For many years it has been said that it is silly to be paying rent when you can own your own home. However, the argument of renting vs. owning is not as cut and dry as it used to be.
Minimal Tax Benefit of Buying vs. Renting
At some point, you may have heard that the tax benefits of owning a home clearly out weight the tax benefits of paying rent. While this was true under prior tax laws, the Tax Cut and Jobs Act of 2018 (TCJA) has nearly eliminated the tax benefits of homeownership. Accordingly, under current tax laws, renters and owners now pay nearly the same federal income taxes.
A Security Deposit vs. 20% Down Payment
A renter is typically required to put down 1 or 2 months’ rent as a security deposit. To purchase a home the lender requires a down payment of 20% to avoid a type of mortgage insurance called Private Mortgage Insurance (PMI). Therefore, in order to purchase a $250,000 home, you will need a down payment of $50,000, plus approximately $8,000 for settlement costs.
A 20% Down Payment Is For More Than Just Avoiding PMI
There are all kinds of ways that you may be able to get around putting down 20% on a home purchase to avoid paying PMI. Mortgage brokers have methods to avoid the 20% down payment and then there is always a gift from a parent for the down payment. I have found that those that cannot save 20% on their own for a down payment for a home may not have the financial discipline necessary to be a homeowner. The cost of homeownership along with other financial responsibilities becomes too much for them to manage. Credit card debt and bills start piling up and they don’t have the knowledge and experience to work their way out of it. Therefore, for your own good, demonstrate that you are financially ready to be a homeowner by saving 20% for a down payment on your own.
28% Rule for Mortgage Payments and 20% Rule for Renters
The 28% rule states that your total mortgage payment of principal and interest (P&I), real estate taxes, and homeowners insurance should not exceed 28% of your monthly gross income. A couple making gross wages of $13,333 a month ($160,000 annually) should be able to afford a total monthly mortgage payment (P&I, R/E Taxes, HO insurance) of $3,733 ($160,000 / 12 = $13,333 x 28% = $3,733). Of course, the lower the percentage the better! As for renters, they should try to keep their rent expense to around 20% or lower of gross income. The renter can then bank 8% or more towards the down payment on a home in the future.
36% Rule for Total Debt Payments
The 36% rule states that all your debt payments, such as; mortgage payments, car payments, and student loan payments should not exceed 36% of your gross income. So that same couple making $13,333 a month total debt payments should not exceed $4,800 ($160,000 / 12 = $13,333 x 28% = $4,800) . However, just because the formula says it is OK to spend $4,800 a month on debt payments doesn’t mean you should! Try to get as far below 36% as possible. Renters trying to save for a down payment on a home should try to keep total debt payments at 28% or lower of gross monthly income.
Utilities and Repairs and Maintenance
Renter’s utilities and repairs and maintenance costs are much lower than those of homeowners. My daughter’s monthly rent includes all utilities except for wi-fi of $60 a month. If the AC or heat isn’t working she calls maintenance. The same for any plumbing issues. She also doesn’t have to do yard work or pay condo fees for building upkeep. As a homeowner, you will be responsible for your own repairs and maintenance, utilities, condo fees, or lawn care. These additional costs as a homeowner can really add up.
Major Improvements
Homeownership comes with an additional cost over renting. The need or desire to remodel that ugly bathroom. How about upgrading that 1980’s kitchen? Then there are other items the new windows or adding a patio. I think you get the point. Homeowners will spend tens of thousands of dollars making major home improvements over renters.
Have You Put Down Roots Where You Are Buying A Home?
Before purchasing a home are you certain that you will remain in the area for at least 5 years? The settlement costs of purchasing and selling a home can significantly reduce the amount of any appreciation gained over the years. Conversely, you may have little appreciation and actually lose money after settlement costs are factored into the sale. There is the opportunity to rent the property if you relocate to another area, however, you then have to deal with being a remote landlord. While no one can predict the future, it may be beneficial to rent until you are confident that you will remain in the area before purchasing a home.
The Opportunity For Appreciation For Homeowners
Alright, I am finally getting to the point that you have been waiting for me to address, the opportunity for the appreciation in home prices! There is no doubt that one of the benefits of homeownership over renting is an opportunity for appreciation in the value of your home. Any appreciation in the value of your home plus the reduction in the outstanding principal on your mortgage will build equity in your home. However, keep in mind how much you have laid out for improvements too. If your equity increased by $40,000 and you spent $30,000 upgrading the kitchen then your net equity growth is $10,000.
Sleep Well While Paying Rent Until You Are Ready to Buy
I fully support homeownership and I believe it is still a strong part of the American dream. If you are currently paying rent then you should continue to do so until you are ready to buy. If someone says you are silly for paying rent you can now explain to them how smart you are by paying rent at this point in your life!
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