People downsize their homes for a variety of reasons. The pros and cons of renting vs buying will vary with your own personal circumstances. When it comes to this debate, there are no pat answers. Therefore, it is not possible for me (or anyone else) to responsibly offer pat advice to a wide audience. What I can do is point out some of the obvious (and not so obvious) considerations. I’m hoping that this will help clarify the decision-making process.
Full disclosure: I currently live about 20 miles north of New York City. My advice is almost certainly influenced by the market I work in as a ®Realtor. The general advice given will likely be most applicable to people planning to settle in similar cultural/employment hubs. I will differentiate between different market types. But readers should understand the context from which I am writing.
Reasons for renting…
Having watched the rental rollercoaster in my area displace thousands of families, I have to say that I tend to go against prevailing wisdom. For various reasons, many talking heads are extolling the virtues and “freedom” that comes with renting. From where I am sitting, this is bunk. Renting long term can become a ball and chain that can ruin your financial life as rents continue to skyrocket. That’s my opinion and I’m sticking with it.
As an agent, I get calls almost every day from desperate renters who are facing double-digit rental increases every.single.year. When I started in real estate 12 years ago, you could get a nice studio for about $1000 a month. I now see studios renting for $2300 a month. That’s over a 100% increase in a little over 10 years. Just ask yourself if your income has gone up over 100% in this time? This is a huge problem which has now reached crisis levels. The displacement is such that it is locking many moderate-income families out the biggest employment hubs in the world. This type of market provides no stability or security. I always tell potential renters that the new “freedom” found in renting might well become a bear trap that costs so much money, it eats away their ability to save for a downpayment.
Most downsizers are trying to create more affordability and stability, not turn their yearly outlay for shelter into a crapshoot.
There are, however, a few circumstances where renting makes more sense…
You can’t afford a down payment…
This is pretty obvious. If you don’t have the capital for a downpayment, you are not going to be able to buy a home. However, if rents are ridiculously high, you might consider crunching the numbers on a low down payment option.
You are not planning to stay in the same location for more than 5 years…
The buying and selling process is no bargain. Commissions, taxes, moving costs, renovations etc…it all costs money. Appreciation and paying down the loan usually doesn’t fully kick in to offset these costs for a few years. Further, you are far more vulnerable to general market gyrations over the short term than over the long haul. That’s why there is a general rule you are not planning to stay in the same location for at least 5 years, you are usually better off renting.
You need to work on credit repair before being able to purchase a home…
In times when jobs have become “gigs” and maintaining health insurance is close to the national debt, many of us will have credit woes at some point in our lives. My suggestion, in this case, is to rent with the bare minimum of space and amenities. Keep that overhead as low as possible so you can pare down debt and increase your credit. This will take TIME, but if you are careful with your money and pay things down in an orderly way, you will be well on your way to a more secure life in a few years. Be patient, but take good care of your situation.
You are moving to a new location and are not certain that you will stay…
This is a situation when renting always makes more sense than buying. You need to get to know an area in order to make the best possible purchasing decision for your needs. Further, if you find that you made a mistake in your location choice, extricating yourself is much simpler.
Reasons for buying…
When looking at the pros and cons of buying vs renting, there are far more pros to buying than cons. Deciding to buy a home is not something to be undertaken lightly. Since the housing crisis of 2008, I will say that most people (at least in the market that I serve) take that purchase very seriously. In fact, in many cases, people actually hesitate for too long. They don’t realize that while they wait, prices or interest rates are rising and their purchasing power is diminishing. The notion of the frantic buyer offering almost any price to snag that home is something we left behind with the crash of 2008.
Here are the main reasons why I feel that for the long-term, purchasing a home beats renting hands down.
Keeping a roof over your head is not an optional expense…
Let’s face it unless you are living in your parent’s basement, keeping a roof over your head is not optional. Shelter is a necessity that only the desperately poor give up on, and they don’t do so voluntarily.
