Are you currently renting? You may think that you’re throwing money down the drain with your monthly rent but did you know that renting isn’t always a waste of money? Let me show you how.
There’s an easy and correct way to determine whether it’s cheaper or rent or to buy. This article will help you determine whether you should buckle down and buy a home now or not.
Table of Contents
The average age of first-time homeownership
The average age of first-time homeownership has been climbing higher and higher with each passing year.
The average age that people buy a home for the first time in their lives in 2022 is 36 years old.
You probably heard of your grandparents buying a home at 18 or 27. It was a lot easier to buy a home with one income compared to today.
People are staying in school longer, and while the housing market has been seeing a constant boom from year to year, the average salary hasn’t increase as fast.
Not to mention inflation, it reduces our purchasing power, meaning we have to spend a larger percentage of our income on daily necessities. With less money left over, it’s harder to save up for a downpayment.
All of these factors combined and more are the reasons why the average age of first-time homeownership has been climbing.
Why it’s not always better to buy than rent a home
Amortization
When you buy a home, you’ll have to pay mortgage bills every month. What you’ll be paying in the first few years is mostly interest on the loan to buy your home, not the principal payment itself.
With each passing year, a larger percentage of your monthly mortgage payment would be for principal, and a few percentages of your monthly mortgage payment would be for the interest.
Inflation
Due to inflation, you won’t always be making money from the appreciation of your house.
If inflation is 4% this year and your house appreciates by 5%, that comes down to only 1% gain overall.
Property tax
There’ll be property tax for you to pay each year. It could be an extra thousands of dollars that you wouldn’t have to pay had you rent instead.
Housing repairs
As your house gets older, you may have to start paying more for repairs. The average American moves house every 4 years. The houses in America aren’t really built to last. There are a lot of repairs to be done on older houses. If you look at the houses in Europe, many of them are still standing after 200 years. This is the result of the response to the rapid demand for houses to be built at the early stages of America’s population growth decades ago. The houses were being built fast but with less durable material. It’s easy to break and requires constant repairs.
Typically, people buy a younger house every time they move, when you own a house for some time, it’s going to accumulate more years. With each passing year, more and more problems will arise.
The average price to rent in your location
Take a look at the average price it would take to rent a home in the place of your choosing. If it’s significantly cheaper, even if you take into account yearly housing appreciation and inflation, it may still be cheaper to rent than to buy.
Regretting location
Do you think you’ll still want to live in the same place in 5 or 10 years? If you don’t know, it’s probably better to hold off on buying a home just yet.
The formula
To determine whether it’s cheaper to buy or to rent a home, we’ll use this very simple formula called the Price-to-Rent Ratio.
You’ll have to find two pieces of properties that are similar and check the price that it’s selling at vs. the price it’s renting for.
Take the total cost of buying the place and divide that by the yearly cost to rent the other place. If you get a number that is more than 15 (PR ratio), it’s less expensive to rent than to buy. If the PR ratio is less than 15, it’s more expensive to rent than to buy.
Price of home / total yearly cost to rent = PR Ratio
You should use the total cost to rent in your calculation. If you have to pay an extra $100 for the maintenance fee and parking then you’ll need to include that.
Another thing to note is that the house that it’s listed at may not be the actual amount it is sold for. Sometimes houses are on sale for much cheaper than it should be sold at just so the real estate agent could claim that the house sold for “30%” over asking. You can check out the actual sold price for a more accurate assessment.
Some stats
- Baby boomers spent 36% of their pre-taxed income on rent on average
- Gen X spent 41% of their pre-taxed income on rent on average
- Millennials spent 45% of their pre-taxed income on rent on average
How much should you pay for rent?
If you have decided that renting is cheaper for you (or you have no choice but to rent because you can’t afford the downpayment yet), here’s how you can determine how much you should spend on rent.
Experts recommend the total housing cost per month to be less than 30% of your total income
Typically 20% of your housing expense would be taken up by utility
This means if you make 70k per year, you can afford to spend $1750/month in total housing expenses. Taking away the 20% of your housing expense for utility (an equivalent $350) means you can afford a maximum of $1400/month in rent.
Monthly income x 0.3 = total housing budget (including utility)
Total housing budget x 0.2 = utility budget
Total housing budget — utility budget = maximum rent budget
Should you buy a starter home?
A starter home is a home that people buy that they may sell when they are able to afford a home they actually want. A starter home is usually a smaller-sized home.
Many people will think that they’ll just get a starter home and they trade up in a few years. Think again.
There are closing costs and selling costs that can eat at your margin. You won’t always make money by owning a starter home before a home you actually want.
The closing cost of buying and selling a home
You should budget 3% — 4% of the price of the house for the closing cost when you’re buying a house. That means if you’re buying a house worth $500,000 you’ll have to save up an extra $15,000 to $20,000 for the closing cost.
You should budget 3% — 7% of the price of the house for the selling cost when you’re selling a home. That means if you’re selling a house worth $500,000, you’ll have to save an extra $15,000 to $35,000.
What you should check before buying a home
Location
You should check to make sure you love the location because you’ll be living in it for the foreseeable future. Is it too far from where your future job may be? What if you want to change job? Would the location of your home restrict you from finding a good job?
Natural disaster risk
Are there any natural disasters that you need to be aware of? Earthquakes? Flood? Tornadoes? This is especially true if you aren’t too familiar with the landscape of your potential new home.
Neighbors
Talk to your potential neighbors and ask them what they think. Is there anything to be aware of? Were there any suspicious activities at the house that you should know about?
Molds
Molds can be very harmful to human health. Get someone to inspect the house before you buy it. It typically costs $300 for a top-down thorough inspection.
Need for minor or major repairs
Again, getting someone to inspect it for you would tell you anything you should be wary of. Anything that could cost you a lot down the roads to fix.
Suspicious past activity
This could be any missing person, any homicide, any criminal activities, etc that may have taken place at the house. You’ll have to do your research on the web and ask several neighbors.
Paranormal activity
Not everyone believes in ghosts but if you do, you should make sure nothing nefarious has happened at the house before.
General history of the house
You’ll want to get an understanding of the general history of the house. When was it built? By who? Who lived there before? Were there any major changes done to the house?
Any development to take place near your home
Some development near your home can drastically drop the price. For example, it could block the ocean view and that’ll impact its market value. Noisy construction may also deter you from buying. If they are building a lot of new buildings or houses near your home, you may want to know how long it’ll take, what kind of properties are being built, what kind of demographic will it attract, etc.
Crime rate
You should understand the crime rate of the neighborhood you’ll be living in. Obviously, don’t choose a neighborhood with a high crime rate.
Schools
Being close to a school can drive up the potential profit you can make from your property if you need extra money. If your property is near a college, you can rent it out to college students. And if you got kids, knowing which school they may attend would also be important. What is the ranking of the school? What is the graduation rate of the school? What is the reputation of the school?
Final thought
Choosing whether to buy or rent a house is a decision that may impact your financial life drastically. You shouldn’t rush into any decision just because the housing market is hot right now. Take your time to consider whether homeownership is right for you and if it is, make sure you check the different aspects of the property thoroughly first before purchasing.
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