You’re probably familiar with the idea that homeownership is the American dream. While taking out a mortgage to buy a home can be a great financial move, there’s no guarantee that you’ll always come out ahead. Renting can also be a smart way to build wealth, if you follow a few guidelines.
No matter which side of the buy-versus-rent debate you’re on, it’s wise to carefully consider the benefits of each. In this post, I’ll review the main pros and cons for owning and renting a home so you know which option will make you richer.
How Can Buying a Home Make You Richer?
Let’s start by understanding four ways financing a home can allow you to become wealthier.
1. Building equity.
The first major attraction of buying your home is building equity. Equity is the difference between a property’s market value and what you owe on it. For instance, if your home is appraised at $300,000 and your mortgage balance is $250,000, then you have $50,000 ($300,000 - $250,000) in equity.
If you have a fixed-rate mortgage, each payment is made up of principal and interest in amounts that change over time. Each monthly payment helps you automatically grow richer because you reduce your outstanding loan balance by a slightly larger amount, which is called amortization.
In other words, with every amortizing mortgage payment, you own more of your home and owe less. However, there are home loans that don’t amortize, such as an interest-only mortgage.
With every amortizing mortgage payment, you own more of your home and owe less.
The benefit of having home equity is that you can cash it out by selling your home. Or you could tap a portion of equity by refinancing your mortgage or getting a home equity line of credit.
2. Having appreciation.
The second way owning a home can make you richer is price appreciation. For instance, if you buy a home for $300,000 and then the value increases to $375,000 over time, you have $75,000 of additional equity.
Historically, real estate has been an excellent long-term investment. But there’s no guarantee that a home’s value will go up or that it will appreciate as quickly as you’d like. If you bought a home in 2007 and had to sell it in 2010, you probably took an upsetting loss.
But if your home value goes up at the same time you pay down your mortgage, that’s a powerful way to build wealth. So, owning real estate gives you the opportunity to grow richer from price appreciation, paying down your mortgage, or from both. In contrast, paying rent is a pure out-of-pocket expense.
3. Cutting taxes.
To incentivize homeownership, the government created tax breaks to reduce the total amount of tax you must pay. Here are five expenses that are tax-deductible every year that you itemize deductions on your tax return:
- Mortgage interest – is deductible on up to $750,000 of debt on a primary or secondary residence for taxpayers who file jointly, or $375,000 if you file as a single.
- Home equity loan interest – is also deductible and included in the $750,000 limit when you use it to buy, build, or improve your property. You can use home equity for personal reasons, such as credit card debt or education expenses, but that makes it ineligible for a tax deduction.
- Points – are certain upfront charges and prepaid interest you pay for a mortgage. If you’re eligible to deduct all the interest on your mortgage, you probably are also eligible to deduct mortgage points.
- Property taxes – are deductible for up to $10,000 for joint filers, or $5,000 for singles. This limit includes the total of your state, local, and real estate taxes. Some states (such as Florida and California) give homeowners a homestead exemption, which further reduces property taxes and typically offers legal protections.
- Private mortgage insurance (PMI) - is deductible, unless your adjusted gross income exceeds $109,000 as a joint filer, or $54,000 as a single taxpayer.
In addition to these annual tax breaks, there’s an even bigger deduction that comes when you sell a home, which is the capital gains tax exclusion. This benefit allows you to avoid paying tax on up to $500,000 of profit, or up to $250,000 as a single taxpayer. But you must have lived in the home for at least two of the previous five years before the sale.
All these tax incentives are fantastic; however, many costs of homeownership—such as homeowners insurance, homeowners association dues, maintenance, renovations, and local tax assessments—are not deductible.
Renters don’t get any housing-related tax deductions. But they don’t have any expenses either, except springing for a renters insurance policy, which only costs $188 per year on average.
4. Paying less per month (in some areas).
Another way buying a home can make you rich is borrowing at a historically low rate. A 30-year fixed-rate mortgage currently costs less than 4.5% APR. Getting a $200,000 loan at that rate makes your monthly payment about $1,000.
Low interest rates can make owning a home cheaper than renting, even with additional costs such as homeowner’s insurance and property taxes. Of course, that isn’t true in large cities, such as New York or San Francisco where home prices are notoriously high.
