Buying vs Renting a Home: Which is the Best Financial Decision?

Buy vs Rent

Is it better to rent or buy your home? You might wonder which is the better financial decision. Renting usually involves paying a lower monthly amount to a landlord, which is essentially money lost. On the other hand, owning a home comes with high mortgage payments, property taxes, and maintenance costs, but your home might increase in value over time. To compare both options, you need to calculate the amount of money that you’ll never get back in both scenarios. In this article, we will explore the cost factors of buying vs renting a home, and other important considerations.

Understanding Home Ownership Costs

Property Taxes

Property taxes are an obligation for homeowners, representing a percentage of the property’s value paid annually to the government or state. In the United States, the average property tax rate is 1.11% for residential real estate. For example, on a $500,000 home, the property taxes would amount to $5,500 per year.

Maintenance Costs

Maintenance costs are another aspect of home ownership that renters need not worry about. As a home owner it is recommended to set aside 1-2% of the property’s value per year for maintenance purposes. Let’s assume a 1% maintenance cost, resulting in $5,000 per year for a $500,000 home.

Mortgage Payment

A mortgage payment consists of two components: the down payment and the cost of debt. Assuming a 20% down payment on a $500,000 home, the remaining $400,000 will be financed over 30 years. The cost of the down payment includes an opportunity cost, as that money could potentially be invested in other ventures. The difference in average returns between stocks (around 7%) and real estate (around 2%) is about 5%. Thus, a $100,000 down payment would have an opportunity cost of 5%, or $5,000 per year.

When buying a house, one of the most significant costs you’ll encounter is the cost of debt, which is represented by the interest payments on your mortgage. The amount you’ll pay in interest depends largely on your mortgage rate, which can vary based on a variety of factors including your credit score, the length of the loan, and market conditions.

For the sake of simplification, let’s consider an example where the annual cost of debt is $28,000. This figure is calculated by multiplying the outstanding loan balance by the interest rate. In this case, we’re assuming an interest rate of 5.6%.

It’s important to note that this is a simplified example. In reality, the cost of debt can fluctuate over time, especially if you have a variable rate mortgage. Additionally, the actual amount you’ll pay in interest can be influenced by other factors such as the size of your down payment, the term of the loan, and whether you choose to make extra payments towards the principal.

Other Buying vs Renting Factors to Consider

Human Behavior and Opportunity Cost

While the financial aspects of buying vs renting a home are important to consider, you should also take into account behavioral factors and your specific individual financial habits. Humans are not always rational and may make impulsive or emotionally-driven decisions.

While it’s true that if you continue renting you could potentially invest the money you would have used for a down payment, this doesn’t guarantee that you will do so wisely. Would you be tempted to waste your savings on expensive distractions rather than investing it for your future?

Behavioral economics, a field of study that blends psychology and economics, has shown that people often struggle with self-control when it comes to money. They might prioritize immediate gratification over long-term benefits, a tendency known as present bias.

Some people are naturally more disciplined savers and investors, while others may struggle to stick to a budget or investment plan. Personal factors such as these can have a significant impact on the financial outcomes of buying vs renting a home.

Build Equity from Buying a Home

A mortgage payment can be seen as a form of forced savings because with each payment, you’re gradually building equity in your home. Equity refers to the portion of the property that you truly own, free and clear of the mortgage. It’s the difference between the market value of your home and the outstanding balance on your mortgage.

When you first start making mortgage payments, a significant portion of each payment goes towards interest, with a smaller amount going towards reducing the principal balance (the original loan amount). However, as time goes on, the portion of your payment that goes towards the principal increases, and the portion that goes towards interest decreases. This is due to the way amortization works.

Amortization is the process of spreading out a loan into a series of fixed payments. At the beginning of your mortgage term, the majority of each payment is applied to interest, but over time, a larger percentage of each payment goes towards paying down the principal. This means that as you continue to make payments, you’re building more and more equity in your home.

Different mortgage terms and rates introduce additional variables into this equation. For instance, a 15-year mortgage will build equity faster than a 30-year mortgage because a larger portion of each payment goes towards the principal. However, the monthly payments on a 15-year mortgage will be higher.

