Buying a home can be an alluring proposition: When you buy a home, you have an asset that you hope will appreciate in value over time. For some, there’s also an emotional payoff from having the freedom to renovate or expand their property as they see fit. Renting, in contrast, is often compared to “throwing money down the drain.” It’s gone and it’s not coming back.
But renting can have its own allure — particularly for those who want flexibility and the ability to move without being tied down to a house, or for those who want the security of a fixed payment, with no risk for unexpected, large home repair costs. These days, buying a house is far from an obvious choice. As the recent housing bubble showed, there’s no guarantee home values will rise.
The country’s homeownership rate fell to 62.9% in the second quarter of this year, matching an all-time low reached in 1965, according to the U.S. Census Bureau.
Many people — especially millennials — are too burdened by student loan debt and high rental costs to become homeowners. High rental costs, coupled with student loan payments, can make it difficult to save up for a down payment. And for some, even if they have the money saved, their student debt load may leave them with too high a debt-to-income ratio to gain approval for a mortgage.
At the same time, lenders remain cautious about offering mortgages to home buyers with lower credit scores. But that doesn’t mean that the desire to own isn’t there. About 79% of millennial renters want to own a home, according to an April survey by Apartment List.
But since a home purchase is often the single biggest investment many people will ever make, it’s important to give the question, buy or rent, serious consideration. If you are wondering what is right for you, here are four questions to ask yourself.
1. Do I have a handle on the true cost of homeownership?
Your monthly mortgage bill is just the beginning of what you’ll have to pay as a homeowner.
Up front, you’ll need enough money to cover a down payment, which could range from 3% of the purchase price to 20% or higher. But if you put down less than 20%, you will likely be required to obtain private mortgage insurance (PMI), which acts to protect the lender if you are unable to pay your mortgage.
While the cost of PMI varies based on a number of factors, it can significantly increase your monthly payment. According to Freddie Mac, you can expect to pay between $40 and $80 a month for every $100,000 borrowed.
You’ll also have closing costs, such as appraisal fees and lender origination fees, which can total 2% to 5% of your purchase price.
Then there are your ongoing payments. Recurring bills include homeowners insurance, real estate taxes, and homeowner association fees.
On top of that, there are the unpredictable costs, like a leaky roof that needs to be replaced. Some experts recommend budgeting at least 2% of your home’s value each year for repairs.
“When people say they don’t want to ‘waste money’ on rent, what they don’t realize is you will ‘waste’ a lot of money on home ownership,” said Patrick Payne, a professor of finance at Western Carolina University.
It’s important to sit down and calculate your after-tax income and compare that to your expected home costs. Keep in mind, there may be some tax advantages to owning your home that should be factored into your calculations. As a homeowner, you might be able to deduct your mortgage interest, property tax, and other types of home-related payments.
The Consumer Financial Protection Bureau has a monthly payment worksheet that can help you assess whether your finances are in good enough shape to shoulder the ongoing costs of homeownership.
2. Do I plan to live in the house for the long haul?
As a general rule, it doesn’t make sense to buy a home unless you expect to live there for a while.
“Our rule of thumb is five years or longer,” said Becky House, education and communications director at American Financial Solutions, a non-profit credit counseling agency.
The reason: You want to give your property enough time to appreciate in value to compensate you for the costs you’ve incurred as a homeowner.
“It takes time for a home to grow enough in value to offset the closing costs and the day to day expenses” of homeownership, Payne said.
Of course, it’s important to note that five years is just a rough rule, and there is no guarantee that your home will appreciate in value. Some homeowners who bought at the peak of the market a decade ago are only now seeing their home’s value recover.
3. Would it make sense to invest my money elsewhere?
Once you commit your money to a down payment, it’s now tied up and no longer available to be invested elsewhere. The same holds true for the roughly 2% of a home’s value we mentioned earlier that is likely to go to repairs.
Owning a home can have many benefits beyond potential price appreciation (you get to live in it, for instance), and performance comparisons won’t be apples to apples. Still, it’s worth having a general picture of how this money might fare if it were put into other asset classes such as stocks or bonds.
From 1926-2015, stocks have returned 10.02% on average per year, followed by corporate bonds (5.99%), Treasury bonds (5.58%), and cash/cash equivalents such as short-term Treasury bills (3.24%), according to data from Morningstar Inc. The level of risk associated with a particular investment or asset class typically correlates with the level of return the investment might achieve.
Of course, stocks and bonds have both experienced periods of far lower returns than the long-term average, and that, too, may sway a homebuyer’s decision.
For residential housing, the general consensus is that the historical return has been at, or slightly more than, the historical rate of inflation, which stood at just over 3% from 1913 to 2015. Keep in mind that there can be big regional differences in home appreciation. And, as with any investment, historical performance is not an indication of how the investment might perform in the future.
4. Am I ready to take on the responsibilities of home ownership?
It’s easy to get caught up in the idea of being a homeowner and forget about the effort involved. When something breaks, you either have to fix it yourself or track down someone else and pay them to do it for you.
“When you’re a renter and you see a bulge in your wall, you call the landlord,” Payne said. “When you’re an owner, you think, what’s this going to cost me?”
If you grow disillusioned with your home, you can’t necessarily count on making a quick sale. All those advantages of homeownership can easily disappear if you’re stuck with a home you don’t want.