The Short-term Financial Implications of Renting and Buying

part 2 of 5 in our American Dream series

In our last post, we discussed the shift in attitudes among Americans around the concept of the American Dream. Many Americans equate the American Dream with homeownership, yet a 2009 National Foundation for Credit Counseling survey revealed that one third of respondents believe they will never be able to own a home. A likely driver of this sentiment is the financial impact that owning a home has on a person both in the short- and long-term.

When evaluating whether or not homeownership is right for you, you first need to examine the costs of ownership and the costs of renting. It sounds simple enough, right? Well, doing this evaluation properly means going beyond a simple comparison of mortgage and rental payments. Let’s look at each situation in turn.

Costs of homeownership

The usual costs that people think about are mortgage payments, taxes and insurance. Too often, though, they use “averages” to estimate these costs, when the reality is that these costs can vary significantly.

Mortgage – You can use an online calculator to determine your expected monthly mortgage payment. When using these calculators, input data that is relevant to you, rather than relying on the calculators’ default inputs. For example, it is helpful to know the geography you will buy in, your credit score, the type of loan you want to take out, and how much money you will use as a down payment in order to determine the mortgage rate that is applicable to you.

Taxes – Counties, municipalities and school districts can all assess real property taxes, so rates can vary wildly. According to the Tax Foundation, residents of Niagara County in New York State pay almost 2.9% of their home’s value in property taxes, while residents of St. Bernard Parish, Louisiana on average pay about 1/10^th of 1 percent of their home’s value in property taxes. Understanding the tax situation in the area where your dream home is located is critical.

Insurance – Lenders will require borrowers to purchase homeowners insurance to protect them in the event of damage or destruction to the home. You’ll need to check rates with a variety of insurance providers to determine what you can expect to pay in your area for the type of home you want to purchase.

Then there are the less obvious expenses of homeownership such as maintenance, repairs, supplemental insurance, home improvements, association fees, utilities and decorating costs.

Maintenance and repairs – This cost depends on a number of factors such as the age of your home, your climate, and the condition it is in when you make the home purchase. As a rule of thumb, though, experts suggest budgeting about 1% of the home purchase price annually. On a $250,000 home, that comes out to $208 each month.

Supplemental insurance – You mean I need more than regular homeowner’s insurance? Yes. Basic insurance does not cover some catastrophes like earthquakes and floods. In addition, high value items like furs, antiques and jewelry may require a rider to your basic policy that provides coverage for an additional fee. You may also need to pay PMI (private mortgage insurance) if your down payment is less than 20%. This protects the lender if you default on the loan.

Improvements – Rarely does someone purchase the “perfect” home for them. Usually, you’ll want to put your personal stamp on your new home, whether that be by changing up the paint colors, ripping out carpets, or knocking down walls. Typically, home improvements lose value over time, so don’t count on a return on this investment. Chock it up as an expense that makes your daily living more pleasant and add it to the total calculation of homeownership costs.

Association fees – If you buy into a subdivision or condominium, you will probably have to pay fees that cover the common area upkeep or other shared expenses.

Utilities – While you of course need to pay utility bills when you rent, there is a good chance they will be higher when you own a home. That is because you may be using more energy in a larger space, paying for watering a yard that you did not have before, or covering some utility bills that were previously included in your rent.

Decorating – If this is your first home purchase, you may need additional or new furnishings for your new home. Again, your new home is likely to be larger than the apartment you’ve been living in, or it may be a different style.

Costs of renting

The costs of renting are a lot easier to figure out.

Rent – Your landlord will tell you how much they are charging in rent so you don’t need to use complex calculators.

Utilities – Your landlord will also tell you what utilities, if any, are covered by your rent. Then, you can easily get estimates of monthly expenses like telephone and cable services in your new area, or use your existing bills as a guideline if you are staying in the same geographic area.

Renter’s insurance – You should ask your new landlord if they require renter’s insurance. If not, then the choice is yours to incur this expense or not. Just realize that if you choose not to get insurance, you will not be covered for loss to your personal property in cases such as fires.

If you‘ve fully reviewed the numbers, and feel that you can comfortably cover the total cost of home ownership, the next step is to understand whether you can also maintain financial security for the long-term by continuing to save for the future. Learn more about this important step in our next post.