November 30, 2020

Why I tell clients to rent even if they can afford to buy

By haziqbinarif

To many, buying a home is the American Dream. Homeownership is also considered one of the key factors in building wealth. Many stretch the limits of their budgets and often spend more than it would cost to rent. As a financial planner, I see this all the time with my clients, and I’ve experienced it firsthand. 

I bought into the American Dream early in my career and was convinced that renting is throwing money away. In 2009, at the age of 27, I purchased my first home. After living the “American Dream” for nine years, I decided to sell my house and downsize. Here are the factors that led to my decision, and why I favor renting at this time.

The true costs of homeownership

Homeownership can be far more expensive than renting when you add up all of the costs. When I purchased my house, I made a 3.5% down payment and paid several thousand dollars in closing costs (even after a generous credit from the seller). A good estimate for closing costs is 2-5% of the home’s value. 

In addition to my mortgage payment, I was responsible for private mortgage insurance, property taxes, and homeowners insurance that was almost 10 times the price of my previous renters insurance policy. Depending on the size of your down payment and your credit score, PMI can cost between 0.2% and 2% of the mortgage.

The homeowners association charged an initial fee that was due at closing. I also paid annual HOA dues that increased significantly during my time in the neighborhood, and was charged a special assessment for deferred maintenance of our common grounds. All in all, my mortgage (including PMI, property taxes, and insurance) was 30% higher than my rent at the time. Of course, that did not include ongoing home maintenance. 

Once I was in the home, the costs really started to add up. My house was twice the size of my apartment and I had an open floor plan with lots of windows. This resulted in hefty utilities in the peak summer and winter months. Regular maintenance cost thousands of dollars each year and included yard work, pest control, a termite bond, gutter cleaning, and HVAC maintenance. 

I also had to take care of some deferred maintenance and make several repairs over the nine years. I was ripped off on multiple occasions as a single woman, despite my efforts to obtain multiple quotes and get advice from friends. I paid thousands of dollars for shoddy work, some of which had to be redone. If you’re still holding out for the American dream, I suggest setting aside 1-2% of the home’s value annually for maintenance and repairs.

I barely broke even when I sold my home

When I sold my home in 2018, the sale price was just over $100,000 more than what I owed on the mortgage. Real estate commissions and closing costs were just over $20,000. When I add up the amount of money I spent on the down payment, closing costs, and house maintenance over the nine years I lived there, I barely broke even. The growth in the home’s value averaged about 3% per year, which is close to the national average for real estate. 

Buying a home is almost always more expensive than my clients’ current living situation, and they underestimate the true costs of homeownership. Also, many of my clients spend years saving up enough money for a down payment and lose out on the opportunity to invest. Some who are opposed to debt are tempted to use all of their extra resources to pay off their mortgage early and end up falling behind on building retirement savings. 

As a renter, my monthly expenses are very similar to the monthly costs of owning my home. They’re more predictable and straightforward because I only have a few bills to pay each month. When something breaks, I’m no longer responsible for finding someone to fix it, and there’s no surprise bill. I also downsized, so I don’t have the hassle of cleaning and maintaining such a large space. Overall, I’m happier and less stressed. 

One of the arguments for buying over renting is that rent goes up each year. The principal and interest on your mortgage indeed remain the same year over year. As your home increases in value, the chances are that your property taxes and insurance also increase. Additionally, as your home gets older, you’ll have more ongoing maintenance and repairs. You may spend money on renovations throughout the years, which isn’t necessarily a good return on investment. 

Building equity (and building wealth)

There are only two ways to build equity with a primary residence: paying down the principal on your mortgage, and appreciation in the value of your home. Putting little or no money down on a house and relying on appreciation alone is not a good strategy. 

While some areas see higher appreciation in residential real estate than others, the national average is 3-5% per year. With traditional mortgage amortization, you pay more interest than principal in the beginning. It takes years to get to the point where you start to pay down the principal at a significant pace. Either way, you need to stay in a home for close to 10 years before building meaningful equity.

While a home can be a good way to build wealth, it can also sabotage your finances. One of the biggest financial mistakes I see is buying too much house. Even worse, having little or no savings after making the down payment can lead to more debt. More debt means more fixed expenses and more financial stress. 

I’ve also seen people wipe out the equity in their home when refinancing. If you take out equity in your home by doing cash-out refinances or use the equity in your home to consolidate debt, it’s harder to build wealth through your home. Even when you refinance to lower your interest rate, you start the amortization cycle all over again and most likely extend the loan term. When you roll the closing costs into the loan, you end up with a higher mortgage balance. 

Building equity in a home can help you build wealth, but it only works when you stay in the house long enough for the value to appreciate and you don’t borrow against the equity.

When does it make sense to buy?

There are many times when buying a home makes sense. I encourage clients to buy a home when they’re prepared to live in the house for at least seven years. Anything less, and your equity could be wiped away by real estate commissions and closing costs when you sell. 

I recommend having a solid emergency fund in addition to the savings needed to purchase the home. Having healthy finances going into a home purchase can prevent a lot of unnecessary stress and worry. A low debt-to-income ratio and good credit are a must.

You should also be in a position where you can put at least 10% down. A 20% down payment is ideal to avoid PMI, but 10% allows you to go into a home purchase with some equity, and it shows that you’re financially prepared. 

Homeownership should fit your lifestyle needs. If you’re looking to raise a family, have pets, make a home your own, or want to feel settled, homeownership is a good choice.

Finally, you should be prepared for the responsibility of homeownership. As I illustrated above, it’s not for the unprepared or faint of heart. Condos and townhomes are less maintenance than a single-family home, but they still come with a certain level of responsibility. 

Now that I’m older (and wiser), I believe that buying a home should be more of a lifestyle decision and less of an investment decision. Investments provide income or grow in value over time, while a primary residence requires ongoing cash flow to maintain. Renting gives me the ability to save and invest more. I’ll probably own again at some point, but I have no desire to own a single-family home again. In the meantime, I’m enjoying the stress-free — and predictable — life of renting.

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