Renting vs Buying: Wasted Money or a Smart Decision?
Renting is more common than ever. Millennials are considerably more likely to rent than their parents and grandparents, but this isn’t always about personal preference and in many cases, they are forced into making that decision because they can’t afford to buy a house.
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But that doesn’t apply to everyone. There are many renters who are perfectly happy with their situation and choose to rent even though they have the money and the means to buy. They have done their sums, looked and the pros and cons, and determined that renting is better suited for their needs.
As strange as this may seem in an age where everyone seems to be saving for a home, there are actually many reasons why you may choose renting over buying. In this guide, we’ll take a closer look at the pros and cons of both options.
Choosing Renting Over Buying
Renting is often seen as “throwing money away”. After all, you could be putting that money to good use in growing your net worth and acquiring an asset. But there are many benefits to renting that you just don’t get when you buy your own home.
You’re Not Wasting as Much as You Think
Many consumers misunderstand how mortgages work and falsely believe that every penny spent on rent is a penny wasted. As a result, they rush into buying a home, knowing that doing so will mean the money they once spent on rent now goes towards a mortgage. It makes sense—rent goes towards growing the landlord’s assets while a mortgage goes towards yours.
But it doesn’t quite work that way. Let’s imagine that you have two options:
- Option 1: Accept a higher rate and poorer terms to buy a $185,000 house right now and focus on mortgage payments instead of rent.
- Option 2: Pay $1,000 monthly rent for two more years as you rebuild your credit score and acquire better terms.
In two years, you will have repaid an additional $24,000 in rent, which could make a significant impact on your mortgage. But it’s not that cut and dry.
Firstly, your mortgage is structured so that most of your payments go towards interest for the first few years. If you have a monthly payment of $1,000 on a 30-year mortgage, just 22%, or $220, goes towards the principal. Once you factor insurance and taxes into the equation, as little as 15% of your monthly payment may go towards clearing the principal.
This means that rather than clearing $24,000 off your $300,000 debt, it clears closer to $4,000. If you wait for 2 years and improve your savings to the point where you have a $15,000 larger down payment and are offered a 1.5% lower interest rate, you could save in excess of $25,000.
So, while mortgage payments are better than rent payments, it’s always worth waiting until your credit score is higher and your finances are stronger.
You Have Somewhere to Live
If you book a hotel room while on vacation, are you wasting your money on something that is unnecessary? Of course not. You’re spending money on a service that provides you with a place to stay for as long as you need.
It’s a similar story with renting. It’s not wasted money because you have a place to stay.
The money may not directly improve your net worth, but it does have an indirect effect. Renting can provide you with a comfortable place to stay, one that may reduce your commute to work or school, improve your social life, arouse your creativity and increase your chances of getting your dream job.
All these things can improve your net worth much more than living with your parents or sleeping on a friend’s sofa.
Rent should never be seen as wasted money but as a necessary expense. Unless, that is, you’re renting a place in the middle of nowhere, far away from work, school, opportunity, and friends, in which case it’s time to consider a move!
Buying Isn’t the Best Investment
It is often said that the best way to invest your money is to get it into bricks and mortar. There is some truth to this and if you buy a property to renovate and rent, it’s one of the best ways to invest. Not only are you significantly increasing the value of the home, but you’re earning a steady stream of money and can keep those funds coming until you’re ready to sell and cash in.
However, if you’re buying a home to live in and you’re using a substantial debt to do so, it’s not the best investment. Contrary to popular belief, residential properties barely outpace inflation over the long term. What’s more, when you acquire a home using a mortgage, you’re assuming a debt that will last for decades and coast you substantially more than the value of the property.
If you buy a $250,000 home with a $200,000 mortgage spread over 30-years, you could pay in excess of $340,000 over the term. Even if the price doubles in that time, your profit will only be $60,000, which isn’t great for a 30-year investment.
In fact, if you put that $50,000 into a savings account instead of a home and you add $1,000 a month to that account (roughly the same as you would pay for a mortgage) you would generate over $170,000 in interest during the same period (based on a 2% APR). On top of that, you would have contributed $360,000, which means you’d have in excess of $580,000.
Of course, it’s not feasible to invest so much money into a savings account, but this gives you an idea of how poor of an investment a home can be. As far as investments go, stocks tend to perform much better and over the last 75 years, they have paid dividends averaging 11% a year.
There are many reasons to buy a home but making money isn’t one of them.
You Have Fewer Responsibilities
When you own your home, it’s your job to mow the lawn, maintain the property, and deal with any issues that arise. If there is a natural disaster of any kind and the insurance company refuses to pay up, you’re the one who foots the bill and could suffer financial ruin as a result.
If you rent, however, none of this matters. You will still be required to perform basic maintenance, but you’re not the one whose life is ruined if there is a disaster and your bank account won’t suffer if major repairs are needed.
If the house begins to fall apart, the owner will need to roll up their sleeves, get their hands dirty and prepare their checkbook; the renter can simply search for another home.
You’re Not Tied Down
One of the reasons renting is more common than ever is that there are more freelancers and self-employed individuals than ever before. All these individuals have a certain sense of freedom that simply wasn’t available to their parents or grandparents. They can uproot their lives and move on a whim, taking their work with them wherever they go and choosing to live everywhere from Portland to Poland.
If you buy a house, you’re making a commitment that ties you to a specific place. You can still sell the house and move but doing so requires an extensive and stressful process; if the market is slow, it could stall your plans to a point where they are no longer viable.
As an example, let’s imagine that you’re a self-employed writer, designer, developer or artist working out of Houston, Texas. You work with clients all over the world, earn a steady pay, and don’t have a spouse or partner to spend money on. One day, you receive an offer from a client in Australia, Germany or the UK, offering you the move of a lifetime for the job of a lifetime.
