The decision to buy or rent your home is a complicated one.
In addition to the financial implications of the decision, there are also lifestyle factors to consider. Owning a home comes with certain responsibilities such as maintenance and yard work that you might rather avoid. It also carries certain risks that renters don't face. If the roof leaks or the basement floods, you could be on the hook for thousands of dollars in repairs.
Where you want to live can also help you make the decision. In a suburb or a rural area, most people own their own homes, and finding a rental may be difficult. On the other hand, there's generally an abundance of rental apartments available in cities, and the price of buying a home may be out of reach.
The financial calculus in renting or owning is also a key component of the decision. The drawbacks of purchasing a home include making a down payment, paying closing costs, and having mortgage payments that may be more expensive than the rent for an equivalent home. In exchange, you get to benefit from the appreciation of your home's value and the knowledge that your mortgage payments won't increase, assuming you have a fixed mortgage rate.
Renters have more flexibility than homeowners but don't get the reward of appreciating home value or the other financial benefits of home equity like being able to borrow against it.
Image source: Getty Images.
Three charts homebuyers should know
The most important number every prospective homeowner needs to understand is the mortgage rate since that is a primary factor in determining monthly payments. The chart below shows how the 30-year fixed mortgage rate -- the most common in the U.S. -- has changed over the last decade.
Image source: St. Louis Fed.
As you can see from the chart above, mortgage rates have been climbing quickly this year as investors anticipate several rate hikes from the Federal Reserve. The upward trajectory is causing some prospective homebuyers to try to close a deal quickly to lock in rates while they're still close to historic lows. It's also worth remembering that rates have been below historical norms over the last decade. For example, through much of the 1990s, they hovered between 7% and 10%, though they've gradually declined since a spike in the 1980s.
As a homebuyer, it's also important to understand how your mortgage rate will affect your monthly payment. The chart below shows how your payment would increase as mortgage rates rise on a loan of $400,000.
| 30-Year Fixed Mortgage | Monthly Payment (Principal & Interest) on a $400,000 Loan |
|---|---|
| 3% | $1,686 |
| 4% | $1,910 |
| 5% | $2,147 |
| 6% | $2,398 |
| 7% | $2,661 |
Data Source: Google.
As you can see, your mortgage rate can make a huge difference in your monthly payment. Going from 3% to 7% in the above example adds nearly $1,000 to the monthly payment, or 58%, so if you intend to buy a home, it's best to do it while rates are still relatively low. The other drawback of higher rates is that a lower percentage of your monthly payment will go to principal rather than interest, which is also important to consider.
Finally, you should also consider the potential capital appreciation you would benefit from as a homeowner. While it's impossible to predict what home prices will do in the future, there are several factors supporting its growth, including a national housing shortage. As you can see from the Case-Shiller home price index below, the average home has increased in value by 340% since 1987, or a compound annual interest increase of 4.3%. In other words, if you plan to stay in your home for several years, there's a good chance you're better off owning.
Image source: St. Louis Fed.
Shop around
Once you understand how much you would be paying as a homeowner, including property taxes, utilities, and maintenance, you should compare that to available rental properties in your area. You may find that comparable rents are significantly cheaper than your monthly payments would be as a homeowner, or you may find they're similar to the carrying costs of a mortgage.
It's important to consider the prospective capital appreciation you can get from owning a home and what suits your lifestyle at the moment. If you don't want to settle down in the area in which you currently live, or you expect to move in the next couple of years, renting could be a better choice.
Take the time to do your research and talk to people, like a real estate agent or a mortgage broker, who may be able to help you make the right choice. Buying a home is one of the biggest financial decisions you'll make in your lifetime. It's best to fully understand the options in front of you before making a purchase.
