At a glance:
Why rent an apartment?
Why buy a home?
How much housing can you afford?
Costs of buying a home
Summary of rent vs. buy a home
Practical ideas you can start with today
A home is usually the single biggest purchase that a person makes. More so than any other purchase, it pays to know all your available options for paying for one.
Why rent an apartment?
There are many good reasons for renting instead of buying.
It is often cheaper than owning
Some monthly mortgage payments are lower than rent, but some cost more. And of course, since houses are normally larger than apartments, you should ask yourself whether you actually need the extra space.
Keep in mind, too, that there are the various things that people naturally buy once they get into a house and see all kinds of space just waiting to be filled up with stuff; that's less likely with a rental.
Remember that a large portion of your monthly mortgage payment is interest. By the time you have paid off your mortgage, you may find that half or more than half of the grand total you paid went to interest.
The mortgage interest tax deduction does offer some relief, but that requires you to itemize deductions.
Since the proportion of the mortgage loan payment that goes to interest decreases each month over the term of the mortgage, it could stop being beneficial to itemize rather than take the standard deduction.
Another advantage of renting: there are no property taxes to pay. Property taxes add hundreds of dollars to an owner's monthly costs.
Again, there is a tax deduction for property taxes, but it is an itemized deduction and may not be as advantageous as the standard deduction eventually.
In fact, federal tax reform legislation now limits the maximum state and local tax deduction (which includes property tax and either income or sales taxes) to a maximum of $10,000 per year.
There are no condominium fees or homeowner association dues to pay, either.
If you are fortunate enough to have some or all of your utilities paid by the landlord, there's another chunk of change you are saving.
No maintenance costs
Mortgage and tax costs are predictable and can be planned. Not always so when your pipes burst, your furnace dies at 2 am on a cold January morning, you suddenly discover termites, or your roof starts caving in. Renters don't have those large maintenance costs.
They are typically limited to light bulbs and other small things.
As a rule, then, renters have more predictable housing costs.
However, landlords work their own ownership and maintenance costs into the monthly rents that tenants pay, and rents can and do increase over the years.
When the housing market tanks and home prices drop over the course of years, renting becomes more attractive, and landlords may increase their rents accordingly.
You can leave your apartment
On top of the advantages noted here, a renter isn't tied to a home. He or she can pack up and move across the country without worrying about whether the home will sell.
No fear of losing your investment
Not everyone makes a profit when selling a home. During a bad housing market, millions of owners find that their homes are worth less than what they owe on them (this is called negative equity, or "being underwater"). Renters need not worry about losing an investment.
Advocates for owning often refer to renting as "throwing your money away" because you are not building equity. Though you're not building equity through owning, any money you save can be invested elsewhere to build wealth.
There are, in fact, renters who have become millionaires this way. Besides that, renters aren't really throwing their money away, because they are getting the use of a home and its advantages for their money.
Why buy a home?
There are lots of reasons to buy a home: the pride of ownership, the freedom of owning your own lodging, and the comfort of moving out of a cramped apartment, to name but a few.
But what makes home ownership a good investment?
Homes typically increase in value
To begin with, homes often increase in value over long time periods, creating perhaps the most common source of capital gains.
The demand for housing has never been greater—especially with the rapid population growth of the last half-century—and that demand has fueled consistent growth in real estate prices.
Home prices typically appreciate in times when the local and global economies are doing well.
However, one should be wary that past growth is no guarantee of future growth.
You can build wealth by making mortgage payments
Generally, your wealth increases as you make mortgage payments.
Although the interest belongs to the institution that made the loan, the principal portion of the payment belongs to you, and it may accumulate—like a savings account—over time.
Your accumulated principal plus the appreciated value of the property is commonly referred to as your home equity, or the amount you actually own (as opposed to what you owe the bank, credit union, or mortgage company).
You can get tax deductions for interest and property tax
But even what you owe on a house has its advantages.
The biggest advantage is the mortgage interest deduction for taxpayers who can itemize deductions. Generally, you can deduct the interest paid on certain loans secured by your home (or second home).
These loans can be the mortgage to purchase the house, or in certain cases a loan or line of credit borrowed against your home equity. You can deduct interest paid on mortgages up to $750,000 if you are married and file taxes jointly, or $375,000 if you're married and file separately.
