Buying a home is one of the biggest financial decisions that a person can make in adulthood. For many people, this is seen as a part of the “American Dream.” In fact, many older adults will tell those in their 20’s and 30’s that renting is a waste of money or about their regrets over not buying sooner.
However, buying a is not a good idea for everyone and should not be entered into lightly. While it can feel empowering to own your home rather than rent, it can come with significant costs and limitations. If you’re having a hard time deciding which option is best for you, consider the pros and cons of owning a home versus renting.
Advantages of Homeownership (and Disadvantages of Renting)
Owning a home is a major goal for many people, and it can come with several important advantages.
#1: Long-Term Investment
It’s crucial to think long-term during the homebuying process. As a rule of thumb, people are encouraged to purchase a home if they plan on staying there for five years or longer. This gives the property time to grow in value to make up for the significant costs associated with buying and selling real estate.
Plan on maintaining or improving the condition of your property, as this is what makes for a good long-term investment. Even if the value of your home depreciates, the land itself may become more valuable.
#2: Building Equity & Credit
Equity is the difference in the value of your home and what you still owe on it. Every time you put a payment toward your mortgage, your home equity grows. Early on, most of your mortgage payment goes to interest, but your loan decreases more rapidly after a few years. Equity can help strengthen your portfolio, as it can help you build wealth over time.
#3: Building Credit
Having a mortgage and making your monthly mortgage payment on time can help you improve or maintain your credit score. That said, if you want a good interest rate, you should aim to have relatively good credit already when you apply for a mortgage. While it’s important for renters to pay their rent on time, it typically does not improve their credit score.
#4: Stability & Consistency
Obtaining a fixed-rate mortgage means that you will pay the same amount each month for interest and principal until the mortgage has been paid off. The property tax, insurance, and other costs may increase over time, but the bulk of your payments are unlikely to keep up with inflation. Having a stable mortgage payment can help you avoid increases in your housing expenses. Conversely, rent can increase with every lease renewal or move.
Since you own the property, you can renovate it however you want. Renters do not enjoy this benefit; any landscaping or home alterations would be subject to a landlord’s approval. Being able to renovate and update your home gives you the potential to increase both its property value and, just as importantly, overall satisfaction while living in your home.
Disadvantages of Homeownership (and Benefits of Renting)
There are some notable disadvantages to homeownership that any potential home buyer should keep in mind.
#1: Upfront Costs
While renters typically only pay a security deposit upfront (which is usually returned at the end of the lease), closing costs on a mortgage are frequently over 2% of the purchase price. Since some of them are fixed, the lower the cost of the home, the higher the percentage closing costs, which can create an extra impediment to buying a “starter home.” For those buying a more expensive home, the variable costs can be a significant amount of money.
Some closing costs include:
- Property taxes
- Mortgage insurance (if less than a 20% down payment is made)
- Home inspection
- First-year insurance premiums
- Title search
- Title insurance
While a down payment is important, it’s not the only cash you’ll need to purchase a home. If you’re purchasing a $300,000 home, closing costs could easily be well over $6,000 in addition to your down payment.
#2: Less Flexibility
If you have a job that requires you to move often, going through the process of homebuying may not make financial sense. Even if you sell your home relatively quickly, it can easily take at least a few months to buy and sell a home. The chances are that you will not close on the sale and purchase within a few days of each other. So, if you must relocate quickly, this can mean paying a second mortgage for a newly purchased home or rent for an apartment as you work to sell your home. With rentals, you have the freedom to leave once your lease is up, or your landlord may allow you to find someone to take over your lease if you need to move before your lease is complete.
#3: Maintenance Costs
If something breaks in your home, you are the one that must pay for the repairs, and many homeowners choose to perform their repairs as well. While renting, a landlord or property manager will be responsible for covering repairs. You usually do not have to worry about painting, landscaping, or roofing. Some apartments are even available to rent completely furnished, so you would not need to purchase furniture.
#4: Property Values Can Fall
If you do not maintain your home or the housing market takes a downturn, your property value may fall. There is no guarantee that your home’s value will increase. In the second half of the 1900s and into the first few years of the 2000s, it seemed that property values could only increase. But, when the bubble burst, many people lost a great deal of money on their home purchase. All too often, the people who wanted to sell their homes couldn’t do so because they owed more than the house was worth.
#5: Home Costs Lack Liquidity
While houses do have value, they usually do not sell as quickly as stocks or other assets. Even if you are in the process of trying to sell your home, you still have to maintain your home and make mortgage payments.
Every individual has a unique situation, so for some people, it may make sense to purchase a home while others will benefit from renting. The pandemic has certainly changed how we live, so consider all these factors when deciding what your next move should be.
Contrary to what “conventional wisdom” might say, buying a home is not an ideal financial move. If you’re considering buying a house, be sure to evaluate the cost and benefits of homeownership as well as your motivations to purchase a home. If you are considering a home purchase, you may want to consult your financial advisor on whether it makes sense for you and how much you should spend. (Hint: the amount you can afford is not the same as the amount the bank says they will lend you).
Thinking about buying a home? Schedule a free phone consultation with us today.
This content is developed from sources believed to be providing accurate information and is provided at least in part by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information and should not be considered a solicitation for the purchase or sale of any security. Original content of Practical Financial Planning, Inc. only is copyright © 2021by Practical Financial Planning, Inc.