The dream of homeownership is almost as American as baseball and apple pie. Buying a home is virtually embedded in our culture as an expectation of what you do when you “grow up.” Because of this cultural norm, many people enter the realms of hefty down payments and long-term mortgages without carefully balancing the pros and cons of owning versus renting.
When you look at homeownership trends and changing real estate prices, a question bubbles to the surface: are you better off buying or renting? The answer, annoyingly, is it depends. Not all situations are the same for every prospective buyer. But lower costs, flexibility and reduced stress make renting an attractive option when compared with the expensive responsibility of buying a home.
Buying a home is cash-intensive
When you buy a home, coming up with the down payment can be a big hurdle. How much you need varies. If you qualify for an FHA loan, you can get away with the minimum down payment for as low as 3.5% of the purchase price. Going this route however, you will have less equity in your home, thus will face higher monthly mortgage payments, as well as likely mortgage insurance premiums (up-front and/or recurring).
A typical down payment is 20% of the purchase price. But there are a lot of other hidden costs in the initiation of a home loan. You also have to pay closing costs that may include appraisal fees, financing fees, title insurance, transfer tax, real estate tax and escrow.
Getting an appraisal assures your lender that the value of the home they are lending you money for comfortably exceeds their loan to you. Financing fees are fees charged by the lender for providing the loan (origination and processing fees). Title insurance provides assurance to both you and the lender that the seller has clear title to the property being sold. Transfer taxes are state and local taxes on the sale of real estate; they are generally split between buyer and seller. Assuming the transfer fees are split, both the buyer and seller must pay a percentage of the sales price in taxes. Additionally, banks providing the loans typically require the borrower to keep one year of real estate taxes in escrow with the bank.
Let’s say you are buying a $200,000 home in the City of Philadelphia, and you are borrowing 80% of the purchase price. The math might break down to this:
- Down payment: $40,000
- Appraisal fees: $375
- Financing Fees (based on 2%): $4,000
- Title Insurance: $800
- City Real Estate and State Transfer tax: $4,100 **
- Real Estate Escrow (based on a market value of $200,000): $2,940
- Other Fees (inspection, recording fees, professional help): $525
- Total Up-Front Closing Cost: $9,800 in fees, plus $2,940 in escrow (pre-paid real estate tax)
- Cash for closing: $52,740
- Real Cost of Home: $209,800
**Assumes you pay half the realty transfer and real estate taxes and the seller pays the other half.
As you can see, buying a house requires a lot more cash than one might think.
Home maintenance is costly
On top of your monthly mortage and related fees, you will likely have monthly fees for utilities, lawn care, homeowners’ insurance and perhaps homeowners’ association fees.
Then there’s the wild card — maintenance.
This cost varies, of course, based on the condition and size of your home, as well as the location and whether it is detached or connected to a larger building. Regardless, if you plan to stay there a while, it will get older. And that means stuff is going to break.
Experts say you should budget between one and three percent of the cost of your home for maintenance every year. On a $200,000 home, that’s an extra $2,000 to $6,000 a year to budget. Budgeting is essential because the costs tend to hit you all at once and you’ll want to be ready for them. In a blink you could be dealing with a heating emergency or a leaky roof. Replacing your roof or heating and air conditioning system can quickly run into the thousands of dollars. If you have not budgeted for these expenses, you could find yourself in financial trouble.
On the other hand, if you rent, you will not have to set aside money for maintenance. That’s because your landlord will generally include it in your monthly rental payments — expected, affordable chunks.
Selling a home is expensive
If you think you will not live in your home forever, just like buying costs, you have to consider selling costs. While you may be able to sell your home yourself, most people use a realtor whose commission usually tallies up to five or six percent of the home’s value.
Let’s take that same $200,000 home in Philadelphia and assume it appreciates 5% in value. You decide to sell it for $210,000.
- Purchase Price: $210,000
- Broker Commission (assumes 5%): $10,500
- City Real Estate and State Transfer Tax: $4,305 **
- Other Closing Fees: $350
- Net Sale Price $194,845
** Assumes you pay half the realty transfer and real estate tax and buyer pays other half.
Real Cost to Purchase Home ($209,800) – Net Sales Price ($194,845) = – $14,955
In our example, the real cost to purchase the home was $209,800; however, after expenses, your effective net sales price is $194,845. Even though the house sold for $10,000 more than you bought it for, you would have lost $14,955.00 (there are tax advantages that are not accounted for in the above example including deductions for real estate tax and interest).
These costs don’t even account for the money you put into the home during the time you lived there. Nor do they account for repairs you may have to perform during the negotiation with a potential buyer.
There are other challenges with selling a home.
- Less flexibility: If you have a job offer in another city or just wish to retire somewhere warmer, owning a home prevents you from picking up and moving at the drop of a hat.
- It’s time-intensive: It can take months (or years) to sell a home. Finding, contacting and scheduling reliable vendors can be time-intensive and frustrating.
- It’s a lot of responsibility: If you’ve ever owned a place before, you know that getting it ready to put on the market is a lot of work. As the owner it all falls on your shoulders to get it done.
Why some people should consider buying over renting
On the other hand, buying a home has some advantages. While risk generally goes up, so may the rewards. Here are a few of the potential benefits of home ownership.
- It may be a good investment: For some people, buying a home is the right thing to do. The most significant advantage is that the money you invest every month helps you to build equity. If you buy at the right time, your investment could appreciate. As a home owner, you may also be able to deduct at least some of your interest and real estate taxes which may have some financial advantages for you.
- It’s great for long-term residents: If you’re planning to stay in one place for a long time, owning a home gives you a sense of commitment to the neighborhood. If you have children, that means they’ll have stability and access to the same schools, parks and other local neighborhood features as they grow up.
- It’s yours: When you a buy a home, you will have more flexibility to decorate, customize or upgrade it than you have in a a rental property.
Questions to consider before making your decision
When deciding to buy or rent you must consider many factors. Here are some questions to ask yourself:
- How much cash do you have to invest in a home?
- After buying, will you have the cash flow to pay monthly costs and maintenance or will you be ‘house poor’?
- Do you want or need to have the flexibility to use your money in other ways?
- Is it better for your career, or other reasons, to be able to pick up and move quickly at the end of a lease rather than worrying about the cost and time to sell a home?
- Are you up for managing home maintenance tasks? Or would you prefer to call a landlord and have him or her take care of the maintenance?
How you answer these questions will help you to decide whether you should rent or buy.