A big part of our financial coaching and education is designed for people who are considering homeownership for the first time. To make a good decision about whether pursuing homeownership is the right move, right now, it’s important to compare the differences of being a renter to being a homeowner. Having access to relevant information will help you weigh all of the benefits and trade-offs between the two.
Here are some key ways homeownership is different from being a renter:
Insuring your home is generally much more expensive as an owner than a renter. Renter’s insurance is designed to cover your personal property only, while homeowner’s insurance covers both the actual structure itself as well as your personal belongings and property.
If you have a mortgage, homeowner’s insurance is a requirement of all lenders, and there must be enough coverage, at minimum, to cover the cost of the dwelling itself. In a rental situation, the property owner typically has dwelling-only coverage, therefore a renter’s personal property-only policy is generally the choice of the renter to obtain. We do, however, definitely recommend you do so to protect your personal items from fire, theft, or other types of covered loss or damage.
When you are a homeowner, a portion of every mortgage payment you make typically increases the excess value, more commonly known as equity that you have in the home. Each mortgage payment you make has a portion paid for interest, which the lender keeps and a portion that reduces the unpaid principal balance. If, for example, your total monthly house payment is $1200, $85 of it would cover insurance, $210 to taxes, $630 to mortgage interest, and the remainder $275 would reduce the principal balance and that portion is considered additional equity in the property.
As each payment is made, the amount paid directly to the outstanding principal balance increases as the amount of interest decreases. As more payments are made, the total portion of reduced principal serves to build equity in your property. This, in turn, is a form of savings that eventually translates to a more valuable asset. Some people borrow against that equity to make home improvements, sell the home and take equity in cash, or use it as a down payment on their next move-up home.
Renters, conversely, do not build any equity. The rental payments to the landlord are just that, payments.
So as a homeowner, you are generally growing equity as you make each mortgage payment, and as a renter, there is no savings or equity wealth accumulation.
Besides building equity from your monthly mortgage payments, generally, over time, your home’s value will appreciate. Under normal market conditions and depending on your location and property condition, it’s assumed that a home’s value could appreciate or increase each year. The amount of increase is very market specific and it’s important to understand that there is also a risk that property values could decline. If your area has low demand, rising crime rates, or aging properties that aren’t being maintained, property values could fall. Things like the quality of schools and the local government could also have a significant impact on your potential appreciation.
When it comes to considering appreciation in the homeownership decision, the unknown property values, both appreciation or depreciation factors make homeownership a higher risk versus a rental situation. Being a renter in a location with great schools may be more expensive than being a homeowner in an area with high crime rates.
Consider our example from point 2, above. Over the course of 5 years, you might build $18,500 in equity from the reduction in your principal balance. If the property value appreciates by 5%, it will be worth an extra $55,250 after 5 years. So appreciation can build your wealth twice as fast as your payments to equity. Now after 5 years you could have $73,750 in total equity and appreciation. As a renter, you would have zero in either.
As a homeowner, you are inherently making both a commitment to the property itself and also its location and surrounding neighborhood. If issues arise that are detrimental in any way, as a homeowner, versus a renter, it’s not so easy to just pack up and relocate. In addition to the basic costs of moving, there are also transactional costs associated with initially buying and later selling the property. There are sizable transactional costs when you sell your home—property inspections, real estate taxes, closing costs, miscellaneous fees, and, if using a realtor to sell the property, usually 6% of the sale price will go to covering their commission. If there’s a good chance you will want or need to relocate within the next few years, buying a home right now might not be a wise financial idea.
Renters are free to leave when their lease ends, and under certain situations, a landlord may be willing to end a lease early, but usually with a cost. This is usually much less expensive than the costs of selling your home.
As a homeowner, you are the sole party responsible for all of the maintenance and repairs to the property. These costs might include repairing the roof and siding, broken windows, heating and air conditioning maintenance, lawn care, snow removal, plumbing, electrical, painting, and pest control. As a renter, typically this upkeep is the owner or landlord’s responsibility.
Property Tax rates vary widely and are set by the location, city, county, and state. While a homeowner will pay taxes directly, a landlord will generally factor the tax rate they are paying into the rental amount that you ultimately pay.
The big difference between homeownership and renting here is the personal tax benefit currently associated with homeownership. Under the current tax code, all amounts you pay in mortgage interest is 100% tax deductible (up to $1,000,000 in mortgage debt, the limit is $500,000 if married and filing separately). The final impact depends on your personal financial situation and overall tax liability. As a sole renter, however, there is no associated tax benefit other than a potential small renters’ credit.
As a homeowner, you are generally free to modify the property however and whenever you like (subject to building code, community related regulations, and the like). Want to build a deck out back? Plant a garden? Change paint colors or tile the bathroom? You are free to do all of these things if you’re a homeowner. As a renter, it’s unlikely that you will have such liberties and will have to get your landlord’s permission for every little and big thing done to the property. Additionally, if you make or pay for any changes that increase the value of the property, the property owner will benefit, not you.
Even in rent-to-own situations, until you are the actual homeowner, pay for and doing improvements is usually not a good idea. When the time comes for you to purchase the property you’ve been renting, the appraisal will take into account the improvements, (and will not consider that you paid for those directly), thus increasing your cost of buying assuming the property. This can be a rude awakening for many people who enter into rent-to-own arrangements.
You can see that renting vs. buying isn’t a clear-cut decision. If you think you might move frequently, renting might be better. You might also want to rent if you don’t like the idea of performing or paying for regular maintenance on the property. Financially speaking, however, homeownership is more often than not the better option. In the end, homeownership is a path that helps you build wealth, while renting simply does not.
Remember that even though renters don’t see a bill for property taxes or pay the property insurance, the owner or landlord has factored those costs into your rental payment amount.
Whether you are a current renter who wants to become a homeowner or an existing homeowner that needs help in budgeting and debt management, we’re available with coaching, counseling, and advice about budgeting, debt repayment, or any step of the homeownership process. Call today for credit counseling (https://www.credit.org/credit-counseling/) or pre-purchase homebuyer education (http://www.homeownership.org/first-time-home-buyer-programs/).