By Rachel Podnos, JD
Learn more about Rachel on NerdWallet’s Ask an Advisor
“Paying rent is like flushing money down the toilet.” Everyone’s heard that one. It’s rare to have a conversation about buying versus renting without that old adage being thrown in. Something else you hear in these conversations is that buying a home is a good investment. The thing is, neither of these things is necessarily true. Like most things in life, it all depends on your situation.
There are certainly benefits to owning a home versus renting: You cannot be evicted (but you can be foreclosed on), you could make a profit if you sell at the right time and, if you stay long enough, your home will be paid off. However, there are many situations in which renting is the more reasonable strategy, in both the short term and the long term. Here are a few reasons why:
Building equity does not equal a good investment
Many people think that because you can build equity in a home, a home is a good investment. But you can build equity in your home for many years and still sell it at a loss. The amount of equity you have in your home has no bearing on whether you will come out ahead if you sell it. What matters is whether you can sell it for more than you paid for it, taking into account the costs involved in the sale, such as real estate commissions. You are at the mercy of the real estate market. Many learned this the hard way in the years following 2008.
The costs of ownership can be very high
When comparing the costs of owning and renting, people tend to consider only the amount of the mortgage payment versus a month’s rent. When you do this, owning often does look like the more economical option. But ownership carries other costs that are frequently overlooked.
Consider this typical assessment of the yearly costs of owning a home (as a percentage of the home’s value; percentages may vary depending on where you live):
- 3% to 4% for mortgage costs
- 1% to 3% for property taxes and insurance costs
- 1% to 2% for repairs and delayed maintenance (such as a new roof)
I have a client who rents a home valued at around $450,000. He pays $30,000 a year in rent (or $2,500 per month). His landlord’s total costs of ownership are about 8% of the fair market value of the home, or about $36,000 a year. His landlord is essentially subsidizing him by $6,000 a year to live in the home. This situation is not uncommon for clients of mine who choose to rent rather than own.
Likelihood of being able to sell for a profit
If you’re thinking about buying a home because it is a good investment, consider that the historical long-term, inflation-adjusted returns of the U.S. residential real estate market are around 1% a year. For perspective, the long-term historical returns of the U.S. stock market are around 7% a year.
Cost of reselling
In addition to the not-so-stellar returns of the residential real estate market, the cost of reselling can be as much as 10%. This further erodes your chances of making a profit off of your home.
Intangible Benefits of Renting
Finally, there are many intangible benefits to renting that you can’t put a dollar value on. I choose to rent, and for me, the flexibility and ease of living it gives me are invaluable. I love the freedom of not being tied down — it gives me great peace of mind. I also love not having to worry about maintenance and repairs. My building’s maintenance service is just a phone call away, and they are able to come at a moment’s notice, regardless of whether I am home.
To sum it all up, do not listen people who tell you that renting is flushing money down the toilet. There are many good reasons to rent rather than buy, and you should thoroughly research the net cost of both options before making a decision.
Image via iStock.