If you’re renting, you can move in a heartbeat. You don’t need a lot of savings behind you and if things don’t work out, you can just reconnect with your old clients from wherever you end up. However, if all your money is tied up in a house, you will need to spend weeks and even months selling it before you can move. By this time, the opportunity may have gone.
Debt is Debt
In the past, we’ve discussed how you can acquire both good debt and bad debt, with the difference defined by whether or not the debt grows your net worth. A mortgage is good debt, as it gives you a sizeable asset against which future debts can be levied. However, it’s still debt, and a big one at that.
A mortgage is a massive responsibility that you could be repaying for the next few decades. It will impact your credit score (albeit only slightly) and your debt-to-income ratio and it will take a sizeable chunk of your money every month. Of course, rent will also take a lot of your monthly income, but typically you’ll pay a lot less as there are fewer obligations.
Choosing Buying Over Renting
Ultimately, the majority of you will prefer buying over renting, and it’s easy to see why. For the majority of families and young couples, it’s the best option. But only if they can actually afford it and don’t need to take drastic measures just to make it happen.
Here are just a few of the reasons why buying is better than renting.
You Have More Say
Renters are forced to abide by strict rules and regulations in their own homes. They need permission before they make any minor changes and they can’t make any significant renovations or upgrades. When you buy, however, you have complete control and can do what you want, within reason.
You don’t need permission from someone just because you want to buy a new carpet, paint the walls or knock down a partition wall. Many renters feel like they’re staying in long-term hotels, forced to abide by the terms of their landlords, prevented from adding their own stamp on their home and even from having pets. This can be very frustrating and if it’s something you’ve lived with for years then owning your home can be life-changing.
You Can Add Value to the Home
If you have been renting the same house for years and have just added a new member to your growing family, you can look into building an extension. Not only will this make your home more livable in the short-term, but it will also improve its value over the long-term. What’s more, all capital home improvements are tax-deductible, although you can’t benefit from this until you sell.
Your home is your most prized asset and you can invest your disposable income into improving it. Whether you’re adding new rooms, renovating the basement, installing a home cinema or adding stables on the property, there are endless opportunities and countless dreams and lifetime wishes to fulfill.
You Can Improve the Energy Efficiency
Tired of over-paying on your energy bills? When you buy your own home, you can upgrade the energy efficiency at will, adding insulation, solar panels, and improving air conditioning to increase its energy rating and decrease those monthly costs.
Of course, it’s a long way to way just to save a few dollars a month, but over a decade or two those savings could be massive and those upgrades will also add value to the property and future-proof it.
To take things to the next level, you can modernize the home as well, adding smart lights, thermostats, and more, turning your home into a high-tech dream.
The average rental agreement lasts for just one year and many Americans are tied into month-to-month contracts. If the landlord decides to sell the property from under you or they simply want someone else to move in, you won’t have much say.
You could be forced to move to a new property in just a few weeks, uprooting you and your family and causing all kinds of stress in the process.
What do you do if this occurs during a difficult time, such as a period of prolonged illness or unemployment? The stress and pressure will make your situation much worse and you may struggle to find a suitable alternative living space.
When you rent, you’re also more susceptible to losing everything. The majority of Americans under the age of 40 have just a few thousand dollars in savings and no sizeable assets to speak of. If they’re renting and they suddenly lose their job and are hit with substantial medical bills, they may be forced into bankruptcy and could struggle to keep a roof over their heads.
Very few loan providers are interested in lending to individuals with low debt-to-income ratios and no assets. However, it’s a different story for homeowners. Even if you don’t have a job you still have a sizeable share of a massive asset, which means loans and credit cards are more readily available and can help to dig you out of a hole.
If you have been repaying your mortgage for several years you may also have enough equity to acquire a cash-out mortgage, home equity loan or home equity line of credit.
Less Stress and Moving Costs
Even if life is kind to you and you don’t suffer from bouts of illness or unemployment, its still a hassle when you’re forced to move around a lot. Every new home brings a new upheaval.
You have to pay moving costs, request favors from friends and family, take time off work, and deal with all the issues that come with moving home (new phone and internet connections, address changes, mail redirection).
It’s also very expensive to live like this. Not only do you need to pay moving companies, but you may also be forced to buy new furniture when old pieces no longer fit in your new residence.
It Makes you More Sensible
Homeowners are more likely to save money for a rainy day. It’s believed that owning a home adds a certain degree of responsibility that simply isn’t there when you’re renting and living without responsibility.
Every mortgage lender has the benefits of an emergency fund drummed into them from the moment they start looking for a home loan. It’s something we have discussed many times as well (see Saving for a Down Payment and the Real Costs of Moving).
An emergency fund is important as it covers you against unforeseen health or employment issues and can even be used to clear debt.
Summary: Choose Carefully
Renting is not fundamentally bad or wrong; buying is not always the best option. It’s important to consider both options closely and to weigh them against your personal situation before making your decision. Don’t rush into the decision as doing so could lead to costly mistakes.
Take your time, consider each option carefully, discuss them with your partner, children, and friends, and if you’re not sure right now, give it a few months or years and wait until you are.
In most cases, renting will be the best option for self-employed individuals small business owners, singletons, and couples without children. They benefit the most from the freedom that renting provides and don’t necessarily need the security or want the responsibility that owning a home can bring.
Couples with children and stable jobs, however, should look into buying a home. Age doesn’t really come into it. On the one hand, younger is better as it gives you more time to repay your mortgage and enjoy the benefits that it brings. On the other hand, you shouldn’t feel like you need to rush just because you’re in your forties or fifties and are still renting.