So renting a home always equals throwing money down the drain, and buying a home is key to building equity … right? Nope. That rule’s about as outdated as the gender roles that went along with the white-picket-fence era.
In fact, more people are deciding to keep on renting — indefinitely. Why? People have different financial goals. Some housing markets are ridiculously expensive (geez, coasts). And if we learned anything from the crash of 2008, it’s that home values aren’t guaranteed to go up. A mortgage-payment-vs.-monthly-rent comparison doesn’t tell the whole story.
If it’s a good fit for you, though, owning a home can have lots of benefits. You get to pick and customize your home to make it your actual happy place. Your housing costs might be more predictable (no landlord to jack up the rent). And owning a home often does help you build equity.
No matter what’s going on in the housing market, the right time to buy a home (if ever) is when you’re financially ready. Ask yourself these five questions to help you decide when (if ever) that may be:
1. Do you have enough saved?
Buying a home requires a pile of up-front cash. Take out a mortgage before you’ve got that pile saved up, and you might be putting your financial stability at risk. There’s the down payment — you can get a mortgage for less, but it’s definitely wise to put down at least 20% of the home’s purchase price. There are the closing and moving costs — which run to about 5% of the purchase price. And then there are the things that renters pass off to their landlords but homeowners can’t, like broken hot water heaters — you’ll probably want to save 1% of your home’s value a year to cover maintenance costs. And you’ll still need three to six months’ worth of take-home pay saved in your emergency fund.
In summary: How much you’ll need to save to buy a home
20% of the home’s purchase price for the down payment
+ 5% of the home’s purchase price for closing and moving costs
+ 1% of the home’s value for maintenance costs
+ 3 to 6 months’ take-home pay for emergencies
If you’ve got that locked and loaded, real estate listings are calling your name. But if you’re not there yet, it often pays to be patient while you save up. Got other financial goals that have to come first? That’s cool, too.
2. Can you afford the cost of ownership?
The US Census Bureau says that if you’re spending more than 30% of your income on housing, you’re “housing-cost burdened.” That’s a good benchmark to try to stay under. Just remember: Besides mortgage payments, housing costs also include homeowners’ insurance, property taxes, and (if applicable) private mortgage insurance and HOA fees.
But there’s a tax deduction for mortgage interest, right? Well, maybe: Only people who itemize their taxes get to take advantage of it. And with the changes to 2018’s tax laws, the standard deduction almost doubled, which means far fewer people are expected to itemize this year. So if you’re planning to factor this into your cost-of-ownership calculations, make sure it applies to you first.
And if the cost of home ownership in your market does fit into your budget, you’ll still want have enough left over for your other financial goals — like retirement, starting a business, or college savings. Because that stuff can’t wait forever.
3. How’s your overall financial picture?
If your job is new, you’re trying to get your own business off the ground (go you!), or your source of income is less than certain for some other reason, it might be safer to keep renting until things solidify. If something were to happen to your cash flow, a lease is a lot easier to get out of than a mortgage is. (Things get even riskier if you put down less than 20% up front: If your home’s value were to drop, you might owe more than it’s worth, and to sell it, you’d have pay the difference.)
Also: Check your credit score. A lower credit score generally means a higher interest rate on your mortgage, which means you’ll build equity — the percentage of the home you actually own — more slowly. If your score’s not where you want it, it’s okay to keep renting while you build it up. (Estimated break points for credit scores vary, but in general, aim to be in the 760-850 range for the best rates, and expect to pay a lot more if your credit’s 700 or below.)
4. How long do you plan to live there?
If you’re going to buy, it’s usually only worth it if you plan to stay there at least three to five years. Couple reasons why: First of all, if you make money off the sale of your home, capital gains taxes can only be waived if you lived in it and used it for two full years’ worth of time within the previous five years (among other conditions). Also: The longer you stay there, the more time you have to build equity. You’ll want to stay long enough that the equity you build can a) justify the closing costs and b) pay off some of the mortgage, especially if you made a “small” down payment. Here’s a handy calculator to help you do the math.
5. Do you expect the home to appreciate enough to justify the difference?
The last recession taught us: Owning a home is not a guaranteed way to build your net worth. Home prices can go down, and sometimes they do. But let’s say home prices in your area are going up. The important question is whether that’s happening fast enough.
Here’s an example: If it’s going to cost you an extra $1,200 a year ($100 a month) to own a home compared to the cost of renting, you’ll want the value of your home to increase more than $1,200 a year. That value should also increase faster than the returns you’d expect to get by investing that in a diversified investment portfolio, too — nobody’s psychic, but you can find a formula to estimate that here.
Choosing and customizing your dream home is one of life’s great pleasures. And, yep, buying a home gives you greater control over your housing costs and helps you build your net worth. But renting can give you greater flexibility and let you direct your money to other your other financial goals. (Oh, and passing your maintenance costs off to your landlord is pretty great, too.)