I'm asked this question about renting vs buying a home quite often. Many people seem to share the sentiment that renting a home is basically throwing away money. But is it really?
Are you in the market to purchase a new home or is it on your list of goals in the foreseeable future? Is one of the factors driving your decision due to the fact that you think renting is a waste of money?
Well, before you make a final decision, below are some key things to consider.
1. Compare your home expenses when it comes to renting vs. buying
A lot of people make the mistake of thinking that they'll simply go from paying rent to simply paying a mortgage and that will be it. However, there are several other associated expenses outside of your mortgage that come with buying and owning a home.
For instance, you'll need to include things like closing costs, the cost of moving to your new home, homeowners' insurance, home maintenance. More specific costs include landscaping, grass cutting, snow removal, association fees, renovation work, decorating, etc.
Its also very important to consider things like the age of the roof, as well as the age of the appliances and systems. For example, plumbing and electrical. This is because if and when these need repair or replacement, they are major expenses.
As a renter, on the other hand, it is very unlikely that you will be responsible for these expenses. You'll still want to make sure you have the right type of renters insurance though.
So don't be too quick to decide that renting is a waste of money. You want to compare your expenses as a renter vs. your potential expenses as a homeowner to see what makes the most sense.
2. Determine how long you intend to stay in the home
Homeownership can be very expensive especially when you factor in your main costs outside of your mortgage. For instance, repairs and maintenance, property taxes, insurance, and home improvements.
If you do not intend to stay in your home for a long enough period of time to be able to build equity, then your home could be a money pit.
Building equity, however, is dependent on the neighborhood, economy, and other factors. If you sell too quickly before you build equity, buying a home can become a sunk cost.
If you purchase a home and decide to sell it a few short years (or months) after purchasing it then you could lose money. It is likely that any equity you build over that period will be eaten away by closing costs, realtor fees, and taxes. All of which could cause you to come out in the red.
3. Review your loan qualification carefully
So many people are financially overextended as a result of underwater mortgages. This is because they went by what the bank said they could afford. They did this instead of looking at their budgets to determine what they could truly afford. It's critical to avoid this costly mistake.
Banks will qualify you for loans based on your pretax income. They can also decide to exclude certain debts when considering your application based on your future earning potential.
For example, let's say you are a lawyer with student loans but you have a high future earning potential. The bank can decide to minimize or ignore the weight of your debt in factoring how much of a loan you are approved for. This is NOT to your benefit.
It's important to factor all your debt and monthly bills into your budget. Then you can use your budget to determine what you can really afford otherwise you can get in big financial trouble.
Its all about planning and doing the right research and determining what works for what you can afford. Your goal should be to keep your housing costs at 30% or less of your income otherwise your budget can get really tight.
4. Be mindful of considering your primary residence as an investment
Another reason people look at purchasing a primary residence is that they feel that they are making a good investment.
However, keep in mind that just because your home may increase in value does not necessarily mean that it's an investment in the true sense of the word. This is because your primary residence is also your shelter.
The goal with an investment is that you earn money when you sell it. You do this by purchasing investments at the lowest possible cost and having the least amount of expenses associated with them. This gives your investments the potential to appreciate and earn you a profit in the future.
When it comes to using your primary residence as an investment, you have to weigh all the associated expenses against the sales price.
You'll also need to keep in mind that when you sell your primary residence you still need somewhere to live. This will also cost you money. This cost will also need to be factored into whether or not your primary residence as an investment is a worthwhile investment.
So for example, let's say you are expecting your home to appreciate by $100,000 in 10 years. How do you deem it as a truly profitable investment? Well, that $100,000 of appreciation will have to be more than your expenses over those 10 years.
This is including your mortgage payments, maintenance costs, repair costs, and taxes over that time as well as the cost to acquire your next place of shelter.
On the other hand, rental property can be looked at as an investment because the majority of the costs will not come out of your pockets. Instead, they are covered by the rent payments you receive. Again you'll need to make sure the numbers work in your favor.
When it comes to renting vs. buying a home be sure to take the factors above into consideration. You also want to consider how your decision relates to your personal finances.
Keep in mind that there is no wrong decision when it comes to whether you rent or buy. Ideally, you want to go with the best decision that works for your life.
If you are in the market to purchase, then check out our free course on buying your first home.