Should You Rent or Buy Your Home?

Owning a home is a key pillar of The American Dream, but should it be part of Your American Dream? Many people and conventional personal finance advice have a proscriptive view of homeownership. They assume that owning a home is always better than renting. But is it?

Everyone knows that owning a home is historically more expensive now than in previous decades. If homes are historically expensive now than in the past, then shouldn’t homeownership also be more expensive than renting, at least in certain cities?

Here’s the way most people and conventional personal financial advice look at the question of whether to own a home or rent. They compare the monthly cost of renting to the monthly mortgage payment of owning a home. That’s it. Under this comparison, of course owning a home is cheaper than renting because it ignores all of the hidden costs of owning a home – such as property taxes, insurance, maintenance, HOA and condo fees, and so on. If you own a car, you understand that the cost of owning a car is not just the car payment; it’s also all the additional costs of keeping the car in working order, fueled, and properly registered.

In fact, the calculation of whether to own a home or rent is very complex because there are opportunity costs as well. You could invest the down payment, for example, and come out further ahead financially by investing it and renting. Owning a home also pins you to one place; moving for new job opportunities or because life requires it results in high transaction costs. There is also the opportunity cost of time spent fixing up and maintaining your home that could be spent on other more enjoyable activities.

So, is owning a home always more expensive than renting? The answer is, “It depends.”

Fortunately, there are calculators available to help us make this crucial decision. For some reason, these calculators are severely underutilized, but running them is very imporant. In fact, you can’t master your money without running these calculations. Maybe people just don’t want to hear that owning a home can be more expensive than renting. Maybe the desire for the quintessential American Dream is so strong that people are willing to put their heads in the sand, even when the numbers are in front of them. But you still have to ask yourself, “Is homeownership part of My American Dream?”

You can use a calculator to make this decision. By inputting numbers into the calculator, you can find how long you can rent a home before renting becomes more expensive than owning an equivalent home. You can also see whether it will ever be cheaper to rent a home or own the equivalent home.

This calculator is straightforward, but there are some assumptions you need to fill in yourself.

  • Home value appreciation: This is the growth rate you expect your home to appreciate after buying it per year.

  • Rent appreciation: This is the growth rate you expect your rent to increase per year.

  • General inflation: This is the rate of inflation that impacts the annual cost of maintaining and renovating a home.

  • Annual return on cash: This is the opportunity cost that you expect your down payment would grow if invested long-term. This number should be 7%.

The hard part is pinning down the numbers for these assumptions. Fortunately, both nationwide and localized data is available among the top 20 largest metropolitan areas. Below are the home value appreciation, rent appreciation, and general inflation numbers for these metropolitan areas (including surrounding areas) and nationwide. All data is from 1992 through 2023, unless stated otherwise, using data available from the S&P Case Shiller Home Price Index and the Bureau of Labor Statistics.

County Level Price Appreciation (2023)

Tips

            The calculator can become quite granular, so here are some tips to help you get the most accurate results.

  1. Compare similar homes to rent and homes to buy. Remember that the point of this calculator is to see whether it’s cheaper to rent a home or buy a similar home. This doesn’t mean that have you have to find the exact same home to compare, but you have to be in a reasonable ballpark. For example, let’s say I’m interested in renting a 1 bedroom/1 bathroom apartment in Columbia Heights, in Washington, DC. After perusing some websites, I find an apartment that I like for a rent of $2,500 per month. Now, if I’m going to compare a similar home to buy, I need to look at what homes are available in the market. I’ll need to find a similar 1 bedroom/1 bathroom apartment in Columbia Heights that I’d be interested in living in. I’m not going to compare a 3 bedroom/2 bathroom house located in Alexandria, Virginia with this apartment; it’s not going to be a fair comparison.

  2. Look up average mortgage rates for your credit score. Mortgage rates change daily, and rates will be higher for people with lower credit scores. In order to find current mortgage rates, Google search: “Current mortgage rates.” Google will pull up the average current mortgage rates and will allow you to adjust the loan amount, down payment, state, and credit score.

  3. Research property taxes locally. Property taxes vary based on city and county. Some areas have higher property tax rates than others. Be sure to Google search: “Property tax rate in ABC County.”

  4. Get reasonable estimates for insurance. The calculator includes homeowners and renters insurance. Insurance rates will vary by coverage and location, but you can use a percentage of the estimated home value to get a baseline for how much homeowners insurance will cost. Start with 0.6% for homeowners insurance and go up to 1.0% if you think you’ll need more coverage (i.e. you own many expensive things or need higher liability coverage). Renters insurance premium of 1.32% of the monthly rent is the default value on NerdWallet, and it’s a reasonable estimate. Your actual insurance premium may be less.

  5. Home repairs and renovations. Older homes require more repairs than newer homes. A new home (less than 15 years old) might need only a few repairs, but older homes will require more. You must account for repairs when buying a home to keep your home usable and safe.

    • If you have a home that’s less than 15 years old, I recommend setting aside 1% of the home’s value for repairs.

    • If you have a home that’s between 15 and 30 years old, I recommend setting aside 2% of the home’s value for repairs.

    • If you have a home that’s more than 30 years old, I recommend setting aside 3% of the home’s value for repairs. Homes that are older than 30 years old have exceeded the use life of many appliances and structure, such as the roof and siding, so you are likely to have large repairs during your tenure.

    • Renovations are voluntary expenses that you do not “need” to make, such as updating a bathroom or kitchen. You should plan to set aside 1% or 2% of the value of your home if you plan to do renovations within the next few years.

  6. Don’t forget closing costs. Lastly, be sure to include reasonable numbers for buyer closing cost. The typical buying closing cost is 4% of the value of the home. This 4% includes lender fees, inspections, appraisals, etc. If you plan to sell the home in the future, and do not plan to bequeath your home to an heir, then your seller closing cost should be 6% paid to your realtor. Recent lawsuits against the National Association of Realtors may change these numbers in the future.

Give the calculator a try and let me know what you find!