Written by: Corey Janoff
This blog post originally appeared on April 11, 2017 on our previous blog website, financialclarityblog.com. It has since been revised and updated.
Some of the most common questions I receive are about purchasing a home. Hence why our last two podcasts have been about buying and selling a home. Is buying a house a smart move? Owning a home is a goal that many people aspire to achieve and part of the American Dream. Numerous young professionals in their 20’s and 30’s that are currently renting are being pressured by family and friends to purchase a house.
“You’re throwing all your money away to rent and not building any equity!”
“Property prices keep increasing, so it will only be more expensive the longer you wait!”
Yes, owning a home can be wonderful and an excellent boost to your long-term financial success. According to a study by the Federal Reserve, the net worth of homeowners is significantly greater than that of renters. But let’s pump the brakes before we dive in and purchase a house, because it doesn’t make sense for everyone.
In this post, we will take a look at the pros and cons of owning a home vs. renting to help people determine what makes the most sense for them.
Advantages of Owning a Home
When you own a house, it is your asset. You can customize it, paint it, landscape it, etc. Make it your home. It is yours, not someone else’s.
Historically real estate appreciates in value over time. I have seen statistics ranging from three to five percent average annual growth for residential real estate. Different markets will have different growth rates over time. Growth isn’t guaranteed though.
As you pay down the mortgage, you build equity in your home (the difference between the appraised value of the house and the balance remaining on the mortgage). You can use that equity as collateral for loans at favorable interest rates. You can also sell the house in the future and potentially receive a rather large windfall of cash if your house has appreciated in value and the mortgage is paid down.
Unless you have a variable rate mortgage, the payments are generally pretty consistent. Payments will rise over time due to increasing property taxes, but that is about it.
Lastly, there are some tax benefits in owning a home in that you can deduct your mortgage interest (up to a certain extent) and property tax payments from your federal taxes.
When you sell your home, you can pocket up to $500,000 of gains tax-free! For example, if you buy a house for $400,000 and sell it years later for $900,000, you don't pay any taxes on the profits (assuming you are married. If you are single, only $250,000 of earnings avoids taxation).
Disadvantages of Owning a Home
You are the owner, which means you get to do all of the maintenance! If the toilet leaks, that’s your problem. Water heater needs replacing or the roof needs to be redone? You get to pay for it. Those are your weeds in the front yard.
Buying and selling real estate is costly! Between the down payment, appraisal fees, inspection fees, title transfer fees, mortgage origination fees, real estate agent commission (typically 5-6% of the sale price), it costs a lot of money to buy/sell property. There is a large up front capital outlay that not everyone is in a position to afford. Also, if you are selling, you need to roll on a fresh coat of paint, clean the carpets, and spruce the place up so you can get top dollar for your listing.
Getting approved for a mortgage is a difficult process for some people. You need to have good credit, consistent income history to demonstrate you have the ability to make payments. You also have to have a sufficient reserve of funds available to cover several months (or more) of payments after all of the closing costs are factored in. It also takes a lot of time to get approved for a mortgage to purchase a home (unless you are paying cash) – often a couple of months.
The big downside to owning a home is lack of mobility. While all the TV shows feature people who flip houses and make a ton of money doing so, there are countless people out there who are unable to sell their home for the price they want.
I have plenty of stories of people who bought a house and then a year or two later changed jobs and had to move to a different city, but were unable to sell their house. That left them stuck with two house payments and put a real strain on their budget.
As a general rule of thumb, unless you plan on staying in the house for at least five years, proceed cautiously before buying. There are transaction costs, real estate agent commissions, and the possibility that the house may not appreciate, or even decline in value from when you bought it. Plus, in order to sell a house, you need to find someone willing to buy a house. Depending on the economy, the area you are living in, and the market for your type of property, selling it could be challenging.
Advantages of Renting
Flexibility! When your lease is up, you can move elsewhere. You can even move before your lease is up! Many landlords will work with tenants to get out of a lease. Worst case, you have two rent payments temporarily, or have to stay in the place a few months longer than you want.
Maintenance costs, or lack thereof, are another big advantage of renting. If something stops working, call up the property manager or landlord to get it fixed. You don’t have to worry about repairing the roof, replacing the furnace, redoing the siding, or the endless list of maintenance projects homeowners have to deal with.
It is a lot easier to rent a home than it is to get a mortgage. Generally there is minimal up front cost. Minimal credit requirements. In some cases, you can fill out an application and move in the same day!
Disadvantages of Renting
It’s not your home. You can’t sell it. You have to get permission before you change anything to the property and sometimes you won’t be allowed to do anything. You have to sign a contract before occupying the unit. You have to get approval before allowing others to live with you. Pets may not be allowed.
You aren’t building any equity in the home. It’s not your asset, so you can’t borrow against it or use the asset for your own financial benefit.
The landlord could kick you out when the lease is up (or sooner under certain circumstances). They could also significantly raise the price to rent the property (some properties have restrictions on this).
As with everything in life, there are pros and cons. There is no absolute path that is best for everyone. If your career path will likely result in you moving to a different city in the near future, or you want the freedom to be able to relocate if you choose, renting has its advantages. Building equity in a home and owning a piece of real estate can have long-term financial benefits as well. The clear choice for you will depend on your goals, objectives and financial circumstances.