When renting makes more sense than buying
Don’t underestimate costs associated with owning home
Many millennials face a tough housing question: rent or buy?
The nagging feeling that buying is something you should do is one big reason that millennials choose to buy, says Bill Nelson, certified financial planner near Boston. We’ve also been told that buying is an investment, and renting is “just throwing money away.”
Many experts recommend buying only if you expect to park yourself there for at least five years. An online rent-or-buy calculator, such as those from SmartAsset.com or Zillow.com, 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 home purchase price. Increases in ongoing expenses such as property taxes or getting hit with a special assessment by a condo board also can blindside new homeowners.
Eric Simonson, a CFP 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 upfront 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, co-author of a study on homeownership in the Journal of Housing Research. Most renters don’t do this, however, 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.”