company is headed in the wrong direction, hang tight and keep renting,” says Brendon DeSimone, manager of the Bedford, New York, office of Houlihan Lawrence and author of “Next Generation Real Estate.”
Evaluate your personal life as well. “Your relationship should be on stable footing,” DeSimone says. Expect to settle down in the near future and even start a family? Don’t buy a place that suits the single-and-no-kids version of yourself. And if your love life is rocky, hold off on purchasing a home together. “I’ve had clients tell me they bought a place because they wanted to make the relationship work,” DeSimone says. “Then they end up getting divorced and are forced to sell too soon.”
Finally, get real about the lifestyle you hope to pursue. When you project what your life will look like in half a decade, does it make sense to live where you are? “Remember that renting gives you the flexibility and freedom to travel,” DeSimone says. If enjoying a free-wheeling, footloose experience is appealing, then don’t spring for a place right now.
2. When You Can’t Afford a 20% Down Payment
Congrats, you found your dream home! Put down less than 20%, however, and it can end up costing you in the long run. “If you can only put a low down payment on a house, that generally means you’ll be charged a higher interest rate,” McLaughlin says. “You’ll also likely have to pay mortgage insurance, a monthly fee that ranges from about $50 to $500 and goes directly to an insurance company protecting the bank’s interest””not yours.” Usually you can stop paying for insurance once you hit a 20% loan-to-value ratio, but in the meantime, the whole situation is a money suck. And since the majority of your mortgage payments are going toward interest, you’re not building a lot of equity.
Contributing less than 20% can also put you in a precarious financial position. “Even if you think you’re ready to be in the home forever, life happens, and the 20% down payment gives you a safety zone,” Lane says. Since the cost of selling can be in the ballpark of 10% of the house’s value, if you’ve only made a low down payment, the closing fees can easily surpass what little equity you’ve earned. On top of that, if the property has lost value, you might not be able to net what you bought it for. And if you don’t have enough ready cash to bring to the closing, you could be stuck in the house or forced to file for bankruptcy. Gulp!
3. If You Already Have a Sweet Deal on Rent
If you’re paying next to nada for a fabulous pad in a high-demand area, it may be savvier to sign another lease instead of buying. “On a month-to-month basis, it’s often cheaper to rent,” says Lane. Of course, just because you’ve scored a bargain, don’t make the mistake of spending that extra cash on fun stuff, like clothes, dinners and trips. “A mortgage is a forced ‘savings’ program, where the amount of principal increases over the years,” Lane says. “So if you do have a crazy-low rent, establish an intentional savings plan and invest the difference.”
Begin by calculating how much you’d pay for a mortgage on a similar home in the same area””let’s say $1,800 a month compared to your $1,200 rent. Then, set up direct deposit to funnel the $600 difference straight into a mutual fund. Who knows? You just might be able to use it for a down payment in the future.
4. When the Housing Market Is Overpriced
You arrive at an open house, and it’s as jam-packed as a Rihanna show. “Heavy demand creates a hot market,” Lane says. “The risk is that you’re under pressure to make a snap decision.” She’s seen people bring home inspectors with them to open houses and make an offer on the spot. But if you haven’t thoroughly vetted the place, you might end up paying for more repairs than you had predicted””or the appraisal might come in lower than the price, meaning your mortgage could be rejected.
That said, buying in an expensive market isn’t necessarily a bad idea. “For example, many markets in California may look high, but they have a great deal of natural and human amenities””beautiful weather, recreation, culture, restaurants””as well as growth in high-wage industries,” McLaughlin says. “People are willing to pay more to live there.” Again, make sure to run the numbers through a rent-buy calculator to see if you can swing it.
5. If Buying Means a Longer Commute
If the kind of house you want in your price range is far from where you work, it may make more sense to rent. “People often don’t take commuting costs into account, but they should,” McLaughlin says. Commuting can add an extra 10% to the price of a house in terms of gas and time””particularly in areas where cars are a big part of culture, like Detroit, Birmingham, Miami, Riverside, Dallas and Houston, according to research from Trulia.
Money aside, commuting also takes a toll on your well-being. Not only is it one of the top sources of stress, it can contribute to obesity, relationship issues and back pain. In light of all that, is having your name on the deed really worth it?
6. When Your Credit Score Isn’t So Hot
As we’ve pointed out in the past, your credit score can impact your life in ways you may not have realized””and the interest rate you’re charged on a mortgage is a biggie. “The best rates out there are around 3.5 to 4%, but if your credit score is low, you’re probably looking at 4.5 to 5%,” McLaughlin says. “That could tip the balance in the direction of renting, particularly in expensive markets where it will really add up over time.”
7. If You’re Not Prepared to Clean Gutters
Having your own house sounds fabulous in theory””you can decorate it however you like, and you don’t have to worry about whether your landlord will jack up the rent.
But there’s a less sexy side of being a homeowner: mowing the lawn, remembering to have the oil tank filled, dealing with a leaky septic tank. If you’re a renter, you can simply pick up the phone, dial the property manager and voila””headache solved. If you’re an owner, you have to do the legwork yourself. “There’s always a list 10-deep of things that you have to get done around the house,” DeSimone says. “If you’re not up for the workload, you shouldn’t be buying.”
Upkeep is also expensive. “Maintenance costs could tack on 5 to 10% of the price of your home per year, depending on the age and condition of your building,” Lane says. On that note, if the place you’re considering has an HOA, aka a homeowner’s association (like many gated communities, condos and apartment residences), familiarize yourself with those monthly fees. “In some markets, like New York City, Palm Springs and San Francisco, HOA charges can easily be US $300 to $400 a month,” McLaughlin says.
8. When You’re New to the Area
Just moved to town? Though it’s tempting to purchase a home right off the bat, press pause. “Not only is your job still in flux, but it takes between six months to a year to get to know a new area,” DeSimone says. “Give yourself time to figure out which neighborhoods you’ll be hanging out in, where the best school districts are, which church you’ll belong to and the easiest commute.” Rather than tie yourself down prematurely, a short-term rental gives you time to get the lay of the land.
This is especially sound advice for Millennials, who as a generation feel pressure to act fast and rush into decisions. “But buying a home isn’t an on-demand transaction; it’s a huge financial, emotional and practical commitment,” says DeSimone. Better to follow your brain, not your heart, on this one.