You’ve probably heard that old expression that “good things come in small packages.” That’s often true. It doesn’t take a very large package to hold a diamond engagement ring or a TAG Heuer watch. On the other hand, there are some very good things that come in very large packages and one of them is a house. But whether you’re single or married, there’s always the age-old question of whether it’s better to rent or to buy.
We favor buying because that’s basically the way we were raised. If you’re an American, the American dream has long been to own your own home. This desire really bloomed after World War II when our soldiers came home, got married and started having children. Builders such as Levitt began building houses (Levittown) that the average person could afford and that’s what many of our vets chose to do.
But as we learned from the mortgage meltdown of 2007 that left so many homeowners underwater, homeownership today is not the same as 40 or 50 years ago. The American dream may still be alive but before you plunk down $20,000, $25,000 or more to buy a house, it’s worth taking the time to determine whether that makes the most sense for you or whether you should be renting.
Price of the house
The price of the home that you would buy is not the only factor in making a rent versus buy decision but it’s a very important one. There is a simple formula that the more a house costs the bigger the down payment that will be required and the higher your monthly payments will be.
As an example of this a $250,000, 30-year mortgage will have a monthly payment of around $960 –not including taxes and insurance. Change that to a $300,000 mortgage and the monthly payment goes to approximately $1520. (Note: Both these examples are based on a mortgage at 4.5% APR.)
How long will you be there?
If you believe you will be living in the same place for five years or less, you’d probably be better off renting. The reason for this is because the longer you stay in the house the more years there will be for your upfront fees to be amortized – or spread out. As an example of this, suppose that your upfront fees totaled 3% (not including the down payment). If you were to stay in that house for five years your fees would amortize at the rate of $1500 a year (3% x $250,000). But if you were to stay there for 10 years, the fees would go down to $750 a year.
A 20% down mortgage means a $250,000 house would require a down payment of $50,000. If you were able to get a mortgage at 10% down, you would still be required to come up with $25,000 cash. As an alternative to this you might be able to pay mortgage insurance or get a government guaranteed loan. An FHA loan program has looser credit criteria than a conventional mortgage and requires only a 3.5% down payment. Plus, the seller pays most of the closing costs.
While this may sound pretty good there are some definite caveats. To qualify you would need to show two years of steady employment with a stable or increasing income, along with a minimum credit score of 620, no more than two 30-day late payments over the past two years, no foreclosures in the past three years, no bankruptcies in the past two years and your mortgage payment will need to be no more than about 30% of your gross pre-tax income. You will find that there may also be some limits on how much you can borrow based on where you live. And finally, you will be required to pay a premium of up to 1% of the loan amount at closing and a monthly premium of up to .9% of the loan amount each year.
If you’d like to know more about FHA guaranteed mortgages, here’s a short video with some good information – courtesy of National Debt Relief.
The costs of maintenance
One thing you never have to worry about when you rent is maintenance and repair costs. One person summed up this issue very succinctly by saying, “owning a home is like having a big hole in the ground that you keep shoveling money into but that never gets filled up.” Ask any homeowner and he or she will tell you that maintenance and repair costs simply never end. The minute after you’ve spent $1,000 to have your house repainted you learn that your entire roof needs to be replaced at a cost of $5000. As a general rule, you should have the equivalent of at least three to six months of your gross salary put away just to cover these kinds of costs.
The good news and bad news of property taxes
Renters never have to pay property taxes – at least not directly. On the other hand, homeowners are required to pay property taxes every year. You would have to check with your county assessor to determine your tax rate but assuming a rate of 1.35%, your property taxes would be $3470 for the first year. In most cases, this tax, along with homeowners insurance, will be tacked onto your monthly payment and then paid by your mortgage holder. As you can imagine, this will increase your monthly payment substantially. However, in most cases, you will be able to write off your property taxes on your income taxes, which could be a good help whenever April 15th rolls around.
The house as an investment
It’s also important to understand that in the final analysis, buying a home is an investment. Like other investments, you need to make sure that it will grow in value over time. As a general rule, houses here in the US increase in value at the rate of 3% per year. Given today’s economy, that’s a pretty good return on investment. But if you were to pick the wrong neighborhood, borrow more money than you can afford or not take into consideration the costs of repairs and maintenance, you could very well see the value of that investment decrease. There are still hundreds of thousands of American homeowners that are underwater – owing more than their homes are worth. This is just not a position you would want to find yourself in.
The joys and pitfalls of renting
We’ve already mentioned what might be the biggest joy of renting, which is no repair and maintenance costs. You won’t ever have to to pay property taxes and your renters’ insurance should be much less than homeowner’s insurance as you would be covering only your possessions and not the structure itself. Your security deposit would be much less than the down payment you would be required to make if you were to buy and your upfront fee would consist of just your security deposit and a month’s rent in advance.
The biggest downside of renting is, of course, the fact that you’re always at the mercy of your landlord. A good landlord will take care of all maintenance and repairs in a timely fashion and basically leave you alone. But do make sure if you decide to rent that you read your lease very carefully. We have a friend who was recently kicked out of her townhouse by her landlord who decided she wanted to sell the unit. As is true of many things in life, it’s always “buyer beware” or this case, “renter beware”.
Which would be best for you?
Of course, this is a decision that only you can make based on your financial circumstances, how long you intend to stay in your house, how much of a down payment you could afford and your comfort level. Some people are simply happier when they live in their own homes while others are just as happy to rent. The important thing is to take into consideration the factors we’ve covered in this article and make a decision that will leave you feeling the most comfortable and in the best financial shape.