Rent or Buy – Which is Better?

The American Dream is often associated with owning your own home. The numbers have varied in the US, but over the last 50 years or so the percentage of householders owning their own home has stayed between 63% and 68%. The number is much lower with minorities, often due to social inequality considerations and the barrier to entry. But if you are a middle aged, white family there is a close to 90% chance you own your own home, either outright or through a mortgage.

While numbers vary country by country, it is noticeable that in places like France and Germany the percentage of ownership is much lower.

In the US at least the maxim is very much that you must own your own home, that renting is a bad thing. But is that really the case?

If you own your own home, great you have stability. Chances are though you are still paying off a mortgage; hopefully this is at a low rate or you have refinanced to get a lower rate. Alternatively you have an adjustable rate mortgage (although these are less common in the US than in other markets). However if you are uneducated in financial matters you might be stuck with a high mortgage rate and not realize it.

Then you have to pay property taxes, these often depend on your state or city but often run to 1-1.5% of the assessed value of your property. Upkeep is also important, the rule of thumb here is typically to spend 1-3% of your house value each year in upkeep.

Other fees might include, home insurance (which is usually more expensive than renters insurance), Home Owners Association (HOA) Fees, condo fees etc. It adds up.

If you rent, although you might not have the security, a lot of that extra cost goes away. Got a problem? Simply call up the landlord, or management company. However that lack of security can be a big thing. Once when we were living near London, we were living in a  nice house, on a year’s lease. About six months in we got a letter from the management company saying that the owners were returning from the far east early and would like to move back in their house in a month. The fact we had a year’s lease didn’t matter, they were allowed to break it. It also was kind of insulting that they sent us a form letter, rather than calling us to talk to us.

That level of potential instability can be a great weight on the mind.

However renting does have a great mobility factor, so if you do want to move you can very easily do so without worrying about the stress of selling a house. Also for most people their house is their biggest asset, so having a large chunk of their net worth in an undiversified item is a big risk. By renting you can diversify the money you would have spent on a house into other vehicles.

The big pro that people talk about with buying a house is the simple increase in the value of the house. Nationally the US house market grew by 6.8% a year from 1968 to 2004. But then the market started to fall, although it has recovered in the last 5 years or so there has been a lot of instability the last 10-15 years. So if we are being generous we could say your house might on average grow 5% a year. However we have already established earlier that we have to put in around 3-4% of the cost a year in taxes and improvements. So the overall rate of return is really only 1-2%.

Lets let at a couple of  hypothetical examples over 10 years.

  1. Buy a house – $300,000 (approx average US house price)
    1. After 10 year’s this is worth $300000 * 1.05^10 = $490,000
    2. Property Taxes (to keep it simple lets just do 1.5% of $300,000 each year) = $45,000
    3. Up keep (again to keep it simple lets call it 3% of $300,000 each year) = $90,000
    4. Insurance etc, lets say $2,000 per year, so over 10 years that’s $20,000
    5. Total gain is $190,000 – $45,000 – $90,000 – $20,000 = $35,000
  2. Rent a house – rule of thumb is 1% of house value per month in rent, so $3,000 per month.
    1. Total rent is $360,000 (of course rental prices might go up over time), so lets simplify to $400,000
    2. Invest the $300,000 rather than buy house assume 8% annual return, $300,000 * 1.08^10 = $650,000. i.e. made $350,000
    3. Renter’s insurance is maybe another $5,000 over 10 years.
    4. So total loss is $35,000 – $400,000 – $5,000 = $55,000

Sure, this is back of the envelope, but buying is better, but it’s not hugely better.

While owning a house is desirable, I don’t think renting is necessarily a bad thing, you have to look at your family situation and make the decision that is right for you. If you think you will move in the next few years maybe you should rent?

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Gary W

Really the only reason to own your house is to own your house. It’s yours, and owning gives you the feeling of permanence. It’s also probably going to be nicer overall because you can modify it the way you want. Then, yeah, in 30 years you own the house and congratulations, you own a really old house that needs a complete remodel if you want to sell it! By the by, in your analysis, you didn’t include interest on the house loan. That sorta implies you pay cash for your house, which all the FIRE folks seem to do since… Read more »