Should I Buy or Rent?

The residential real estate market is picking up, back from its slowdown in recent years.  With more inventory available, buyers may be asking themselves if now is a good time to move. That consideration brings up a classic question: is it better to buy, or to rent?  Most sites like Trulia or Redfin have a "rent vs. buy" calculator tool, but before you use it, you should understand the criteria these sites use to make the tool in the first place. 

For example, according to real estate aggregator-site, Trulia, the gap between the costs of renting and buying has narrowed nationwide: buying is now 38% cheaper than renting, instead of 44% cheaper, like it was only a couple of years ago.  But, does that really mean that buying is better than renting? Why? What considerations should go into your decision?

The Buy vs. Rent report that Trulia puts out compares costs for a seven-year period using five calculations:

  1. The average rent and for-sale price for an identical set of properties;
  2. The initial total monthly costs of owning (assuming 20% down and a 30-year fixed-rate mortgage at 3.5% interest, as well as annual maintenance, insurance, utility, and property tax expenses) and renting (monthly rent plus renter's insurance);
  3. The future total monthly costs of owning and renting;
  4. One-time costs and proceeds (for owning, this includes closing costs and capital gains tax of 15% for gains above the $500,000 annual exclusion; for renting, this includes one month's security deposit); and
  5. The net present value to account for opportunity cost of money (this compares cash flows over time.)

The first criterion listed, average rent/sale prices for identical properties, assumes that identical properties exist in your area. Is that right? Can you really rent a 3 bed/ 2 bath space that will allow you to keep your pets, for example? If not, your decision whether to buy or rent might take a lot less time than you thought.

You may notice that the second factor in this list, up-front costs, only accounts for a down payment of 3.5% (instead of the traditional 20%).  Many mortgage lenders will not consider a mortgage for someone who does not have a 20% down payment, even though their standards have slightly relaxed from the near-impossible credit and income requirements of the past few years.  That 3.5% interest rate is available, though, if you take advantage of the programs offered to homebuyers by the FHA.

The final consideration when using Trulia's tool is the seven-year period they use to calculate the amount of each cost over time. How long are you really planning on staying? How much more will your out-of-pocket costs for down payments, closing costs, and repairs really cost you, if you stay 3 or 4 years, say, instead of 7? 

Ultimately, renting or buying is a matter of preference and circumstances. Be sure to account for the ones that really matter in your life when using any Buy vs. Rent comparison tool.