Renting vs. Buying: 55 Pros and Cons

December 17, 2012 3 Comments »
Renting vs. Buying: 55 Pros and Cons

It has been far too long since I’ve written a mortgage match-up, so without further ado, here’s a biggie: “Renting vs. buying.”

This is certainly an intimidating question, and one that’s difficult to sum up in one post, but I’ll do my best to cover as many pros and cons for each as possible (feel free to add more in the comments section!).

First and foremost, there is no universal yes or no answer to this question seeing that real estate is constantly in flux and extremely local.

These days, home prices are well off their recent (ridiculous) highs and mortgage rates continue to break new record lows, which is surely making many renters salivate at the notion of homeownership.

After all, if you can buy a home for $100,000 less than your future neighbor while also snagging a mortgage rate several percentage points better than theirs, you’d be in pretty good shape, right?

That’s the hope, barring a complete implosion on the economic and housing front.

But nothing is ever that easy, is it? With homeownership comes responsibility, while renting may be relatively carefree.

Rent vs. Buy Ratio

Before we talk about the pros and cons of renting vs. buying, I wanted to touch on the many ways pundits determine if it’s more economical to buy than rent, and vice versa.

There are plenty of different buy versus rent calculations out there, but most compare annual rents to asking prices to find out if it’s a good or bad time to buy.

For example, there is the “rent vs. buy rule of 15,” which says to multiply the annual rent of a comparable property by 15.

So if rent is $1,000 a month, it’s $12,000 annually. Multiple that number by 15 and you’ve got a suitable purchase price of $180,000.

Trulia uses a “price-to-rent ratio” that follow the same formula, whereby you take the list price and divide it by one year’s rent.

Using our prior example, $180,000 divided by $12,000 would be 15. Trulia considers ratios of 1-15 as more favorable to buy than rent, whereas numbers of 16+ favor renting.

Of course, hot cities like New York City and Los Angeles will typically have much higher ratios.

Is That Rental Property a Good Buy?

There are other rules used for purchasing a rental property, including the 1% rule, the 2% rule, and a home’s gross yield, all of which are pretty simple formulas

The 1% rule basically says to purchase a rental property only if each month’s rent covers 1% of the purchase price.  So if a home is listed at $200,00, you need to bring in at least $2,000 in monthly rent for it to make sense.  This is easier said than done.

The 2% rule is a lot less forgiving.  In our preceding example, you’d need to get $4,000 a month in rent, which is probably next to impossible in most situations today unless you buy a very cheap foreclosure or snag some other fire sale.  These types of properties will most likely need a lot of TLC to get into the shape necessary to rent.

Finally, there’s a home’s gross yield, which is calculated by taking the property’s annual rent and dividing it by the purchase price.  So if the annual rent is $24,000 and the purchase price is $300,000, you’d have a gross yield of 8%.  A yield of 8% or higher is generally pretty good and anything in the double-digits is pretty spectacular.

However, you can’t rely on a blanket rule to make your home buying decision.  You need to factor in the true cost by using real-time mortgage rates, expected home price appreciation, the desire to own vs. rent, and much more.

So bust out a calculator as opposed to going with a rent vs. buy rule of thumb if you want a truly accurate picture.

Even if a property doesn’t meet these rules, it could still be a very worthy purchase.

Pros of Renting

Let’s start with the beauty of renting an apartment or a home. When you rent, you pay a landlord a certain dollar amount each month.

Put simply, this dollar amount is typically less than the going cost of a mortgage, assuming you factor in the insurance and taxes. Oh, and the maintenance.

Sure, a mortgage may appear cheaper, but guess what happens when your toilet breaks? You can’t call your helpful resident plumber and get a free fix.

You’ll either have to get down with some DIY or open your checkbook. So renting, while seemingly the same price or even more expensive than owning, might still wind up cheaper.

There’s also a huge psychological freedom to renting. You aren’t locked in for 30 years. At most, you probably have a 12-month lease agreement. And there’s even a good chance you’ve got a month-to-month deal in place.

