We’ve all heard the expression, “renting is just throwing money away.” But millennials are 8% less likely to own a home than their parents or grandparents were at the same age, according to a study by the Urban Institute. Depending on your personal and financial goals, there are good reasons to rent a home instead of buying one. Then again, it’s true that homeownership is one of the primary ways Americans build wealth, assuming the value of the home increases by the time it’s sold. If you’re moving in the not-too-distant future, here are the most important questions to ask before making the decision to rent or buy.
How long will you live in your next home?
Broadly speaking, the longer you live somewhere, the more cost-effective homeownership becomes. That’s because buying a home costs more money up front (thanks to down payments and increased legal fees), while renting often costs more on a month-to-month basis. Plus, assuming the property values in your neighborhood trend steadily upward over the years, you’ll hopefully make a profit when you sell your home.
Experts don’t really agree on exactly how long it takes for homeownership to become the wiser financial choice, but at the very least, you should be confident about living in your home for a few years before you considering buying. Renting a home is much more flexible, since most leases only last between 6 and 24 months. But you definitely won’t make a profit when your lease expires, and therein lies the wealth-building advantage of homeownership.
Can you afford a down payment?
One of the biggest obstacles for prospective homeowners is the lump sum paid up front. For the bank who finances your loan, a down payment is like a “security deposit” that proves you’ll be able to pay your mortgage every month. How big of a down payment are we talking about? “Between 3 percent and 20 percent of the home’s price,” says BankRate’s Poonkulali Thangavelu. “Some loans may have a lower threshold, but down payments below 20 percent will mean paying for private mortgage insurance, or PMI, which is an additional monthly expense.” On the other hand, renting a home usually requires a much smaller financial commitment up front, often “the first month’s rent, last month’s rent and a security deposit equal to one month’s rent in advance,” says Thangavelu.
Home Price 250 000 500 000 750 000 20% Down Payment $50,000 $100,000 $150,000 10% Down Payment $25,000 $50,000 $75,000 3% Down Payment $7,500 $15,000 $22,500
How healthy is your credit score?
To buy a home, you’re going to need a loan from a mortgage lender. And one of the most important factors a lender will consider before approving or rejecting your loan application is your credit score. According to BankRate, you’ll probably need a credit score of at least 620 to qualify for the highest mortgage rates, or a score above 760 to qualify for the lowest. Meanwhile, the average renter falls in the 600-620 range. If you need to check your credit score, see our review of the Best Credit Report Services. If you need to improve your score, here’s our guide for millennials.
Can you afford the hidden costs of homeownership?
If the dishwasher in your rental apartment breaks down, your landlord will probably replace it. If your dishwasher breaks at home, you’re on the hook. And that’s just one example of the kinds of surprise maintenance costs you can expect as a homeowner. (Although, if you buy one of our picks for the Best Dishwashers, hopefully you can avoid this particular crisis.)
Also not included in your mortgage: homeowners insurance. According to the Insurance Information Institute, the average annual home insurance premium in 2016 was just under $1,200, while the average renters insurance premium was only $185.
Renting vs. Buying: Pros and Cons
Renting Buying Less risky Steady monthly mortgage rate Potentially risky investment Lower insurance premiums Monthly rent cost can go up Privacy Higher insurance premiums Easy to move out Landlords make the rules More control Hard to move out Maintenance costs included No wealth-building opportunity Opportunity to build wealth through equity Maintenance costs not included Cheaper in the short-term More expensive in the long-term Cheaper in the long-term (potentially) More expensive up front Pro Con Pro Con