Are You Really Throwing Away Money When You Rent?

There's a lot of pressure to buy a house in America.

In fact, owning a home is described as part of the American dream and many people would prefer to make monthly mortgage payments because they feel like they are "throwing away money" when they send their rent to a landlord every month.

But, are you really wasting your cash if you rent? Is renting the wrong choice for everyone and is homeownership the surest path to wealth?

Renting can be the right choice in some situations

While you may want to buy a house in order to try to build equity, this only makes sense if you are in the right financial position to do so.

First and foremost, you have to be sure you are going to be staying put for a while. If you plan to move within around two to five years, then you could end up losing a lot of money if you try to buy a home.

There are high transaction costs associated with real estate sales. If you don't live in a house long enough for property values to go up at least 6% or so, you likely aren't going to be able to make enough on your home sale to get back the closing costs and fees you paid. In this case, buying a home could cost you rather than helping you build wealth by acquiring the home as an asset.

You also have to be sure you are in a good financial position to cover your mortgage costs and other costs of homeownership, such as property taxes and maintenance. In fact, you should budget around $1 for every square foot of living space for your home maintenance costs every year. If you cannot afford the house and you end up getting foreclosed on or struggling to invest any money because the property is so expensive, a home won't help you build wealth either.

In these situations, since buying won't improve your finances in the long term, you absolutely are not throwing away money renting. You are paying for a place to live that you can easily move away from without worrying about transaction costs. And, if it is cheaper to rent than to buy, you are paying for a more affordable place to live that won't interfere with your financial goals.

You may also not be throwing away money if you can rent a place for less than it costs you to buy one and you invest the difference. The stock market has tended to provide a better ROI than real estate over time, so if you're investing the extra you save due to renting versus buying, you could end up with a higher net worth in the end. Instead of throwing away money here, you'll be paying for a place to live that enables you to do better things with your cash -- as long as you actually follow through with investing.

Here's how to decide if you should rent or buy

To decide if you should rent or buy, consider your financial situation, whether you're ready for homeownership, and how much it costs to own versus rent. If it doesn't make sense for you to buy due to these factors, renting is the right choice. It's not a waste, since it's buying the right housing option for your current situation.