The interest deduction for home equity loans—which was previously limited to home equity loans up to $100,000 ($50,000 if you are married and file separately)—was limited even further by the recent tax law, beginning in 2018.
It now applies only to using the loan proceeds to buy, build, or improve the home that secures the loan, as opposed to paying off other debts, buying a car, taking a vacation, paying for education, etc. Grandfathering rules for use of the old limits and rules apply.
You can also deduct the property taxes you pay, if you itemize deductions, subject to the overall $10,000 limit for state and local taxes.
And when your family decides to sell the house, the first $500,000 in capital gains ($250,000 for single taxpayers) is generally tax-free. Special ownership and use rules apply, however.
How much housing can you afford?
Whether you rent or buy, the amount you pay per month should be about the same, percentagewise. Let's look at both.
When renting, your rent and other housing costs should be about 30% of your net income. So, if you are taking home $1500 a month, your housing costs should not exceed $450.
This may be easier said than done, which is why getting roommates may be necessary for some. This 30% figure is a helpful guideline because you will have other expenses that will compete for your income.
An advantage of meeting this number when you are renting instead of owning is that many housing expenses will already be covered in your rent—for example, the cost of a repairperson, new windows, carpeting, etc. You might also get such amenities as a pool, an exercise room, and free utilities.
The idea of buying your first home can be intoxicating and intimidating at the same time. The first consideration is what you can afford to spend on a house. Consider this from a couple of different angles:
How much of a monthly payment can I afford?
What savings do I have available for a down payment?
How do I plan to cover other expenses such as the earnest money deposit and closing costs?
Housing numbers you should know
Guidelines for owning are a little different than for renting. The rule of thumb for monthly payments is that they shouldn't exceed 25 to 30 percent of your monthly gross income.
Monthly payments include your mortgage principal and interest, real estate taxes, mortgage insurance, and homeowners' insurance, so be sure to include these if you are running your own numbers.
As for down payments, they range from nothing to 20 percent or more, with most buyers falling in between these two extremes.
Here are some other useful percentages to know when owning: your total housing costs shouldn't consume more than 32 percent of your gross monthly income.
When you've been renting, it has been easy to underestimate the ongoing costs involved in homeownership, which range from simple and fairly inexpensive matters such as calling the plumber to unclog your sink to the budget-busting cost of putting on a new roof.
And your total debt load—including car loans, student loans, credit card debt, etc.—shouldn't exceed 40 percent of your gross monthly income.
What the numbers look like
So, if you and your spouse have a combined gross income of $50,000 a year, the numbers work out like this:
Monthly payments between $1,041 and $1,250
Total housing expenses not to exceed $1,333
Total debt load not to exceed $1,667
These are important numbers, because they are the ones that lenders will come up with when you start asking about getting pre-approved for a mortgage.
A mortgage pre-approval means that a lender has checked you out and made a commitment to offer you a mortgage for a certain amount based on your financial situation.
How to get the best mortgage deal
Buying a home is one of the biggest purchases you'll ever make. That's why it is very important to fully research all your options for financing that home purchase with a mortgage.
It's also a good idea to look at your credit report and credit score before finding a house so you can deal with any potential problems before you fill out mortgage loan applications.
Be prepared before you apply
There are numerous tasks to take care of before you actually apply for a mortgage. One of the first steps is to obtain a copy of your credit reports at www.annualcreditreport.com or call 877.322.8228.
You are entitled to a free credit report once a year from each of the three major credit reporting bureaus, Equifax, Experian and TransUnion.
Once you have your credit report in hand, you can go over to ensure that all the information is accurate, including your name, address and past history of bill payments.
If there is inaccurate information, you should write to the credit bureau and the creditor that has provided the inaccurate information to get it corrected.
When you are ready to apply, be completely transparent on your application. Come prepared with all of your financial information, including pay stubs, tax returns and documentation of any other income you may have.
Shop around for rates
You should also shop around for rates and fees on mortgages before you apply, using sites like Bankrate at www.bankrate.com/mortgage.aspx and Zillow at www.zillow.com/mortgage-rates.
It's also a good idea to call some local financial institutions because not all banks or credit unions are included in the searches on these two sites. Also, rates change daily.
The bigger the down payment, the more equity you will have in your new house. In addition, you may qualify for a lower rate with a down payment of 20% or more.
