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?
If you are in the market to purchase a new home or if it's on your list of goals in the foreseeable future because you think renting is a waste, below are some things to consider before you make your final decision.
1. You need to compare your expenses as a renter vs. your expenses as a homeowner
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 e.g. landscaping, grass cutting or grass cutting equipment, 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 (i.e plumbing and electrical). This is because if and when these need repair or replacement, they are major expenses. Based on this, it's a good idea to bulk up your sinking fund in the event of any unplanned home repairs that come up. The last thing you want is to wind up house poor.
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 before you make the decision 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. You need to determine how long you intend to stay in the home
Homeownership can be very expensive and if you do not intend to stay in your home for a long enough period of time to be able to build equity. 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 it is very likely that any equity you build over that period will be eaten away by closing costs, realtor fees and taxes and you could even come out in the red.
3. You will need to review your loan qualification carefully
So many people are financially overextended as a result of underwater mortgages because they went by what the bank said they could afford as opposed to 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 and can decide to not include certain debts based on your future earning potential (for example) and 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. Owning your primary residence is not exactly 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, with the hope that they will appreciate to 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 which 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. In order to deem it as a truly profitable investment, 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 rent payments you receive. Again you'll need to make sure the numbers work in your favor.
So as you consider purchasing a home, it's very important to take the factors above into consideration especially as it relates to your personal finances.