Pickering / Ajax Real Estate Blog

By James E. McWhinney – Investopedia.com

When making the decision either to rent or buy a place to live, there are two broad categories of factors that must be considered. The first and most obvious category represents the financial aspects of your decision. The second category is a set of personal and emotional factors, which are more intangible but play an important role in the decision to rent or buy. Here, we look at the financial factors, including the initial and ongoing costs as well as the long-term pros and cons of owning your home.

Examining Your Finances

The first step in the decision-making process is to determine whether or not you can afford to purchase a home. Issues to consider include your ability to make a down payment (generally between 5% and 20% of the home’s purchase price) and pay closing costs (which may be an additional 5%). These costs are likely to exceed substantially the initial payment and security deposit that would be required if you were renting instead of buying. Of course, having enough money to cover the initial purchase of a new home is only half of the battle.

Before moving into your new home, you’ll need to put some thought into how much it’s going to cost you to stay there after you take up residence. Many financial experts suggest that your monthly mortgage payment not exceed 28% of your gross monthly income and that your total monthly debt payments not exceed 36% of your gross monthly income. If you go beyond these limits, you may run into trouble because, in addition to paying the mortgage each month, you have to factor in home maintenance. From carpet to window coverings, new appliances to a new roof, everything costs money and nothing lasts forever.

Renting may be a little easier on the pocketbook because it provides a fixed-dollar cost for monthly expenditures, which are paid simply with the rent. Besides perhaps increasing from year to year, the rent remains steady. And, if maintenance issues arise, the landlord pays for the repairs. Instead of spending your money on a new roof, you can invest it or spend it as you like.

If you’ve done the math and can afford to make the initial purchase and service the ongoing debt, the next factor you have to decide is whether this purchase benefits you financially. A rent-controlled apartment in New York City, or a place in a suburban location outside of a major city, quite possibly charges a month’s rent that is significantly less than a monthly mortgage payment for properties within the city.   Of course, even if the monthly cost of renting is less than the cost of buying, there are long-term financial considerations that must be taken into account.

Long-Term Cost/Benefit Analysis

Proponents of buying often cite the ability to build equity, the tax breaks and the investment value of a home as solid reasons to buy instead of rent. While these arguments have merit, there are downsides to all of them. This chart outlines the positive and negative long-term realities of the equity, tax breaks and investment value associated with buying a home.

Equity

Some of the money that you give to pay a mortgage goes directly toward building equity in your home. You will never again see any of the rent money that you pay.   Home equity can serve as collateral for a loan, enabling you to convert the equity into cash.

Equity takes time to build, and payments made during the first few years of a mortgage go primarily toward interest on the loan. Should you move after living in a home for only a few years, you may have little or no equity in the property. And after the costs of selling the home, you could end up losing money.

Investment

Real estate in the form of your primary residence is likely the single largest asset in your portfolio. Over the long term, price appreciation can be significant. Many homeowners downsize their primary residence when they retire; they sell at profit, purchase a less expensive home and use the profits to supplement their income.

While history shows it is likely that your home will appreciate over time, there are no guarantees. There are always areas of the country where homes have lost value, and owners are unable to sell them at a price equal to or greater than the purchase price.

Do the Calculations

A variety of online calculators are available to help you evaluate the financial aspects of the rent versus buy decision, but keep in mind that you need to estimate a range of variables that includes the number of years you will stay in the home.

And to estimate the investment profit the home will provide for you, you must assume the yearly rate of appreciation on the home’s value. The results provided by a calculator and the investment evaluations you make are only as good as the assumptions used to calculate them, and don’t forget to consider the cost of ongoing maintenance. After you have carefully considered the financial issues, it’s time to explore the non-financial issues.

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