And speaking of high prices, an often-overlooked benefit of owning a home is that it’s a hedge against inflation, when you have a fixed-rate mortgage. That’s because your payment is locked in for the term of your loan, such as 15 or 30 years, no matter what happens to interest rates or the economy.
Rents may increase during periods of inflation, but a fixed mortgage can’t go up. Owning a comparable home becomes more affordable when prices rise. If you use your additional discretionary income wisely, that can help you grow rich.
Also see: How to Prepare Your Credit for A Mortgage Approval
How Can Renting a Home Make You Richer?
Places to rent come in all shapes and sizes, from single-family country houses to high-rise studio apartments in the city. There are landlords and management companies offering rentals no matter where you want to live.
One pro for renting is not having many upfront expenses.
Here are four ways signing a lease instead of a mortgage can make you richer.
1. Having flexibility.
Having the flexibility to relocate for work or family needs is an often-overlooked benefit of renting. Landlords typically require a 12-month lease, but you may also have the option to get a shorter term or to pay month to month.
Being able to pick up and go for your company or to take a higher-paying job could go a long way toward making you richer. But if you’re a homeowner and want to pull stakes, you’re usually stuck until you sell the property or find a reliable tenant to help you pay the mortgage.
2. Paying less upfront.
Another pro for renting is not having many upfront expenses. You typically must pay a security deposit for potential damages, which could be equal to a month or two of rent. That’s much less than having to fork over a down payment for a home, which is usually at least 3% of the purchase price.
You also need to make an earnest money deposit with your purchase offer and pay closing costs. Plus, the cost to furnish a rental can be less expensive than a home, if the square footage is smaller.
Keeping more of your cash may allow you to invest more and to begin growing a nest egg earlier than you could as a homeowner.
3. Being insulated from market downturns.
Renters stay protected from potential market downturns, such as recessions and real estate bubbles that pop. In fact, renters may come out ahead if rents go down when the economy struggles.
Over-inflated housing prices can even burst and cause prices to plummet in micro markets, such as certain towns or neighborhoods. Timing and location is everything in real estate.
4. Paying less per month (in some areas).
As I previously mentioned, where you live is a big factor in whether renting or owning a home will be cheaper. But no matter what, renters get to skip many expenses that homeowners can’t because their landlord is responsible for upkeep on the property. You don't have to worry if your air conditioner stops working or you see water dripping from the ceiling.
In addition to money savings, renters save time when a repair isn't yours to make. Homeowners must find the right professional, request bids, make sure the company or person is insured, decide whether to make a homeowner’s insurance claim, and take time off from work to manage repairs.
Should You Buy or Rent a Home?
Just like many issues in personal finance, the answer to whether you should be a homeowner is “it depends.” Your financial situation, goals, and lifestyle are unique.
There’s no right or wrong answer, nor is there a cut-and-dried way to compare the cost of renting to the cost of owning a home. Plus, there are non-financial considerations that may tip the scales for you in either direction.
On one hand, the pride of owning a home is something many people want to experience. You may yearn to have your own patch of land and space to spread out. The sky’s the limit if you want to decorate, remodel, or plant a garden.
Like many issues in personal finance, the answer to whether you should be a homeowner is “it depends.”
But getting a mortgage is a big commitment that must fit in with your financial goals, such as investing for retirement and paying down debt. Just because you qualify for a mortgage doesn’t mean homeownership is right for you.
A good rule of thumb is to never buy a home unless you’re certain that you’ll live there for at least five years. You never know how long it could take to sell.
On the other hand, renting can allow you to avoid the cost and hassle of maintenance. If you travel frequently for pleasure or work, it can be easier to leave an apartment vacant than a home you own.
Some apartments offer on-site services and amenities such as a 24/7 concierge, dry cleaning pickup, a clubhouse, pool, gym, guest suite, and theater. If you use these amenities regularly, consider what they’d cost if you didn’t rent.
If renting saves money and reduces stress so you can accomplish your financial objectives, it may be the way to go. The key is investing your savings that you would have spent on a home. But if buying a home has more advantages and you’re willing to put down some roots, then owning an affordable home is a terrific goal.
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