Should I buy? Or should I rent?
If you are considering the purchase of a house or condominium, your individual needs and situation will ultimately determine the best decision for you.
Because buying a house or condominium is one of the most significant financial commitments most people make in their lifetimes, it is important to make this decision carefully and with the most accurate information.
In our experience, however, prospective buyers often receive biased or incomplete advice. Many of the claimed benefits of buying a house or condominium are exaggerated, incomplete, or in error.
Make a careful decision. Make the correct decision.
We have compiled information and perspectives that we think should be considered by every potential buyer, utilizing reputable and verifiable sources. While the purchase of a house or condominium may make sense for you at some point in the future, it may not make sense now given your current plans and ambitions.
Home ownership is more expensive than renting; not a great investment; and a long-term commitment that lessens your freedom and flexibility.
Renting allows for greater freedom and flexibility. Your best choice may be to “Rent your home, own your life.”™
Home ownership is likely more expensive than you think.
Home ownership is more costly than you probably realize. Most calculations of the costs of owning focus on the payment of principal, interest, taxes, and insurance (PITI), ignoring or downplaying other expenses associated with owning a home. An appropriate comparison of the costs of owning and renting should include much more, as follows:
Utilities: As a renter, you likely do not separately pay for most of your utilities. From your rent, the landlord may pay for heat, water, and rubbish removal. When you purchase, you will need to pay directly the significant costs of these services.
Repair and Maintenance: As part of your rent, your landlord provides you with repair and maintenance services, including lawn mowing, landscaping, snow removal, painting, plumbing repairs, and electrical repairs. If you buy, you might perform some of this work by yourself, but your time has value. If you choose not to perform this work, you will need to hire someone, at an additional cost.
Major Costs: Nothing lasts forever. If you are renting, a broken refrigerator is your landlord’s expense and problem. Once you buy, that expense and problem is yours. Homes need a lot of upkeep. A homeowner should plan on periodic significant outlays for carpet, tile, appliances, water heaters, furnaces, washers, dryers, roofs, siding, windows, concrete, etc. You should expect that these costs will total about 2% of value annually, or $4,000 per year with a $200,000 home.
Mortgage Insurance: With a down payment of less than 20%, you will typically need to pay for mortgage insurance. This insurance usually includes an upfront payment (0.50-2.25% of the loan amount) plus an annual premium of about 0.50% of the outstanding loan amount.
Condominium Dues and Assessments: If you are buying a condominium, you will also need to pay association dues, which are often quite substantial. If other condominium owners in the building fail to pay their association dues, your dues may need to rise to cover for the amounts those other owners did not pay. In addition, condominium associations have the right to mandate additional assessments to pay for the cost of needed capital replacements and improvements. Condominium associations often maintain insufficient reserves for these items, which may lead to unexpected and possibly substantial assessments being levied against each owner.
Set-Up Costs: On average, a new homeowner spends between $3,500 and $5,000 in the first year of ownership beyond what they would have spent if they had not purchased. This spending is needed to equip and outfit a home.
Get informed. Be realistic. Don't be fooled.
Tax Deductions May Be Illusory: You may not be able to deduct the mortgage interest and property taxes you pay from your taxable income. The tax benefit for homeowners is less than most people believe. Look at your tax return. If you did not itemize your deductions this last year, as is true for 65% of taxpayers, it is likely that you will not fully benefit from the mortgage interest and property tax deduction. To the extent that your total itemized deductions are below the standard deduction allowed everyone, you will not receive a tax benefit for paying mortgage interest and property taxes. Almost half of all homeowners do not receive an additional tax deduction.
Minimal Reduction in Your Taxes: Even if you do receive a deduction from your taxable income, what really matters is the reduction in the actual taxes that you pay. Your tax savings with owning a home are equal to your additional tax deduction (i.e. above the standard deduction) multiplied by your income tax rate. If your income tax bracket is low, your actual tax reduction will also be low. Use TurboTax or another similar program to determine your actual taxes with owning vs. renting. You may be surprised at how small the tax savings are.
