Should I rent or buy a house?
Is it better to rent or to buy a house?
Mana’s thoughts on one of the biggest financial decisions you’ll ever make.
For decades, becoming a homeowner was synonymous with “making it” in America. At the end of the first quarter of 2020, US Homeownership rate rose to 65.3%, driven by increasing demand due to decreasing mortgage interest rates, as well as people spending a lot more time at home (and thinking hard about whether they enjoy their home). As people contemplate how they want to live during this pandemic, we thought this would be an opportune time to revisit a topic many of our clients are contemplating at this very moment: should we continue to rent? Or is now the time to buy a house?
Similar to an investment strategy, the question of buying or renting is a highly personal one. Over the past few months, many of our clients have asked us to help them decide between buying or continuing to rent. This question becomes even more important if you live in an expensive city where your monthly rent or mortgage payment could equal over half of your take home pay. If you’re in the market to buy a house, we want to arm you with the knowledge you need to make an informed decision. A recent survey showed that 63% of millennial homeowners regret their first home purchase - 63%! We don’t want you to be part of this statistic, so we’ll lay out both the macro and micro arguments to help you make the decision whether buying or renting is best for you right now.
The decision on whether to buy or rent boils down to way more than just the numbers...
The answer to whether you should buy or rent depends on your current lifestyle, your future lifestyle goals, your job security, and how long you plan on living in your new home.
If you have inconsistent earnings, a not-so-good credit score, a job that could relocate you, or you have a dream to spend a year traveling around the world or retire early - then it probably isn’t the right time to buy a house. Alternatively, if you’ve decided that the city or town you live in is one you want to put roots down in, where rent is pricey, and you have sufficient savings beyond your emergency and retirement funds, then it could be a good idea to consider buying.
Let’s first discuss all the reasons why you should continue renting.
REASONS FOR RENTING A HOME
Flexibility and freedom: Imagine a big life event - like going back to grad school, moving for a job, getting married, starting a family - that may require you to pack up and move to another city. Moving only a year or two into paying down your mortgage could cost you tens of thousands more than renting. You may be saving for the day when you can pack up and take off traveling around the world for a year (post Covid, of course). If you’re a renter vs an owner, it is much easier to break a lease or wait until a year-long lease expires than it is to sell a house.
Avoiding the costs of homeownership: Apartment owners escape many of the costs associated with homeownership. If you buy a house, in the first year you’ll have to fork up a hefty downpayment (we recommend 20% of the value) plus closing costs. Additionally, in the first year and every year thereafter, you’ll pay mortgage interest, annual property taxes and any costs needed to maintain your home...which can all add up. The median home price in California today is $578,267. If you were buying a home in California and put 20% down, you’d have to have $115,655 saved for the down payment. If you don't save enough for a 20% down payment, your lender will require you to make mortgage insurance payments (also known as Private Mortgage Insurance or PMI), which will make your monthly payments even more costly. If your sink springs a leak as a renter, you simply call your landlord who will pay for a plumber. If your sink springs a leak as an owner, it’s both your financial and personal responsibility (remember, your time is valuable!). And finally, if you live in a gated community or condo complex, the owner - not the renter - is on the hook for things like Homeowner’s Association dues.
Owning a bigger house just a few years in the future: If you’re actively saving for your down payment to buy a house and the monthly payment is no issue, what would waiting 1-3 years longer do for your home purchase? Instead of purchasing a “starter home”, you could use the money saved by renting to build a bigger down payment and/or funds to renovate to create your dream home instead. Taking a pause to imagine and plan this kind of scenario can be a useful exercise.
More money to invest for your future self: How much could that $115,655 grow if invested over the next twenty, thirty, or forty years? Without a big downpayment to save for, you could put away more for your future - like in retirement. Better yet, investing the difference between your annual expenses of buying versus renting could enable you to retire even earlier. In fact, according to research released in June of 2020 from Florida Atlantic University, renting and reinvesting the savings from renting, will outperform owning and building home equity in terms of wealth creation.
If any or all these reasons build a strong enough case for you not to buy, then it might make more sense to keep on renting. However, there are just as many compelling reasons why it could be a great idea to buy a house instead of renting. Next, we’ll present those for you to consider.
REASONS FOR BUYING A HOME
Home is where the heart is:. Achieving homeownership is a traditional step on the ladder of personal fulfilment and life accomplishments. Many homeowners are proud to acquire a valuable asset to fill with memories and pass down to their children someday. For others, owning a home can signify ultimate stability. My childhood was filled with impermanence. After my biological father left us, my mom, sister and I bounced around motels and temporary housing - sometimes spending nights in our van when money ran extremely low. For me, buying a house signified a place to plant roots that never had the chance to be planted before. It was the first step towards my vision for financial freedom, and so for me, it was well worth the cost. Although buying “just for the sake of buying” is not shown to be a good approach, research supports the idea that planning your vision of homeownership carefully before you achieve it has positive psychological benefits.
An investment you can live in: Some people think of their home as both an investment for their future and a place to settle and feel comfort in. If the value of your home increases and amounts to more than you’ve paid in mortgage, interest, taxes, and maintenance over time, you’ve earned a return on your investment.
Ownership: One of the best benefits to home ownership is that you pay off your home, it’s yours! If you have the resources to take on a 15-year fixed rate mortgage, you could own your home free and clear in that short period. You could save tens of thousands of dollars with a 15-year mortgage over a 30-year mortgage. How would it feel to have no monthly housing payment after 15 years?
