Rent or Buy? What Should You Do?

next stock market crashShould you rent or buy your next place? This is the age old question that many people answer incorrectly.

If you live in West Michigan (like I do), here’s the advice you’ll likely get in life:

  • Go to college
  • Get good grades
  • Snatch up your future spouse
  • Get a solid job
  • Stop throwing your money away in rent and buy a house

By the way, this should all be done before you’re 25 years old….

So is this advice that we should all be listening to? I’m going to go with, “Heck no” on this one Bob.

This advice might work for a few of you and you’ll be happy as clams for life. For most of us though, this just won’t work out. Some will grow unhappy with the massive debt load and others might even end up destitute!

What worked 50 years ago just doesn’t work the same way today.

Rent or Buy? What Should You Do?

First of all, what you SHOULDN’T do is hop on Google and type in “Rent or Buy Calculators”. While these calculations seem high-tech and super easy, they have one major design flaw. They all assume that your rental cost will be roughly equal to your mortgage amount.

If, after reading this article, you find out that you can’t buy a house quite yet, then you should rent for AS CHEAPLY AS YOU POSSIBLY CAN. If your apartment has tennis courts and a pool, then you’re paying too much on rent.

But, before I give you 20 lashes about something you haven’t even done yet, let me step back, take a breather, and explain to you why you shouldn’t buy a house right now.

1) Do you have any consumer debt?

When considering the buy or rent situation, understand that consumer debt costs you at least 6% in interest (student loan debt) and can cost you as high as 20% (credit card debt). Do you know how much you’ll earn on your house? Approximately 1-2% net. It’s ludicrous to buy a home before you get rid of your high-interest consumer debt.

2) Do you have a 3-6 month emergency fund?

If you can’t decide whether you should rent or buy and you don’t have an emergency fund of 3-6 month’s worth of expenses, I can help you. DON’T BUY A HOUSE.

The more things you own, the greater your chance of expenses. If you own nothing, then pretty much the only thing that can go wrong is that you lose your job. If you own a car, a boat, and a house, suddenly there are TONS of things that can cost you money. In these instances you should really have an emergency fund of $10,000 or more.

If you don’t have an emergency fund, then you have no business buying a house.

3) Can you buy a house for less than 2x your salary?

Your primary residence is NOT an investment. It earns you no money while you live there and it barely increases in value over time. If you want to be wealthy later in life, then I would urge you to buy a home that costs less than twice your yearly salary (see the practices of the rich in the graphic below).

rent or buy - traits of the rich house hopping

If you earn $50,000 a year, look for a house that costs less than $100,000. If you earn $200,000 a year, find a house that’s less than $400,000. Then, make a point to pay it off as quickly as possible and put your money toward real investments. You know…the kind that actually earn you money.

What if you can’t possibly buy a home for less than twice your yearly salary? Then either don’t buy one or you’ll have to rent something so cheap that you can make a massive down-payment on one later in life.

4) Can you afford the payments of a 15 year mortgage?

Almost everyone buys a home on a 30-year note these days. Why? Because they want to buy the biggest house possible! Is this smart? Again…HECK NO!! Even with the low interest rates, you’ll likely pay twice as much for your house after those 30 years of payments.

If you’d rather keep thousands of dollars in your pocket instead of your bank’s, then I’d suggest only buying a home if you can afford the 15-year loan payments (ie. payments that are less than 25% of your take-home pay each month).

5) Do you have a 20% down-payment?

Confused on whether you should buy or rent? The down-payment should have a lot to do with your decision.

Why?

Two reasons.

First – if you don’t put 20% down on your home you’ll be subject to PMI (private mortgage insurance). This is an additional amount that you pay the bank because they’re worried about you defaulting on your loan. You pay them the money, it doesn’t reduce the principle amount you owe, and you’ll never get the money back. It’s really a raw deal and you should avoid it like the plague.