Consider the different kinds of loans—while a fixed rate 30-year mortgage could be the best deal, it is possible that an adjustable rate mortgage might work better for you if you aren't planning to live in your home more than five or seven years.
When you've found the best combination of a loan rate, points and fees for you, and you have a contract on a home, it's time to lock your rate. Different periods are available to lock your rate, including 30, 45, 60, or 90 days.
Typically, a purchase takes around 45 days to close, though a variety of situations can extend that. If your rate lock expires before the closing, you may have to pay again to extend the rate lock, so be conservative, even though it can cost more to lock the rate for longer.
Consider points and fees
All too often, points and fees are an afterthought, but they are very important. Points represent 1% of the total of your mortgage loan balance.
By paying points, you can obtain a lower interest rate for the life of your loan. In general, the longer you plan on staying in your home, the more money you can save by paying points up front.
While the specific costs involved in closing on a loan can vary depending on where you live, they tend to range between two and five percent of the purchase price of a home.
They include a variety of fees from loan origination to inspections to appraisals to title insurance and searches.
Some of these fees are fixed, but some can be negotiated. Don't be afraid to ask your lender for some concessions on points and fees. Any money you save you can put to better use elsewhere.
Costs of buying a home
How much does a home cost? Before you get too comfortable with the asking price in the real estate ad, you should be aware of all the expenses you will be expected to pay.
Paying for the home
First, there is the price of the home itself. The seller offers his or her house for sale at the asking price. This price may be negotiable depending upon the condition of the home and other factors.
After the negotiations are done, the agreed-upon price becomes the cost of the home. To secure this cost, the buyer is expected to make a non-refundable payment to the seller.
This is called earnest money. This amount will be deducted from the amounts paid when the sale is completed.
Other fees beyond the loan
Most people finance their home purchase through a mortgage loan from a bank, credit union, or other lender.
Many mortgage lenders require a fee that may include the cost of the application as well as appraiser fees, credit reports, and costs to acquire the loan, such as a loan origination fee and "points," a fee as a percentage of the loan amount.
Mortgage loans rarely cover 100% of the purchase price, and a cash down payment is expected at the closing, when the transaction is finalized.
Title and hazard insurance
The lender may also require that you have the title to the deed insured, in order to guarantee that someone else cannot claim the property from you after the sale.
Title insurance guarantees that the seller is the real owner and has all rights to transfer ownership. You pay a premium to the title insurance company for this service. You may be required to insure your new purchase with hazard (i.e., fire, earthquake, flood, etc.) insurance.
You may also be requested to purchase mortgage life insurance (optional) and private mortgage insurance to protect the lender from default due to your insolvency.
Other points to remember
Real estate transfers are complex legal matters in most states. You may have an attorney to advise and help with negotiations and paperwork leading up to, and including, signing of all agreements.
You will also need additional cash at the closing to cover fees for recording the new deed to your home, as well as a deposit for real estate taxes.
Together, all of the costs involved in closing a home purchase can add anywhere from 3% to as much as 10% to the cost of the home, in addition to the actual down payment applied to the purchase.
Summary of rent vs. buying a home
Homeownership has its pitfalls. You will have that mortgage for a long time—unless you need to move, in which case you may have trouble selling quickly at a good price.
Indeed, there are a lot reasons that you may lose money, including building a new home and moving soon after. Finally, you will not be able to count on the landlord anymore to make repairs, mow lawns, and paint siding. Renting definitely has its own advantages.
Still, for most people, homeownership is part of the American dream.
Not only do you get to live in your own "castle," you own an investment that can grow in value, helping build your wealth and providing a potential source of capital.
But be sure you understand the full costs of buying a home, and the many factors that can influence its value, before you pick up the real estate ads.
Practical ideas you can start with today
Make a list of what you need and want in a home, including ideal neighborhoods.
Determine whether buying or renting is more advantageous.
Set up a dedicated fund and begin saving up for a down payment and other housing expenses.
Get preapproved for a mortgage loan with a payment you can comfortably manage.
Meet with a mortgage loan officer to determine whether I can afford to buy a home. Discuss your monthly payment and the other expenses you will have to pay.
Negotiate for the purchase of the house you want and be sure you thoroughly understand everything you sign.
This content was created in partnership with the Financial Fitness Group, a leading e-learning provider of FINRA compliant financial wellness solutions that help improve financial literacy.
Read more information and tips in our Housing section