Weighing the Options: Renting vs. Buying Your Home
The decision between renting and buying your primary home is one of the most expensive dilemmas we face in our lifetimes. It's a choice that requires careful consideration of things like personal preferences, financial circumstances, and long-term goals. As a fiduciary financial planner for women, I must act in my clients’ best interests. So, while owning your home is portrayed as the ultimate American dream, I'm in the camp that—despite “conventional wisdom”—buying a primary residence is not necessarily the greatest financial decision you’ll ever make. But that isn’t bad news. In fact, there may be many reasons why you should feel good about the possibility of renting instead of buying.
Why People Buy
So many of us have received this advice when we were young: “Buy a home, because renting is throwing your money away. You want to build equity.” Like millions of people, I took that advice. My husband and I bought our primary residence. But bought is a loose term, really, because the bank owned most of our home for the entire 11 years we lived there, and we basically paid them rent with the added privilege of upside risk of all sorts (more to come).
This is not to say that we are sorry we bought instead of rented. We had our reasons, a lot of which had to do with where we were in our lives. Sometimes you buy a home to get into a school district, to be near your job or your family, or because you love the area. There are a million reasons why people buy homes—very valid emotional, psychological, and logistical ones. Control over their space, not answering to landlords, the desire to create a sense of stability, pride of ownership, something to call their own—these are all very common behavioral reasons why people buy their primary homes. There is no price you can place on these things. Many times, in life we make decisions that are not financially optimal but work for us and where we are. And that is OK. But it is important to understand the trade-offs.
The State of the Residential Housing Market
Before delving into the reasons why renting a primary residence might be better than buying, it's also important to understand the current state of the real estate and mortgage markets. These are influenced by various factors, including supply and demand dynamics, economic conditions, construction costs, and government policies. Interest rates and demand play a significant role in determining the affordability of homeownership. Understanding these market forces is crucial in making informed decisions.
Right now, trends show that housing affordability continues to decrease, even factoring in wage inflation. According to the National Association of Realtors’ Housing Affordability Index, from 2020, monthly principal and interest payments on a primary home have increased from 14.7% of income to an average of 24.9% in 2023. Anyone not living under a rock knows this intuitively and the data bear this out.
The Federal Reserve is responsible for raising and lowering interest rates through various mechanisms. When rates go up, as they have been over the last year plus, mortgage rates follow. In particular, the 10-year Treasury rate is the big bellwether for fixed-rate mortgages. Since Fed rates have increased, mortgage rates have as well. Unless and until Fed rates drop, it should be expected that mortgage interest rates will follow.
There are other factors making home purchasing challenging, including strict lending standards, student loan debt, and competition from cash buyers.
The Challenges of Buying Your Primary Home
High Initial Costs
Purchasing a home typically requires a significant upfront investment. You'll need to cover costs such as a down payment, closing costs, and potential upfront repairs or renovations. For individuals who don't have substantial savings or struggle to meet these financial obligations, renting may be a more feasible option.
The “Building Home Equity” Argument is a Stretch
If you own your primary residence but you owe a mortgage, you don’t fully own it. You own the value of your home minus whatever the lender is owed. So, depending on the size of that mortgage and the value of the home, you might own very little of it, especially early on. Sometimes, in the worst cases, you are upside down, meaning what you owe is more than what the house is worth. So, where’s your equity in all these instances? With the lender—it’s the lender’s equity, not yours.
Equity in a home, if you have mortgaged a lot of its value, takes a long time to build in a traditional fixed mortgage because the amortization of the payments means you pay mostly interest up front—the lender wants to lower its risk right away and make its profits as soon as possible. It’s even worse if you are in an interest-only mortgage structure where you never build equity because you are not paying towards principal. So, really, it is a terrible deal if you think about it.
The fastest ways to build equity in your home are:
- Pay it down aggressively.
- Hope that it appreciates quickly.
Only one of these things is in your control, and most people financing a house long-term have a harder time paying it down aggressively, otherwise they would not have needed the size of the mortgage they took on. And almost half of homeowners live in their current home for six to ten years. So, if you have a 30-year fixed rate mortgage, and you sell and move within that timeframe, you will have paid mostly interest, and have built little to no equity in your home.
To put it another way, the housing market can be notoriously unpredictable, with prices fluctuating and trends shifting over time. Timing the market correctly to maximize gains from homeownership can be challenging, and staying long enough to weather economic cycles is not the norm.