Second – the bank will force you into their escrow program where they manage your insurance and your property tax payments. It doesn’t sound all bad…until you discover that they charge you a hidden fee to manage it….and that they’re pretty incompetent at it (my bank always seemed to withdraw $1,000 too much each year, which meant I couldn’t do anything with that money that was going nowhere).

6) Do you plan to stay in the area for 3+ years?

When considering the rent or buy situation, one of the major pieces always revolves around how long you plan to stay in the area.

Why?

Because buying and selling homes can be expensive:

  • Realtor fees
  • Moving costs
  • Staging costs
  • Time off from work

Not to mention the lack of equity you build up in your home with a quick move (most of the initial mortgage payments go toward interest, not the principle).

My rule of thumb. If you might move within three years or less, just rent something super cheap instead of buying a home. Put your extra money into a money market or savings account to use on a house purchase later in life.

Rent or Buy?

When it comes down to it, most people that buy houses should probably be renting. The result of their premature purchase? They become house poor and feel strapped for the next 30 years of their lives. I don’t know about you, but I’d much rather rent a piece of crap apartment for three years and then buy a decent house that will allow me to live a life full of travel and experiences. Wouldn’t you?

If you enjoyed this article, Get email updates (It’s Free!)

6 comments to Rent or Buy? What Should You Do?

  • Dr Mo

    Really good post. I appreciate your comment about those rent vs buy calculators. They can be really helpful if all else is the same but that rarely holds true.

    • I’ve seen it again and again. The point of renting is to spend less and save up money. Not to spend the same amount as if you had a mortgage! Thanks for noticing Dr Mo! 🙂

  • Nice article, Derek. I’m 50 now, but I got the same advice from family 25+ years ago. College, job, wife, house, kids.

    The rent vs. buy issue is a sticky one, for sure. There are many variables and the math is not very approachable by most. I’ve been researching it heavily over the last couple of years and I’ve reached similar conclusions to yours above for young people considering the question. Jumping into a mortgage and responsibility of home ownership before the rest of their financial house is in order is a recipe for years of money pain. Your advice should be very helpful for those trying to figure out if they are ready (financially) to buy.

    The middle years of wealth accumulation are less clear cut on rent vs. buy advantages and I think people need to recognize the emotional side of it. For some (maybe many?) the idea of owning a home, possibly mortgage free, is a very powerful and attractive thought. If so, I’m not sure putting an analysis in front of someone telling them over their lives they’ll save $100k (arbitrary number) renting isn’t going to sway them. And I think that is totally okay. Money is a tool and if that extra expense is worth home ownership, then it is a great decision for that person. Of course, the buying is better crowd would say the same thing to a prospective renter and my reply would be the same – if renting is what you really want, then do that and accept the expense.

  • Hi Derek, no not suggesting do whatever no matter what. My point is that I have seen very compelling cases made for both rent and buy, but I think there is an important emotional component that transcends the financial aspect as long as the buyer/renter is willing to accept the fact that their choice may be sub-optimum financially. And as you know, the math gets very complex, particularly over long time periods due to taxes, investment returns, appreciation/depreciation, cash flow, etc., so I don’t buy there is a clear cut “winner” on rent vs. buy. I know you aren’t advocating that, just clarifying my point.

    To put it another way, in a few years as we hit semi-retirement, we’ll be selling our house and renting a small apartment. I’ve run the numbers a dozen different ways and for our specific situation, this is financially a very good decision for us. But, we are tolerant of apartment living and don’t have much emotional attachment to our dwelling. My parents, on the other hand, are positively horrified that I’m even considering selling my house and paying rent, even though they would agree that financially it makes sense for us. They would never rent, no matter the cost and I presume they are willing to accept responsibility for that higher cost (assuming they were in my situation).

    Kind of a long way around, but that’s what I’m talking about. 🙂

Leave a Reply

You can use these HTML tags

<a href="" title=""> <abbr title=""> <acronym title=""> <b> <blockquote cite=""> <cite> <code> <del datetime=""> <em> <i> <q cite=""> <s> <strike> <strong>

  

  

  

CommentLuv badge