Great Debates: Renting Vs. Buying

Ah, one of the biggest Great Debates in the financial field, and perhaps the biggest argument when it comes to housing, period.  Which is more beneficial for your bottom line, buying a home outright or renting and investing the difference?  While the overwhelming majority of advisers maintain that buying is better, there are some staunch advocates of renting and investing.  The real story is more complex and nuanced than a simple, all-or-nothing answer.

A caveat before we begin; the entire debate about which method of putting a roof above your head is best assumes that buying a home is more expensive than renting (at least, in the early years), that our renter is putting most, if not all, of the difference in cost into investments, and that these investments will generate a substantial rate of return (high enough to beat house price increases, for example).  If any of these assumptions are wrong, there really is no debate: buying a house is a more profitable prospect.  If buying is less expensive than renting, if the renter blows the extra money on frivolities, or if our renter just socks the money away in a low yielding account, then buying becomes a much better deal than renting.

If we assume these caveats hold, though, things get much murkier.  The commonly held conclusion is that renting is less expensive in the early years of owning a home (because there are large upfront costs to buying, such as a down payment and closing costs on the house, as well as a fixed mortgage rate that is higher than rental costs to start), but after several years of living in the house (usually cited as 5-15), the fixed mortgage payments mean that living costs will be less than the rent paid out.  The common suggestion is that if you know with some certainty that you are going to stay somewhere for at least 5-10 years, buying will be a better deal for you.  But this ignores a number of factors that will influence how profitable each housing technique will be, including:

-Investment Returns: If you do in fact rent and invest the difference, how much your investments return will be a major determinant of whether renting is profitable for you.  If your investments do well, it can more than make up for the ever-increasing rent you’ll be paying; if they do poorly, you’ll be doubly hit, suffering from both rising rents and laggard investments.

Housing Appreciation: If you buy, on the other hand, one of your major assets is going to be your house.  As it rises in value, you’ll be able to pocket more money if you sell it, making buying more profitable.  If prices shoot to the stratosphere (as they did in the early 2000’s), you’ll have huge potential profits when you sell; if prices lag (or even fall, as many have done in the past several years), buying will look like a much worse idea.

-Years to Collect Down Payment: Something often neglected in even the best discussions of renting vs. buying, how long it takes for our buyer to save up the down payment on the house can be a big factor in which is more profitable.  The longer it takes a would-be buyer to build up their down payment, and the more they have to cut down their investing in order to do so, the more attractive renting and investing start to become.  Especially now, when it’s gotten much harder to get a mortgage without a substantial down payment, the years needed to divert money from (potential) investments into down payment savings can give our renter/investor a substantial head start in building up his/her net worth.

(Dependent on investment returns and housing market conditions, of course; if our would-be buyer has enough saved up for a down payment in a year like 2008, when the stock market seemed to be disintegrating and house prices were falling, they’d be in a pretty good place to buy.  Such is the impact the broader markets (for stocks and homes) can have on the relative profit possibilities of each.)

Inflation & Taxes: A major factor in determining which is the more profitable, and one that’s even more unpredictable than investment returns or appreciation, these broader conditions have all kinds of influence on which is better.  If taxes are raised on selling houses (or the substantial tax deduction currently available is dropped), renting will start to look better; if investment taxes are raised, buying becomes more attractive.  High inflation can make stocks decline in value while helping to drive appreciation, while low levels of inflation can keep appreciation low and help investments (and even this is a gross oversimplification of how inflation affects the housing and stock markets).

As a result of all these factors (most of which require making assumptions about future conditions), saying definitely which is better, renting or buying, is impossible without knowing more about the specific properties and market conditions.  Luckily, there are several good rent vs. buying calculators out there, which will help you to make your decision: Probably the best and most complete renting vs. buying calculator I’ve seen, covering everything I’ve mentioned above (except for the years to save up the down payment) as well as several other factors I didn’t get into (closing costs, maintenance on the property).  It generates a very thorough data table, as well as a simple explanation of when buying becomes less expensive than renting (if ever), as well as whether your investments as a renter will later generate more profits than buying.  It’s a bit complex, but every thing is explained, and it’s a good place to play around with the numbers to see what is the best for you in the long term. While not as complete as MichaelBlueJay’s, it’s a pretty thorough calculator, which should enable you to determine which is the better deal.  (Just click on the ‘Am I Better Off Renting?’ link to open it up.)  It also have a few inputs that seem to be pretty unique to this calculator, including points and origination fees, although it’s easy enough to work around this lack in the other calculators.  Still, using it in conjunction with other calculators can lead to a better understanding of the best deal for you. Possibly the easiest calculator to understand (due to the large graphic in the middle of the page), it provides a nice visual representation of when (if ever) buying will become more advantageous than renting.  Based on the data you enter (in the upper bar, the appreciation/rent increase sliders on the left, and the optional advanced setting entries), you can view a variety of options to see how it affects the graph.

My Conclusions

As mentioned above, it’s hard to say that renting or buying is always better, in all circumstances, because neither really is.  If you are only staying somewhere for short period of time (less than five years, especially, although it’s worth looking closely into your expenses for ten to fifteen years out), renting is almost always better; the transaction costs of buying and selling houses will definitely make it less expensive just to rent.  For longer periods, buying a house is usually better, although if you have the discipline to invest the difference between your rent and your potential mortgage/other buying costs in a reasonably high yielding investment, renting might be better.  But that’s if, repeat IF, you figure out the difference and diligently invest that difference; if you can’t do that (or know that you won’t), buying is probably the better choice for someone who isn’t planning on moving for a while.


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