If you are paying $2000/month in rent, that’s $24,000/year. In a little over 4 years, that’s $100,000 In 10 years (assuming your rent hasn’t increased) that’s $240,000. With that kind of monthly expense, isn’t it better to be building a nest-egg from some of that money instead of throwing it all out the window? The fact is that the only person getting rich from your rental payment is your landlord.
The rental market is very volatile and unpredictable…
As previously stated, rents in many major employment hubs are rising rapidly and show no signs of slowing. As older but quiet neighborhoods become gentrified, that stable rent you thought you could count on can go up at double-digit rates year after year. You can not rely on your rental rate remaining reasonably stable.
In many markets, it actually costs less to own…
Over the past year, I did some stats that compared owning a co-op over renting an apartment of similar size. Here is a link to the original post. In our market, there is no doubt that buying beats renting. The infographic posted shows the comparison and what general parameters I used to crunch the numbers. Purchasing beat renting by almost 100% in terms of monthly outlay. So, in this case, there is little doubt as to what is cost-effective month-to-month. A person who owns a 1 BR co-op comes out ahead of someone renting a comparable unit by over $120,000 in about five years time. That’s not chump change.
This was in good part due to how ridiculously expense renting has become. At the time of the housing crisis, the talking heads started touting renting as the cure to all that ailed homeowners. “Set yourself free!”, “Get rid of the ball and chain of homeownership!” But many of these were the same interests that were promoting 0% downpayment loans and negative amortization products in the period leading up to the crash. When “spin” finds its way into the public collective, there is almost always a vested interest involved. I try not to engage in “group-think”. The origins of such trends generally have one goal in mind. Usually, this involves getting you to buy into something that lines someone else’s pockets.
Just as I told homebuyers to avoid loan products that were too good to be true in 2007, I tell potential renters that the new “freedom” found in renting might well be a money pit that destroys their ability to save for a downpayment.
Amortization of your loan builds wealth…
If you are thinking of buying a home, condo or co-op, an amortization calculator is your best friend. Every month, when you pay your mortgage, you are paying off some of the principal of the loan debt. That amount changes over time, but you can easily calculate how much of the loan you are paying down. But looking at the yearly amortization can be instructive. In the infographic example, the co-op cost $150,000, and the loan amount was for $120,000. This resulted in $11,500 in amortization over 5 years time.
Appreciation averages out to about 3% a year in the US…
Granted, if you buy at the top of a market, your home value could go down. But if you are in it for the long term, that’s just a “paper loss”. Popular locations tend to be very resilient. For the most part, the typical appreciation for real estate in the US is north of 3%. When doing this calculation, I tend to keep the number at 3% to be conservative.
In the infographic example, if you calculate appreciation at 3%, you come up with $24,000 over 5 years. This, of course, can vary in two major ways.
- Real estate does tend to be cyclical. But real estate is a long-term investment, it’s not like trading stocks.
- Real estate is also location driven. In popular locations near cultural and employment hubs, 3% is very conservative But if you are living in a very depressed area where there are no job opportunities or cultural draws, you may be facing a continuous decline in value.
Homeownership builds wealth…
The above is the example of the hypothetical profit on a $250,000 home bought with a standard 80% loan. After five years you would have $48,250 more in equity and $15,700 in amortization. That’s $63,500 in wealth that you couldn’t build from a rental. Further, in many cases, the monthly outlay is less with a condo than it is with a rental.
Stability, stability, stability!
Rents are rising in major metropolitan hubs at an alarming rate. Owning your own home, even if it is just a studio co-op, stabilizes your outlay. When you rent, your outlay is determined by your landlord. Your landlord will be certain to extract as much money from you as he/she can. This means your outlay is extremely volatile.
When you own your own home, there are several factors that contribute to your outlay. They are not as volatile as rent.
