“Should I rent or buy?” As a realtor, I get asked some form of this question often enough from people in my age group (late 20s / early 30s) that I thought I should address it in a blog post. Many people feel that renting is like throwing away money or paying someone else’s mortgage for them. I’ve seen many articles from people in the real estate industry stating that buying is cheaper than renting and that they should buy. But the answer isn’t always that simple. True, in most cases (but not all), owning a home will pay off in the long run (maybe about 4-7 years) over renting. But let’s look at some other factors that you should think about to help you decide.
I’ll be using sample figures to give a more concrete example. Figures in your area may be higher or lower. I am in the northern Virginia / D.C. Metro area and will be using figures that I feel people in my area can relate to. Also, most of this information will apply to potential first-time homebuyers.
Related blog posts:
- Homebuying 101: A Quick Guide for First-Time Homebuyers
- Paying Off a 30 Year Mortgage in 5 Years
- 10 Personal Finance Tips for 20-somethings from a 30 Year Old
How much is your rent now?
You should consider the amount that you pay for rent now. If you are in a 1-bedroom apartment in a nicer area, you may be paying about $1,500/month, including utilities. If you are sharing a house with a bunch of roommates, you may be paying $800/month including utilities, which is about half as much as renting on your own. A mortgage payment will feel like a huge difference if you’re used to paying $800/month and transition over to paying for a place to live on your own. If you’re single and comfortable living with roommates, it may be much cheaper staying in your current living situation.
Do you have any debt?
By this, I mean do you have any credit card debt (carry a balance), car debt, student loans, or any installment plans? This will all affect your monthly cash flow, your ability to get approved for a mortgage, and how much house you can afford. Try to pay off as much debt as you can before looking to buy. Ideally, you want to be completely debt-free, but I understand that can be difficult with the cost of education and the cost of living rising rapidly.
Do you have an emergency fund in place?
It’s good to have about 3-6 months of expenses in savings. Owning a house means you will have to maintain everything on your own. If something essential breaks down, you will have to pay to fix it. In this area, I would recommend having at least ~$10,000 in savings for unplanned emergencies if you own a home. If you’re in the process of paying off debt, I would recommend keeping a much smaller emergency fund until the debt is paid off.
How much do you have saved for a down payment?
Ideally, you want to have at least 20% saved for a down payment on a house. However, in this area and other high cost-of-living areas, that can feel like an impossible amount. Not having 20% doesn’t mean you won’t be able to buy. Just expect to pay some form of PMI though (private mortgage insurance). PMI protects the lender in case you default, but you have to pay the premiums. I would shoot for at least a 5% down payment or more, if possible.
How long do you plan to stay?
If you’re only planning to stay in your area for a few years, renting may be the better option. The break-even point depends on a bunch of factors, but historically, it takes about 4-5 years of living in the same place before buying becomes cheaper than renting. It’s a bit shorter now with interest rates being at historic lows. If you’re planning to stay for 3 years or less, I would probably recommend renting. Some people tell me they plan to rent out their place if they move. Unless you’ve been a landlord before, I wouldn’t recommend this plan, especially if you are moving far away. Being a long-distance landlord can be a headache if you’ve never done it before.
What is your price range?
If you’re looking to move to a place closer to the city, prices can be very high and you may end up being “house poor” by spending a huge portion of your take-home pay on housing. That’s no fun. Make sure your monthly “PITI” payment (principal, insurance, taxes, insurance) is reasonable. Dave Ramsey recommends your housing payment be less than 25% of your take-home pay for a 15-year mortgage. I know that seems unreasonable to a lot of people, especially in high cost-of-living areas like D.C. Just make sure you are comfortable with what you are paying for housing.
Consider selling costs.
You’ll have to pay closing costs when you buy a home, but many people don’t know that you don’t have to pay anything to the agent that’s representing you when you buy a home. That’s because the seller pays both sides of the commission. In fact, many agents (including myself), when representing buyers, give money back to the buyer as a rebate at closing. On the flip side, the costs of selling a home is something most buyers don’t consider. Typically, it’ll cost about 4.5-6% of the sales price to sell your house. If your home sells for $300,000, that can be about $18,000 that you’ll have to pay in commissions at settlement. Make sure to factor that in if you choose to buy.
What tax deductions can you take?
If you own a home, you will be able to deduct mortgage interest that you pay as well as property taxes. This can save you a good deal of money at tax time, but I wouldn’t recommend keeping a mortgage around if you can pay it off just so you can get a tax deduction.
What are closing costs and how much are they?
When you buy a home, you’ll have to pay closing costs. This pays for title insurance, government recording fees, lender fees, payment to the settlement agent, escrows for taxes and insurance, and other miscellaneous fees. In my area, this tends to be about 2-3% of the sales price or around $5,000-$10,000 in most cases. It might be more or less depending on the state you live in and the price of your home.
Other factors?
There are many other factors that I haven’t discussed in detail above like mortgage rates, schools, distance to work, forecast for growth in the area, etc. Buying a home is a big decision, and it may or may not be the right decision for you at this point in your life. Ask lots of questions and do your research. A lot of people will give you advice. Consider their advice, but decide for yourself what path you will take.
If you have any further questions about real estate, feel free to contact me at either mrfrugalee@gmail.com or at my real estate email: realtordannylee@gmail.com. I am a licensed realtor in Virginia.
Very helpful post. With both rent and home prices being so high here in New York, it always feels like I’m stuck between a rock and a hard place on this question.
Thanks. It’s usually much easier to buy in places like the Midwest where housing is more affordable. There is a big barrier to buying in cities like NYC, SF, LA, and DC. It’s possible, but much more difficult unless you’re ok living in the suburbs.
Well, this is a great article and if you go to any parties, church, or any other social gathering of young adults the mentality is buy, buy, buy and if you aren’t, why not? Well, if you look the views of some like Warren Buffett or Robert Shiller, Nobel prize winning economist and co-originator of the Case-Shiller housing index, housing is like having a kid and not really a great investment over the long term. People especially vastly underestimate the costs of maintenance, repair, renovations and rarely factor them into any calculations on gain.
They just oh, wow, my neighbor bought his house of $300k 15 years ago and now it’s $1m! Well, that doesn’t always happen and also the amount of money he put into the house, whether interest, renovations, taxes, maintenance, will dramatically cut into that apparently $700k gain. Plus stocks and mutual funds return more over the long term. HOWEVER if you just spend any extra money you might have from renting on cars, watches, and other rapidly depreciating consumer items, yes, you might as well buy. People need to think and not just follow the herd however in buying.