Choosing whether to rent or buy a home comes down to several factors that differ from situation to situation. Deciding how much house you can afford, as well as ongoing costs, can help you decide if buying is the right move — but don’t forget to consider how fast you’ll build equity. Plus, more personal questions, like where you want to live and how long you want to stay there, might be even more important than your finances.
Is it cheaper to rent or buy a home? It depends.
Whether you’ve long dreamed of owning a place of your own or you just keep hearing that you’re throwing away money on rent, you may be ready to calculate the financial advantages and disadvantages of renting vs. buying a home.
But deciding what move is best for you involves much more than comparing your monthly rent to a potential mortgage payment. Determining the financial impact of buying a home includes considering short- and long-term costs, the benefits of building equity, and what your financial situation might look like after closing.
Not sure where to start? We’ll walk you through some important things to consider before deciding if you should rent or buy.
How much house can I afford?
Buy vs. rent: What kind of house can you afford?
Before you decide to rent or buy, think about what buying means for your financial situation. Namely, just how much house can you afford to buy?
Answering that question may go beyond straightforward factors like your income, your credit profile, and housing prices in your area. Consider not just what the home costs, but what it will take to keep making your mortgage payments and maintain (or improve) the value of your home. If homeownership is on your mind, it’s a good time to review your finances to see if you’re ready to buy a home.
Keep in mind that the house you can afford to buy might look very different from what you can afford to rent. And if the rental property looks more attractive to you, you might choose to rent instead of buy, even if buying a home makes sense financially.
Determine the size of your down payment
When you purchase a home, you’ll generally need to put some money down. While require a down payment of as little as 3% of the total price, most buyers will need to put down 20% if they want to avoid paying private mortgage insurance.
In addition to your down payment, you’ll also need to cover closing costs. These costs are generally 2% to 5% of the home purchase price, or between $4,000 and $10,000 for a home that costs $200,000.
Calculate your debt-to-income ratio
When assessing your ability to repay your mortgage, a lender will consider your debt-to-income ratio along with your credit. This ratio compares your monthly debt payments to your monthly gross income. Lenders usually want to see that those monthly payments are less than 43% of your monthly income, although that figure may change from situation to situation.
Keep in mind that lenders may also consider what your debt-to-income ratio would look like after giving you a loan — not just your current ratio.
Factor in an emergency fund
Before you consider purchasing a home, think about whether you’ll have enough money left over for an emergency savings account. An emergency savings account is a financial cushion to help you cover unexpected situations or expenses, like unplanned medical bills or a busted water heater — and a homeowner’s budget can differ from that of a renter.
As a rule of thumb, experts say you should plan to have three to six months’ worth of living expenses saved in an emergency fund. If you buy a home and aren’t able to work emergency savings into your budget, you might be unable to pay your mortgage if an unexpected event changes your financial situation.
Estimate the costs of ongoing maintenance
One of the costs that can catch prospective homeowners off-guard is the cost of ongoing maintenance. If you’re a renter, a cracked window, broken pipes or a damaged roof usually isn’t your problem to fix. But when you’re the owner, those maintenance costs fall on your shoulders.
Maintenance costs vary based on the age and location of your home. According to a 2017 survey from Zillow and Thumbtack, the average unexpected cost of owning a home is $9,080 per year, of which $3,021 is landscaping, cleaning, and maintenance (the remainder is property taxes, utilities, and homeowners insurance).
While those maintenance costs are just an average, make sure you factor in these expenses when deciding if renting or buying makes more sense for you.
How much house can I afford? Estimate Now
How long do you want to stay where you are?
If you’re trying to decide between renting and buying, another thing to consider is how long you play to stay in the area you’re in now if you buy.
Buying a home is a long-term commitment, which means it’s typically not worth it for just a short-term stay. If your craving settling down somewhere and sticking around for years, buying a home can make sense. But if you prefer flexibility and want to be able to move around without much issue, renting is most likely the better option for you.
Before you decide, weigh the tradeoffs between putting down roots or having the freedom to pick up and move at a moment’s notice. How long you decide to stay somewhere can impact not just the logistics of moving, but also the economic component of whether you should rent or buy.
Remember that equity increases over time
If someone has ever told you that you are just wasting money on rent, they are likely saying that your monthly payment will only go to the landlord or property owner. When you buy, part of the mortgage payment is used to build equity in your home. However, this may not be all that impressive if you leave your home long before your mortgage expires.
Equity is the difference between home expenses and mortgage debt. Your equity increases when you pay back the mortgage or the value of your home increases over time.
But during the first few years, you own your home, you’ll slowly build up capital because most of these loan payments go towards paying back the mortgage interest rather than the principal.
If you own the home for a longer period, most of the mortgage payments go to principal, which increases your equity. If you don’t plan to stay at home for long, you can sell it without as much capital as you planned.
Factor in selling costs if you plan to move
While it is possible to sell your home within a few years of purchasing it, the associated costs might not make it a sound investment. When you sell your home, you’re generally on the hook for several expenses that can add up quickly and outweigh what you earn on the sale.
Aside from the costs of making repairs, staging your home, and making updates to ensure it shows well, you also have to pay a commission to the real estate agent, which can average 5% to 6% of the home sale price. For a $200,000 home, you could end up spending $10,000 to $12,000 just on the real estate commission to sell the home.
If you sell your home within a few years of buying, your home may not have had time to gain enough value — or to build up enough equity — for you to cover these costs.
For example, if you purchase a home for $200,000 and sell it for $208,000 two years later, you might need to spend as much as $12,480 in real estate agent commission to sell the home. While the sale price of the home has increased by $8,000, you’ve spent enough money in fees to give you a loss of $4,480 on the sale.
Next steps: Don’t forget the emotional questions
The subtle financial issues that arise when deciding between renting or owning a home are an important part of the process. However, keep in mind another important aspect of deciding to rent or buy – what’s going to upset the balance of your life.
Earlier we touched on some of these issues, such as how long do you want to live in what kind of place or house you want to live in. However, there are other things to consider, such as do you want to take responsibility for homeownership. For example, the need to repair yourself may seem simple until it comes time to find a crew to replace your roof.
After all, the financial aspects of taking care of your purchase are only part of your decision. Considering both renting and buying, this will help you make not only a smart choice but one that is comfortable for you.