High Purchase/Sale Costs: The cost of buying and selling a home is approximately 10% of its value. Real estate commissions alone average 6-7% of the sale price. In addition, you will also need to pay mortgage financing costs, title insurance premiums, appraisal costs, closing costs, deed taxes, mortgage insurance premiums, mortgage points, and costs of preparing a home for sale. If you buy, you might not realize the full extent of these costs because a majority of the fees are paid at the time of sale. The net effect of these costs is that if your home increased in value by 10% and you were to sell, you would realize nothing after paying transaction costs.
Renting allows for greater freedom and flexibility. Your best choice may be to "Rent your home, own your life.”
Price Appreciation Minimal: Contrary to popular belief, homes are not a great investment. On average, between 1975 and 2008 home prices increased at only 1% in excess of inflation. With inflation of 2.1% in recent years (2000-2010), this means that, on average, more than three years of appreciation would be needed to pay your transaction costs alone. Most other investments have far better returns. Housing prices may have increased at a higher rate during the housing bubble from 2001 to 2006, but price declines since that time have erased those out-sized gains. Based on long-term trends, it is difficult to believe reasonably that housing-bubble era price gains will return.
Equity Build-Up Slow: While your mortgage payments will reduce your outstanding loan balance, the amortization, or pay-down, is quite slow. Initially, all but a small part of a mortgage payment is interest. With a 5.5%, 30-year loan, you will still owe 92% of the original loan amount after making monthly loan payments for five years.
Low Down Payment Loans Risky: While a low down payment loan may allow you to buy a home with little of your own money, such a purchase is a highly-leveraged bet on increases in housing prices. If prices do not rise, you may be required to write a large check in order to sell. With a low-down payment mortgage, even a slight decline in home values will leave you with negative equity (i.e. underwater) and at a much higher risk of foreclosure.
Long-Term Commitment: Buying a home, along with the 30-year mortgage that usually goes with it, is one of the longest-lasting commitments that any of us will ever make. With a home purchase, you will have fixed costs that need to be paid regardless of any change in your personal life, including a job change or job loss. Like other long-term commitments, it makes other changes in your life more difficult. While a home can be sold, a sale is neither cheap nor easy. While tax incentives, low down payment mortgages, and low interest rates may make it easy to purchase, it is your long-term needs that should be the basis of your buy vs. rent decision.
Renting Out Home Money Loser: Thinking that you can keep your home as an investment property if you later decide to live elsewhere probably does not make financial sense. Most people need the money from the sale of one home to buy another. As set out above, owning a home is expensive. Having a home as an investment property just adds to those costs. Because rents are generally insufficient to cover all of the costs of owning, most landlords of single family homes lose money on a monthly basis. Being a landlord is a time-consuming, hands-on business. The Minnesota Multi Housing Association (MHA) has information available for people who are considering becoming landlords.
Rent Not Throwing Money Away: A majority of what you pay in rent is applied toward the care and upkeep of the property, utilities and providing services to you. As discussed above, in owning a home, you will separately need to pay for these same services in addition to the payment of principal, interest, taxes, and insurance (PITI).
Weigh your options. Consider your lifestyle. Don't get stuck.
Freedom; Flexibility: With an apartment, your commitment to living in that location is limited to the term of your lease. Your money is not tied up in an asset that cannot easily be sold. If you decide to change jobs, return to school, relocate to another city, get married, or have a child, you can easily move to a different location that better fits your needs at that time.
Life Stage: Most people in the Minneapolis-St. Paul metropolitan area will eventually buy a home. Whether buying makes sense for you at this time depends on your personal situation. If your circumstances are such that you can realistically make a commitment to live in the same location for the next 5-7 years, buying may make financial sense. However, if during the next 5-7 years, you are likely to change jobs, return to school, relocate to another city, get married, have a child, or any other major life event, buying probably does not make financial sense and you are better off renting.