Similarly, the interest rate on your mortgage will also affect how quickly you build equity. A lower interest rate means less of your payment goes towards interest and more towards the principal. However, interest rates are often tied to the length of the mortgage term, with shorter-term mortgages typically offering lower rates.

Tax Benefits of Buying a Home

In the United States, as a homeowner you can deduct mortgage interest from your taxable income, which can reduce the amount of income tax you owe. You can claim this deduction for interest paid on mortgage debt up to $750,000 for buying, building, or significantly improving your primary or second home. However, to benefit from this, the total of your itemized deductions, including mortgage interest, must exceed the standard deduction set by the IRS ($12,550 for single filers and $25,100 for married couples filing jointly).

Flexibility of Renting a Home

Renting offers more flexibility in terms of mobility. If you anticipate the need to relocate frequently for work or personal reasons, renting may be a better option. Owning a home ties you down to a specific location and can make it more challenging to move.

Market Conditions

The real estate market can be unpredictable, with fluctuations in housing prices influenced by a variety of factors including economic conditions, interest rates, and supply and demand.

In the past five years, the US property market has seen significant growth. This has been driven by a combination of factors including low interest rates, limited housing supply, and strong demand. The COVID-19 pandemic has also had a significant impact, with many people moving or buying homes due to changes in work and lifestyle.

In a seller’s market, where demand exceeds supply, home prices tend to be high. Buyers may face competition and may have to act quickly or offer above asking price to secure a home. This has been a common scenario in many parts of the US in recent years, with homes selling quickly and often above asking price.

On the other hand, in a buyer’s market, where supply exceeds demand, buyers may have more room to negotiate and may be able to secure a home at a more favorable price.

When considering buying a home, you should consider not only the current market conditions but also the potential for future appreciation or depreciation of property values. While real estate has historically been a good investment over the long term, short-term fluctuations can impact the value of your home.

Lifestyle and Personal Preferences

Owning a home comes with responsibilities such as maintenance, repairs, and yard work. Some individuals prefer the convenience of renting, as these tasks are typically the landlord’s responsibility. Evaluate your lifestyle and determine if homeownership aligns with your preferences and willingness to handle these tasks.

Long-Term Plans

Consider your long-term plans and financial goals. Are you planning to settle down in a particular area for a significant period? Do you have the financial stability to handle homeownership expenses? Assess your future goals and how owning or renting aligns with them.

Rent-to-Own and Lease Options

rent vs buy new home

Rent-to-own or lease-to-own options can provide a middle ground between renting and buying a home. These arrangements allow you to rent a property and then have the option to purchase it after a certain period. Here are a couple of specific scenarios to illustrate how these options can work:

Scenario 1: Rent-to-Own with a Portion of Rent Going Towards Purchase

In this scenario, you enter into a lease agreement with the property owner, but with a twist: a portion of your monthly rent is set aside and goes towards the future purchase of the property. This can be great if you’re interested in a particular property but aren’t ready or able to buy it outright.

For example, let’s say you find a home you love, but you’re not quite ready to secure a mortgage. You could enter into a rent-to-own agreement where you pay $1,500 in rent each month, with $500 of that going towards the future purchase of the home. After a set period, say five years, you’d have $30,000 ($500 x 60 months) set aside towards buying the home.

This also provides the owner with a guaranteed income for a longer period of time, potential for higher rent, and tenants that are more likely to treat the property like their own home.

Scenario 2: Lease Option

In a lease option scenario, you pay the owner an option fee for the right to purchase the property at a later date. This fee is typically non-refundable, but it secures your right to buy the property at a predetermined price.

For instance, you might pay an option fee of $5,000 for the right to purchase a home at $200,000 anytime within the next three years. If the home’s value increases during that time, you still have the right to buy it at the agreed-upon price, potentially saving you money. If you decide not to buy, the owner keeps the option fee.

