Should I Buy or Rent? Comparing Housing Costs

Homeownership is seen as security and status. A survey conducted by Chase found that two-thirds of millennials are determined to reach their goal of buying a home. 

But is buying a home the right choice financially? 

There’s certainly a plethora of information out there presenting a seemingly final answer to the question above, but nothing in personal finance is one-size-fits-all.

Buying isn’t always better than renting, nor is renting always better than buying. Instead of making any claims for one or the other, this post will instead give you all the information you need to run the numbers and make the best decision for your situation.

Specifically, we’ll break down all of the expenses associated with buying a home, and compare them to the expense of renting. I also made a calculator so you could conveniently run the numbers for yourself. (It’s near the bottom if you want to skip ahead.)


The Cost of Renting

The numbers behind the cost of renting are really straightforward. It’s simply what your monthly rent payment is. Your landlord is the one responsible for taxes, maintenance, and other expenses.

The only thing to note here is that (obviously) none of that rent payment ends up back in your pocket. It’s purely an expense, whereas some of your monthly payment when you own a home goes into the home’s equity.

Everyone is aware of this, and it’s what encourages many to want to own a home, because who wouldn’t want to pay themselves instead of their landlords?


The Cost of Buying a Home

It’s true when you buy a home that your monthly payment is contributing to your equity in the home, and therefore your wealth. This benefit makes homeownership much more appealing than “throwing away money on rent”. However, there’s a lot more to it than that.

Your monthly mortgage payment covers the following items:

  • P&I
  • This is the heart of the mortgage. You are paying down the principal of your mortgage plus the interest that your lender charges you on that loan. You can use an amortization calculator to see a detailed breakdown of how much of your payment goes to the principal (and therefore your equity), and how much interest you will pay for the duration of that mortgage.

    You can also simply divide the amount of the mortgage by the mortgage’s term (in months) to get an effective average of how much of your payment contributes to your equity every month. I’ll give an example of this below.

  • PMI
  • This is Private Mortgage Insurance. The most important thing to note about PMI is that it protects your lender, not you. This is an insurance policy that your lender holds to protect themselves in the event you stop paying your mortgage. PMI is typically required if your equity in the home is less than 20% of the home’s value.

  • Homeowner’s Insurance
  • This is a policy that protects you and your property. The amount you have to pay for homeowner’s insurance varies with the size of the property, location, condition, age, and other factors, such as how much your deductible is for that policy. You can find the average cost, by state, for homeowner’s insurance premiums online. However, to get the most accurate number possible, you will want to get a quote.

  • Property Taxes
  • Property taxes vary by location. Typically, you will pay property taxes to the city, county, and school district in which you reside. These are applied as a percentage of the home’s value.

    Nationally, the average effective tax rate is 1.1% of the value of the home per year. The median home value in the US is $346,800 (as of Q4 2020). This would amount to $3,814.80 per year, but this obviously can vary quite widely around the country. Here in Austin, TX, property taxes are around 2%, so the taxes on a $300,000 home would be $6,000 a year! ]

    The best way to get an accurate number is to visit the website for your county’s tax office and look up the property’s address.

  • HOA
  • These cover things like private roads in a housing community or shared amenities. Not all homes are in an HOA, and HOA fees can vary quite widely. Be sure to check the fees for your HOA, if applicable, and also read the HOA’s bylaws.

    (You can click on each one to expand additional details).

    Other Numbers to Consider When Buying a Home

    Maintenance

    When you own a home, you’re the one on the hook for maintenance and repairs. Depending on the age, condition, and location of the property, your budget should include at least 1% of the home’s value for annual repairs. This isn’t part of your monthly mortgage payment, but it is good practice to set this money aside every month so you’re not hit with a surprise repair that breaks the bank. For the median-value home, this would be $3,468 per year, or just under $300 per month.

    Tax Deductions

    Property taxes and mortgage interest are deductible items on your taxes, but this requires itemizing. 

    An owner of a $250,000 home paying the national average property tax rate (1.1%) and 2.98% interest (mortgage rate for a 30-year loan, at time of writing) would pay $12,004.80 on taxes and interest during the first year of the loan.

    Note, the standard income tax deduction for a single filer in the US is $12,400 ($24,800 for married couples). Unless you spend more than $12,400 on your property taxes, mortgage interest, and other deductions throughout the year, then you should take the standard deduction. That is to say, you will not save any additional money on your taxes by owning a home. (Your numbers will vary.)

    Crunch these numbers yourself, or speak to a tax professional, to determine if you will be able to save any money on your taxes by owning a home.

    Closing Costs

    Closing costs cover a variety of fees associated with completing a mortgage and home purchase. These typically range from 2% to 5% of the value of the home, and you pay them upfront. This would be $6,936 to $17,340 for the median-value home in the US.

    Running the Numbers

    The only part of your mortgage payment that goes to your equity (and therefore your wealth and net worth) is the Principal.

    Interest, PMI, Insurance, Property Taxes, and HOA fees are all expenses – money you will never see again.

    This likely isn’t a surprise, but what may be a surprise is how much all of these costs add up. In fact, less than half of your mortgage payment goes to the equity in your home.

    Example

    Here’s a breakdown of what it would look like for the “average” home in the US. I’m using the average and median values that I listed in the drop-down menus above that the different parts of a monthly mortgage payment.

    • Home Value: $346,800
    • 20% Down Payment (so no PMI expense)
    • An average $1,476 per year for Homeowner’s Insurance
    • 1.1% Property Tax Rate
    • 1.0% set aside for Maintenance

    As you can see, only about 40% of the mortgage payment is actually going to equity, and the majority of it is expenses! Keep in mind, the numbers may vary considerably depending on where you live. For example, living in Austin, I would have to pay almost twice as much in property taxes!

    Run the Numbers for Yourself – Should You Buy or Rent?

    I made a calculator that you can use to see what portion of your monthly payment goes to your equity versus expenses. Try it out!

    Make sure to fill in all the values, and if something behaves strangely, please let me know! I will fix it.

    Also, if for some reason it’s not loading (it should be directly underneath this line), you can open it in a new page here.

    Summary

    The decision to buy a home is as much a personal and emotional decision as it is a financial one. And, of course, your location and situation probably vary from the numbers described above. For example, you probably wouldn’t be able to find a home to rent for $1,100 per month if the median-valued home in that area is $346,800. In my location though, the property tax rate is double what we used in our example, and rent is relatively more affordable, so I found renting to be more favorable.

    Educate yourself on the different aspects of homeownership, run the numbers to know what your monthly expenses will be, and decide what works best for you.

    What do you think of buying versus renting? Let me know in the comments!

    3 comments

    • Great food for thought. Could you give some advice on how to get good estimates for insurance and maintenance costs?

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      • For insurance, the quickest method is to Google some averages for your area. Here’s a good list that mentions the average annual premium for each state in the US: https://www.bankrate.com/insurance/homeowners-insurance/homeowners-insurance-cost/
        To get a precise estimate, you would want to get a quote. Your current insurance company (for other things you may have like auto, renter’s, etc.) is a good place to start. You could also ask friends or family who already own a home in your area.

        For maintenance, the process of buying a home typically includes an inspection which looks at just about everything (electrical, plumbing, roofing, the foundation, HVAC, etc.) You can then get a quote for any repairs that may be needed. This gives you an idea of upfront maintenance costs. From that point forward, one of the general rules, like 1% of the value of the home per year, is a good place to start.

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