The largest chunk of your outlay is usually your mortgage. If you get a fixed rate loan, that amount will not change no matter what other inflationary forces are out there. When I created this infographic, people could still get loans at 4% interest. This translated to $570/month at that time.
In the case of our co-op, the property taxes and maintenance were rolled into one fee. This is the way it is calculated in cooperatives. In any case, the taxes comprised 50% of the co-op monthly, so they were $365/month.
For people living in the US, most property taxes are strictly local. Sometimes you will have village and town taxes. These can vary wildly from town to town, so make sure you know what municipality you are paying taxes to. It can be confusing, which is one of many reasons why you should have a buyer’s agent if you are purchasing. For people living outside the US, I don’t have the knowledge base to inform you well. Do your due diligence and make sure you understand which hands will be in your pockets and for how much.
These apply to co-ops and condos, however, most single-family homeowners should definitely set aside a similar proportion of money for repairs and the unexpected! In this case, we are talking about $365/month.
In this example, the bottom line is that 44% of your outlay is rock-solid stable. It can not go up unless you change the terms of the loan. This still allows you to take advantage of lower interest rates when they are available but offers total stability for the life of the loan. This is huge given the relentless increases in rent over the past 10 years.
As for taxes and maintenance, these do go up over time, but not at the rate that rental outlay has. You can get some handle on this situation by taking a look at the history of the building and its maintenance fees. Your real estate agent can help you there. The same can be said for property taxes. This is public record and you can easily find out whether the municipality you are interested in has a history of unstable tax rates.
At the end of the day, you have more control over outlay in a place that you own.
Crunching the numbers – checklist…
I: Pick a location or a couple of potential locations for your purchase or rental.
II: Understand what the median rental rates are for whatever type of housing you are considering.
- Get the monthly rental rate.
- Make sure you understand all the potential fees which can really add up. These include extra for parking, common space use, storage, pet fees.
- Make sure you understand clearly what is included in the rent. Having to pay for your own heat, hot water and electricity can change the affordability considerably.
- Be sure to include an outlay for renters insurance. This is not expensive, but be aware that you need it.
III: Get your arms around what it will cost to own a home and whether you qualify for a home loan.
- Find out what your monthly loan payment is. You won’t get an exact number before locking down the loan, but a good lender will get you very close. Do not skip this step. It will save you a lot of time and heartache.
- Find out what the property tax bite is.
- Check the history of tax rates in the municipality. Make sure the area isn’t prone to unexpected spikes in rates. If they are, calculate how workable that is.
- Check with an insurer about what homeowners insurance will cost you.
- Make sure that you set aside a monthly fund for unexpected repairs.
- Get a ballpark as to what gas and electricity costs are going to be.
- If you are buying a condo or co-op, make sure you understand all the fees including maintenance, parking, pet fees etc.
- When purchasing a condo or co-op determine what is included in terms of heat, hot water, electricity? These can differ from complex to complex.
When talking about the pros and cons of renting vs buying, there is a great deal to unpack.
Yes, I’m big on owning your own home, even if it is just a studio. Since most of the talking heads out there are extolling the virtues of renting, my views will probably offer a better balance if nothing else.
In any case, smaller is often better. One of the main goals of many downsizers is to make the most of a smaller space in exchange for keeping the amenities that a prime location offers. So don’t be disappointed if your downsize is tighter in terms of physical space then you would have preferred.
In all things, you must be comfortable with your decision. If you are at all uncertain about remaining in a given location, then you should rent and get to know the area before committing to a purchase.
If you have any questions, about this process, feel free to email me at RGHicks@downsizingup.com. I’ve been a ®Realtor for quite a while and have seen many different situations and scenarios.
It’s not just you: 5 signs rent is totally out of control…
Skyrocketing rents make mortgages more attractive…
Rental rates soar by double digits in half of Canada’s largest cities…Residential rents continue to skyrocket in Ireland…
Wild rent hikes are leaving Europe’s cities totally unaffordable…
The global housing crisis…
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