In short, you won’t feel trapped, and you can freely move on if you want/need to for any reason, such as job relocation, downsizing, upsizing, etc.

This should make it a lot easier to sleep at night.

Cons of Renting

On the other side of the coin, renting seems to be synonymous with temporary. If you want to establish a household, renting an apartment or a home might not be the best way of going about it.

You might also be limited to what you can do to the unit. Pets aren’t allowed? You can’t paint the place? You can’t do X, Y, or Z?

Oh, and those rent payments never stop – sure, 30 years is a long, long time, but your lifetime will probably be longer.

There won’t be any relief in retirement when you rent – you’ll keep paying your landlord for “as long as it takes.”

And at the end, you won’t have anything to say for it, no home equity or ownership, despite all those payments. Nothing to hand off to your kids or to sell for cash proceeds.

Additionally, your rent can and will most likely rise, even if some level of rent control is in place.

So you might be paying less than your neighbor with the mortgage today, but if your neighbor’s mortgage is fixed, they’ll still be paying the same amount in the future while your rent shoots higher.

Pros of Buying

Okay, so we’ve discussed some pros and cons of renting, but what about buying?

Well, the obvious advantage is that you actually gain home equity, or ownership in your home.

In other words, over time the home or condo actually becomes your property, as opposed to renting, where you never own anything aside from the measly contents.

Additionally, owning might be a cheaper alternative than renting these days in many markets across the United States thanks to the low interest rates on hand.

Do a simple online search and you’ll find plenty of places where it’s “better to buy than rent.”

In many cases, your mortgage payment, even when factoring in taxes and insurance, may be less than what a landlord charges for rent.

Why pay $2,500 in rent if you can make a $2,200 mortgage payment, especially if you can write off the interest and the taxes?

That’s right, with homeownership comes tax benefits. Of course, the future of the mortgage interest deduction hangs in the balance, but real estate taxes are still fully deductible.

Factor in the tax savings and your mortgage payment gets even cheaper compared to a rental payment.

An owner of property also has fewer restrictions, and can add or modify to their heart’s content, less any government bureaucracy.

This means you can make your property worth even more over the years, or simply make it more useful/attractive for you and your family.

Cons of Buying

There are plenty of disadvantages to owning property as well. First off, you must come up with a sizable amount of money, either for down payment or to buy outright.

With rent, typically you just need the first and last month’s payment. When buying, you’ll need at least 3.5% of the purchase price in most cases (FHA loans), which can be a hefty amount in higher-priced areas of the nation.

There’s also a good chance your mortgage payment will exceed the rents in your area. This can certainly vary, but don’t be surprised if it comes at a premium.

You also have to pay real estate taxes and insurance, which don’t stop once the mortgage is paid off. You may even need to pay costly HOA dues.

Factor that all in and you could still be paying thousands each month to live “rent-free.” That doesn’t sound very free, does it?

You also become the landlord when you own. Remember that helpful handyman at your old apartment complex that fixed your leaky faucet with a smile? That’s your responsibility now Bob Vila.

Oh, and you better believe that every little thing that’s wrong with YOUR property will give you stress, each and every day.

You can’t just pack up and move along with ease. It takes time (and money) to unload a property, and you might not make out as much as you think once you factor in real estate commissions and less-than-anticipated home price gains.

Heck, your house might even lose value and you could be foreclosed on if you don’t hold up your end of the bargain.

In Summary

As you can see, there are plenty of pros and cons to buying vs. renting, and vice versa.

When you rent, you pretty much know what you’re getting into. You’re not going to make any money, but you’re not going to explicitly lose any either. And it’s mostly a hands-off type of deal.

With a home, you’re making a bit of a gamble on your future, and the future of the economy. After all, you need to put a certain amount down, and you need to ensure you keep making money so you can keep up with your mortgage payments.

You’ve also got to set aside an emergency fund so you’re able to pay for repairs if and when necessary.

But ideally, the tradeoff is that you’ll be rewarded for making that homeownership leap of faith.