Limited Flexibility
Owning a home ties you to a specific location, which can limit your flexibility and mobility. If you anticipate frequent job changes, desire the freedom to explore different areas, or have a lifestyle that requires frequent relocation, renting may provide more flexibility and the ability to easily move to different places relatively quickly. One of the most compelling reasons to consider renting instead of buying is the flexibility and mobility it offers. Renting provides the freedom to easily relocate based on changing circumstances or career opportunities. For individuals who value geographical flexibility or have uncertain plans for the future, renting allows them to adapt quickly without the constraints of homeownership. Whether it's a job relocation, personal circumstances, or a desire for a change of scenery, renting can provide the necessary flexibility.
Maintenance and Repairs
Home maintenance and repairs can be a chunky expense. According to Rocket, you should expect to pay costs of 1-4% of the home’s value every year. The estimate is a range based on the age and condition of the home. From my own experience of living in a 100-year-old house in a flood zone, we had years where the costs well exceeded that range. This does not even factor in upgrades. Renting, on the other hand, often shifts the risk and responsibility for maintenance and repairs to the landlord. This means you won't have to worry about unexpected expenses for fixing a leaky roof, a faulty HVAC system, or a broken appliance. Renters can enjoy a hassle-free living experience while leaving the maintenance tasks to the property owner.
Opportunity Cost
When you purchase a home, a significant portion of your wealth becomes tied up in the property. This means that you may have limited funds available for other needs or investment opportunities that could potentially offer higher returns or better diversification. Renting provides a buffer against the uncertainty and potential risks associated with buying a property at the wrong time. By renting, individuals can patiently wait for a more favorable market or take advantage of investment opportunities in other sectors.
Referring to the earlier point about equity—you don’t have to build equity. You can buy it in the form of stocks. Stocks are called “equities” for a reason—you are buying a small stake in a company. You can do this very inexpensively one by one, or a whole basket at once in the form of mutual funds or exchange-traded funds. This can be accomplished in the time it took you to read this sentence. Then, you could be diversified versus a primary residence where you are making a big bet on one sector (real estate), in one location (where you live), which can’t be sold immediately (illiquid), and that costs you money (transaction costs, principal, interest, taxes, insurance, maintenance, repairs), and generates zero income (if you are living in it).
The Case-Schiller Home Price Index, a national composite of single-family home prices, shows this consistently over the last 100 years. The difference between equity returns and real estate returns has accelerated considerably since 1980, and, even factoring in the 2009 housing crisis, the difference is startling. Of course, you must factor in timing. You can prove any economic theory if the information is cherry-picked. But in the long term, the trend is blatantly obvious.
How to Decide? Plan!
When it comes to the rent-versus-buy decision, financial planning is essential. It allows individuals to assess their financial situation, lifestyle needs, and goals, which will help them decide the most suitable housing option.
This is a subjective decision; there is no right answer. There are simply answers which are more or less financially optimal. What works for someone may not work for someone else. It’s a lot to sift through. A fiduciary, fee-only financial advisor can be a great guide through this process, and provide valuable insights based on your specific situation. This also adds an extra layer of expertise and objectivity to the decision-making process.
A note on real estate agents: while a real estate agent is important as you move through the purchase process, they are not experts at looking at a client’s full financial picture. Unfortunately, I’ve seen agents encourage clients to take on more mortgage than would be optimal because they do not have the benefit of other financial information. This is another reason why working with a financial advisor who is separate from the purchase process is very important to have a broader view of how much borrowing makes sense.
Ultimately, the rent-vs-buy decision should be based on individual circumstances, financial planning, and long-term goals. By making an informed choice with the right guidance, individuals can find the right path that aligns with their needs and aspirations.
Renting FAQ
1. Is renting really a better option for everyone?
Renting may not be the best choice for everyone. It depends on individual circumstances, financial goals, and personal preferences. Renting offers certain advantages, but it's important to weigh them against your specific situation before deciding.
2. What if I prefer the stability of homeownership?
If stability and long-term roots are important to you, homeownership may be a better fit. Owning a home provides a sense of permanence and the ability to personalize your living space to your liking.
3. Can renting be a long-term solution?
Renting can be a viable long-term solution for some individuals. It provides flexibility and allows for easy adaptation to changing circumstances. Renters can enjoy the benefits of hassle-free living without the commitment and financial responsibilities of homeownership.
4. How can I protect myself as a renter?
To protect yourself as a renter, it's important to thoroughly review and understand your lease agreement. Consider renter's insurance to protect your personal belongings. Maintain open communication with your landlord and promptly report any maintenance issues.
5. What are some potential downsides of renting?
While renting offers advantages, there are potential downsides to consider. Rent prices may increase over time, limiting your ability to budget predictably. Renting also means you don't have the same degree of control over your living space as you would with homeownership.
Jennifer Kirby is a fiduciary financial planner who specializes in working with self-reliant women. She helps them balance today's wants and tomorrow’s needs—without depending on anyone else.