Both of these scenarios offer a way to transition from renting to owning. However, they also come with risks and complexities, such as what happens if you decide not to buy or if you can’t secure a mortgage when the time comes. It’s crucial to have any rent-to-own or lease option agreement reviewed by a legal professional to ensure you understand all the terms and conditions.

These options aren’t right for everyone, but they can provide a path to homeownership for those who need more time to save for a down payment, improve their credit score, or simply want to try out a home or neighborhood before committing to a purchase.

Benefits of Owning a Home

There’s something undeniably special about owning your own home. It goes beyond mere financial calculations and enters the realm of personal fulfillment.

One of the significant advantages of homeownership is the predictability of fixed payments. If you have a fixed mortgage, your payment remains relatively stable over time. This allows you to budget accurately and plan for the future. Unlike renting, where landlords have the freedom to increase prices at any given moment, owning a home provides a sense of security.

Another aspect that sets homeownership apart is the control and freedom it affords. When you own your own home, you have the freedom to make modifications and updates without having to seek permission from a landlord. It’s your space to truly make your own.

Speaking of security, owning a home offers a level of stability that renting often cannot match. Your home is yours, and as long as you keep up with your mortgage payments, you don’t have to worry about being evicted because the property changes hands. It provides a sense of rootedness and the ability to plan for the long term.

Interestingly, inflation can actually work in your favor when you have a fixed mortgage. Over time, as the value of the dollar decreases, the amount you owe on your mortgage remains the same. In other words, you owe less in terms of real value as time goes on. It’s a subtle but advantageous effect that can help you build wealth in the long run.

One of the most beneficial aspects of homeownership is the potential for capital appreciation. Your home’s value can increase over time, potentially offering substantial returns on your investment. A home in my area that sold for $599,000 back in 1995 recently fetched $3.23 million. That’s a remarkable increase in value that outperformed the median home price appreciation in the United States by a considerable margin.

But homeownership isn’t solely about financial considerations. There’s something deeply fulfilling about owning a place to call your own—a place to retire and spend the rest of your life comfortably. It provides peace of mind and a sense of belonging.

Benefits of Renting

Renting, on the other hand, comes with its own set of advantages that make it a viable choice for many people.

One significant benefit is flexibility. When you rent, you’re not tied down to a particular home for an extended period. If you decide to leave your current city next year or even next month, you have the freedom to do so. Breaking a lease, though not ideal, is much easier than trying to sell a home.

Renting also simplifies your financial responsibilities. Unlike homeownership, you don’t have to worry about property taxes, maintenance costs, or other unforeseen expenses. Renting provides a level of simplicity and convenience in this regard.

Additionally, renting often grants access to amenities that may be financially out of reach for homeowners. Large apartment buildings in major cities often offer desirable perks like doormen, gyms, pools, and communal spaces for gatherings and events. These amenities can enhance your quality of life and provide a level of convenience that might be harder to achieve as a homeowner.

One of the most referenced studies in this area is the yearly Buy vs. Rent Index by professors Eli Beracha and Ken H. Johnson. This study compares the relative wealth creation between buying a home and renting a similar-quality home and investing the saved cash flow into a portfolio of stocks and bonds. The study found that in some cities, depending on the year, renting and investing the saved cash flow can outperform owning and building equity, in terms of wealth creation.

Wrapping Up

When it comes to deciding between buying vs renting a home, you need to consider your personal circumstances and evaluate the numbers specific to your location. Currently, with high mortgage rates, renting may appear more appealing in the short term. However, if you have a long-term outlook and plan to stay in one place for several years, buying a home can provide significant upside in terms of investment potential and personal fulfillment.


  • Amber Aldridge

    Amber Aldridge is a Lead Writer at MoneyMaver covering personal finance, budgeting, and debt management. Amber passionately champions the cause of individuals who feel excluded or overlooked in the present-day economy. She is deeply committed to supporting and empowering those who face challenges in today’s economic landscape. With her background as a teacher, she adeptly shares practical advice that truly benefits families striving to manage their finances. “Learning about and making the most of budgeting and debt management has profoundly transformed my life. Being a single mom of 2 kids, I draw from my real-life experiences, and love passing that knowledge onto my readers”.

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