Is Buying Better Than Renting?
Buying is better than renting.
This advice is so common it is almost considered fact. Renting is just throwing your money away when you could be building equity. People often overlook the costs of homeownership, which erodes the ability to save or spend on other things. The reality is that some people may be better off renting instead of buying depending on the circumstances.
First, the standard advice is generally sound. Owning real estate is an excellent way to build wealth over time. So how does this good advice go wrong?
WHAT YOU PAY IN RENT IS NOT EQUIVALENT TO A MORTGAGE
When we bought our first home, it was the result of a simple assessment. We could own a home for just a few hundred more dollars than what we paid in rent each month. Of course, we should buy! Unfortunately, we did not understand how costly houses can be to maintain. After we moved in, we had a very common experience for new homeowners. Things immediately started going wrong. We used a large portion of our cash for the down payment, budgeted for certain projects, and were completely unprepared for several large, unexpected repairs. Some were so large that even if we had been more prepared, we would not have been able to cover the costs. As a result, shortly after moving into our new home we had to take on more debt to pay for those additional repairs.
PEOPLE DO NOT APPRECIATE HOW LOANS AMORTIZE
The equity you are building with each payment is minimal in the first several years of a mortgage loan. For instance, the first payment on a 30-year conventional mortgage at 4% interest will direct roughly 70% of every dollar to interest payments. Only 30% goes to the principal or loan balance. While you are building equity, it goes slowly in the first ten years of the loan and can be diminished by the cost of ownership.
FLEXIBILITY
The reality is that a mortgage ties you to a location. That may mean more limited choices in your professional or personal life should you need to make a change.
TRANSACTION COSTS
Real estate is incredibly expensive to sell. Traditionally, agents charge around 6% of the property value to list and sell. For example, to sell a $400,000 home you will lose $24,000 in home equity right off the top. In addition, there are myriad fees you must pay to the city and county to list your home for sale, and repair costs to satisfy the buyer.
When should you buy?
- When you plan on staying in your home for at least 7 years. That is typically enough time to ensure you have enough equity to absorb transaction costs when selling.
- When you can comfortably afford the down payment and still have ample reserves.
- When you can afford to make ongoing repairs and shoulder the additional costs associated with owning a home.
Many people rush into buying their first home. Some would be far better off saving longer and becoming more financially stable before taking on such a large obligation. Our first home set us back financially instead of moving us forward and it took years for us to dig out of the financial hole.
Conventional wisdom is great, but it is often off the mark or fails to provide the necessary disclaimers. The same is true for home ownership.
If you would like to discuss your situation with an advisor who will act as your fiduciary you can contact us here.
This is not a recommendation and is not intended to be taken as a recommendation. This material was prepared for general distribution and is not directed to a specific individual.
LPWM LLC does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisers.