Most Buy vs. Rent Calculators Unrealistic: Buy vs. Rent Calculators are commonly promoted to those deciding whether to purchase a home. Please be aware that most of these calculators are developed and promoted by those who benefit financially from the purchase of homes and contain skewed assumptions and calculations. As with many things, the assumptions that are made determine the outcome. Common unrealistic assumptions include those relating to tax benefits, mortgage costs, mortgage insurance premiums, appreciation expectations, purchase and sale expenses, and apartment rents and costs.
Becoming “House Poor”: People commonly buy a home that is at or close to the maximum loan they can get. Lenders may approve you for a loan that is higher than what you can comfortably afford. Payments on such a mortgage loan may be so high that you will no longer be able to afford other activities and things that you currently enjoy. Before you buy, make out a realistic and detailed budget. If your total housing costs are higher than what you currently pay in rent, you should think about where you will cut back your discretionary spending. Many living costs are fixed. Discretionary spending usually goes towards things that we enjoy most.
Rent your home. Own your life.
While home ownership may have its benefits, do not forget the lifestyle advantages of renting. With an apartment, you do not have to devote any of your leisure time to shoveling snow, mowing the lawn, repair and maintenance, or any of the other chores of owning a home. Life is simpler and greener. Your time away from work is yours. People living in apartments generally have shorter commutes than those who own because renters can more easily move to be near their jobs. Also, you are closer to the amenities of a city than someone who buys in a distant suburb. Shorter commutes and less distance to city amenities also mean burning less gasoline and reduced wear and tear on your car.
Make your own decision.
Before you decide whether to buy a house or condominium, carefully think about your situation and make your own informed decision. Many of the people who are promoting one decision over another have their own vested interests and biases. Your landlord, admittedly, wants you to continue living where you are. Similarly, many of those promoting homeownership get paid only if you purchase, something that inevitably leads to bias. Take the time to consider this important decision carefully, and make sure your assumptions are based on accurate, factual information applicable to your specific circumstances.
Adapted with permission from "Perspectives on buying a house or condominium"
by Otness Management Company, February 2010
NPR Talk of the Nation, “Re-Thinking American Dream of Home Ownership”, National Public Radio, December 15, 2009. www.npr.org (Both Audio and Transcript Available).
Joseph Gyourko, Professor Wharton School, “5 Myths about Home Sweet Homeownership” Washington Post, November 15, 2009. www.washingtonpost.com.
Mark Zdechlik, “Home Sales Encourage Consumer Spending”, Minnesota Public Radio, May 27, 2009. minnesota.publicradio.org.
“Is It Better to Buy or Rent?”, New York Times, June 2, 2008. www.nytimes.com (Better Than Average Rent vs. Own Calculator).
Natalia Siniavskaia, “Spending Patterns of Home Buyers”, www.HousingEconomics.com, December 4, 2008.
Brett Arends, “Is Your Home a Good Investment?”, Wall Street Journal, May 27, 2009. www.wsj.com.
Jon Hilsenrath, “Fed Economist: Housing Is a Lousy Investment”, Wall Street Journal, January 5, 2010. www.wsj.com. (Speech by Karen Pence, the economist in charge of the Federal Reserve’s household and real estate finance research group).
Beth Braverman, “When it Makes Sense to Rent”, CNN, May 26, 2009. www.cnnmoney.com.
Robert Shiller, Irrational Exuberance, 2nd Edition, 2005, (Preface to 2nd Edition and Chapter 2 include a discussion of the housing bubble).
SOI Tax Stats-Individual Income Tax Return (Form 1040) Statistics. www.irs.gov/taxstats/indtaxstats.
“What will Refinancing Cost?”, The Federal Reserve Board. www.federalreserve.gov/pubs.
Don’t Buy the Myths: Renting Can Be A Smart Investment. National Multi Housing Council. www.nmhc.org.
Minnesota Multi Housing Association. www.mmha.com “Rent your home, own your life.” is a trademark of MHA.