The possibility of a future income source: Let’s say you purchase your home, live in it for five or more years, and then move out because you need more space or you’re moving to a new city. If you don’t need to sell your home just yet, you could explore renting out your home for either the short- or long- term to create an additional stream of income. Depending on the state of the rental market at that time, you may be able to use that rent to pay most - if not all - of your mortgage payments. Remember to seek professional tax advice before you make this decision. Once your first home isn’t your primary residence anymore, it will be treated differently when it comes to taxes.
Reduction of your tax bill: If you are a high income earner and want to create more deductions, various tax breaks help offset some of the cost of homeownership. However, some of these lost some of their luster in the Tax Cuts and Jobs Act of 2017 (read the next section for more details).
California specific long term hold + intergenerational benefits: In California, there are several Propositions that exist to provide preferential tax treatment to homeowners. In the late 1970s, hyperinflation was causing home prices to increase so significantly (50-100%+ year over year) that individuals were unable to pay their property tax bills at the higher valuations. Proposition 13 was passed in 1978 and limits the amount that the property tax assessment can increase on an annual basis to 2%. Proposition 8 was passed the same year and allows for reassessment of property values in a declining market. Lastly, Proposition 58 & 193 permits parents and grandparents to pass on property to their kids when they die without a tax reassessment at an unlimited property value assessment for their primary residence and up to $1 million for other real property.
REASONS FOR BUYING… A LESS EXPENSIVE HOME
If after you’ve read all this, buying a home is still in your future, we wanted to bring up a point that has recently become an important consideration for many of our clients, especially as they contemplate life during and after the pandemic: buying a less expensive house for more freedom in the future.
In Mana’s financial life plan process, we talk about our client’s short- and long- term goals, and we’d encourage you to think above and beyond your goal of home ownership when it comes to deciding how much house you want to buy.
In a recent financial life plan, we presented a client with two different scenarios:
Scenario 1: They buy the $1.5mm house very much in their range of affordability
Scenario 2: They buy a $750,000 house and invest the difference
The Result?
This couple also had dreams of being able to choose whether they worked (or not) come age 55. In our plan, we showed them how buying the $750,000 home and investing the difference in a diversified global portfolio of stock and bonds growing at a reasonable rate of 5% each year would enable them to retire eight years earlier.
REASONS FOR BUYING… NON TRADITIONALLY
Aspiring homeowners always ask us: should I/we buy our primary residence first? Or does it ever make sense to buy your second home or vacation property to generate income first?
Like all answers in financial planning, our answer is it depends. But it’s safe to say that, in several cases over the past year, we’ve analyzed a client’s situation in which it does make more sense to buy a second home, rent that home out, and wait a few years to purchase the primary residence.
When it comes to home buying, I hope it’s been clearly stated: the right answer for you won't’ be the right answer for everyone. And sometimes, it is a financially wiser decision to eschew conventional wisdom.
READY TO MOVE FORWARD? RUN YOUR NUMBERS.
Now that you understand the fundamentals of the “buy vs rent” argument, you’ll want to work through your personal situation and evaluate if the numbers make the most sense for you. If you’re a Mana client, we work with you to arrive at your own personalized analysis.
If you do decide that buying a home is in your future, be sure that you have all or most of the following:
Excellent credit - that means a score of 750 or more. An excellent credit score is essential to getting the best mortgage terms. In other words, better credit will save you money.
A steady income - if you don’t have a reliable source of income, lenders will be less willing to take the risk of lending you money and may penalize you with a higher interest rate loan if you do qualify.
A downpayment of 20% or more - PMI will add extra, non tax-deductible costs to your monthly mortgage payment.
An Emergency Fund of at least 6 months of expenses - Saving for a down payment shouldn’t come at the risk of not having this cushion of cash (especially during uncertain times like these).
A monthly mortgage payment that’s 30% or less of your take home pay - To minimize regret, your target should be a mortgage payment you can handle. And don’t forget about the continued monthly savings you’ll need for maintenance and repairs which you’ll be responsible for. It’s a good idea to plan to spend anywhere between 1-3% of your home’s purchase price each year in home maintenance and repairs.
A plan to stay in your house for at least 5 years. The upfront costs - inspectors, realtors, closing costs, moving, furnishing - will inevitably equate to more than renting would cost in the first few years of homeownership. However, if you annualize those costs and spread them out over the number of years you stay in a home, the more it makes sense to buy. Plus, the longer you stay, the more your monthly payments will be going to paying down your mortgage debt (instead of paying for interest).
If you’d like to buy a house and meet this criteria, congratulations - you’re well on your way to becoming a homeowner! If not, don’t worry - it may be a wise decision not to buy. Wherever you’re headed, creating a long-term plan, understanding the details and mapping out the steps to get there is a sure path to get you there sooner and keep you happier on the journey.
Stephanie Bucko and Cristina Livadary are fee-only financial planners based in Los Angeles, California. Stephanie is the Chief Investment Officer and Cristina is the Chief Executive Officer at Mana Financial Life Design (FLD). Mana FLD provides comprehensive financial planning and investment management services to help clients grow and protect their wealth throughout life’s journey. Mana FLD specializes in advising ambitious professionals who seek financial knowledge and want to implement creative budgeting, savings, proactive planning and powerful investment strategies. As fee-only fiduciaries and independent financial advisors, Stephanie and Cristina never receive commission of any kind. Stephanie and Cristina are legally bound by their certifications to provide unbiased and trustworthy financial advice.