Below, I’ve added a fairly exhaustive list of pros and cons for those pondering the rent vs. buy question:

Rent Advantages

  • May be cheaper than a mortgage payment
  • Fewer (if any) maintenance costs
  • No down payment required (less deposit)
  • No real estate taxes (renters insurance optional)
  • Less stress (who cares, it’s not yours!)
  • Freedom to move or downsize when necessary
  • No risk of home price depreciation
  • Some utility bills may be included
  • “Free” amenities such as pool, gym, security
  • Money can be used for other, more profitable investments
  • Can’t be foreclosed on

Rent Disadvantages

  • Rental payment may exceed monthly cost of mortgage
  • No ownership or wealth creation
  • Payments never stop when renting
  • Rent will rise over time
  • Must deal with a landlord or management company
  • No tax benefits
  • Rules, regulations, and limitations
  • More temporary, less stability
  • Always at the mercy of the property owner

Ownership Advantages

  • You can build home equity and wealth
  • Sizable tax deductions possible
  • Your space, your rules (pets welcome)
  • Ability to remodel, expand, tear down
  • Pride of ownership (social status, accomplishment)
  • Potentially better for children, family structure
  • Mortgage can improve your credit history/score
  • Ability to borrow against your home (HELOC or cash-out)
  • No more monthly payments once mortgage paid off
  • Fixed payments (if you choose a fixed mortgage)
  • Mortgages are the cheapest loans available
  • No landlord
  • Can exclude capital gains when you sell (partially)
  • Inflation hedge
  • Can rent out to others
  • Can sell and use proceeds for bigger/better home
  • Retirement nest egg
  • It’s the American Dream!

Ownership Disadvantages

  • Home prices may lose value
  • Could overpay for your property
  • Obtaining a mortgage (and finding a home) is a hassle
  • Not everyone qualifies for a mortgage
  • You must pay taxes and homeowners insurance
  • Total housing payment can be more expensive
  • Mortgage payment can rise (if an ARM)
  • Sizable down payment necessary
  • Maintenance costs can be excessive
  • Pricey HOA dues (if applicable)
  • You’re “stuck” in a home (long-term commitment)
  • Increased liability and responsibility
  • Transactional costs of buying and selling
  • Ownership is stressful!
  • Taxes and insurance generally rise
  • Your home can be damaged or destroyed (and not fully insured)
  • Can be foreclosed on and lose your home

3 Comments

  1. RickfromWI September 6, 2013 at 2:36 pm -

    You present it as an OR decision, renting or purchasing, you missed the AND decision. Right now is a great time to buy owner occupied rental property(rates low, prices still historically low). How does this work? Buy a duplex, live in one side and rent out the other. Wait, then I have to pay a mortgage, taxes and insurance and put up with neighbors. Yes, and no. Right now, with the right property, the rent can pay the mortgage and the insurance on the property and the owner will probably owe the property taxes (like a paid off house would). In short, you need the down payment, but from a cash flow point of view, the renter pays the lion’s share of the expenses. Negatives? Sure, you can get one of those renter Pros listed above (who cares, it’s not yours!). But remember, you write the lease, you write the lease terms and what are breaches to break the lease. No discrimation allowed, but there are ways to mitigate losses or hassle from a bad renter. You can set high standards, primarily credit, then you have to find people to meet them. The downside is that you must continue to adhere to your standards or you can be guilty of discrimination (you cannot drop the standards this one time because you want the other side filled). Worst case is you have to make a mortgage payment or two between renters. Can owner occupied work? Both of my sons are doing it right now – without coughing up a mortgage payment. Choose carefully a high demand area (low vacancy rates) with very good rents. Do your homework. It can be done very successfully. Remember – treat your renters well – they are buying the house for you.

  2. Colin Robertson September 7, 2013 at 9:10 am -

    Rick,

    Good angle I failed to mention. Thanks for sharing this viewpoint, I suppose some can enjoy the best of both worlds.

  3. victoria March 23, 2014 at 5:39 pm -

    Not many people can own AND rent at the same time, so this is a good overview of the benefits of each.

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