If you are a renter and pondering whether it’s time buy a home, one thing that might be on your mind is a rent vs. own analysis. As you can imagine, this analysis will help you determine the financial benefits of owning a home vs. staying a renter.
Many online rent vs. own analysis tools are available, but a little caution is needed, as some of these tools are very biased and skewed. Some always find that it typically makes sense to buy, while others show that you should rarely buy. Most of them look at the difference between the monthly rental and mortgage payments and take into account tax benefits, equity earned, sales prices and other variables associated with home ownership.
The biggest problem with most of these tools is that they are way too complex for the average person to understand. And because this is the biggest financial decision you will ever make, it isn’t a smart idea to just trust, while not understanding, what’s behind the analysis.
But there is a simple way to do a rent vs. own analysis that will return the correct decision the vast majority of the time for the average home buyer. And it’s completely unbiased.
Long-term ownership
Ask yourself: Am I very confident that I will own the home at least five years?
If the answer is yes, it probably makes sense to buy because it will improve your net wealth.
If the answer is no, you should stay a renter because owning will most likely diminish your net wealth.
That’s it, the math is just that simple!
Why it works
When you sell a property, you pay about 10 to 15 percent of the sales price in costs. These costs are 5 to 6 percent in sales commission, 2 to 3 percent in escrow, title, closing and other costs, plus most likely a few percentage points in credits to the buyer, overlapping occupancy costs if you’ve already moved, plus extra costs of moving. It really does add up quickly, and your overall costs are always higher than you anticipate.
For example, if you bought a house for $200,000 and its value increased 3 percent per year, it would be worth about $232,000 at the end of year five. If you sold it for $232,000 and subtracted out 15 percent in sales costs ($34,800) you would net a little less than $200,000 on the sale.
Notice that $200,000 is the exact amount you paid for the property five years earlier. Now some people will think: Well if it cost less monthly to own than to rent, then it still made sense because you saved money along the way. But figuring the true monthly cost to own is more complicated than a simple comparison of your monthly housing expenses vs. what it would cost to rent. And a true analysis usually finds that it costs more to own than to rent, even with the purported “tax benefits of home ownership.”
The end result is that owning a home is much more expensive than people anticipate, plus the sale of a home is also much more expensive that most people realize.
And that’s why five years is about the breakeven period, in the vast majority of cases. If you don’t plan to keep a home for a long, long time, you’re better off financially by renting someone else’s property until you do find a place you plan to own for the long haul.
Related:
- Is Home Ownership a Good Choice for Young People?
- What’s the Best Way to Earn Wealth in Real Estate?
- How to Choose a Good Real Estate Sales Professional
Leonard Baron, MBA, is America’s Real Estate Professor®. His unbiased, neutral and inexpensive“Real Estate Ownership, Investment and Due Diligence 101” textbook teaches real estate owners how to make smart and safe purchase decisions.