Rent vs. Buy: Are you Ready to Buy Your First Home?

Did your rent just increase? Or maybe a friend just bought their dream home. Suddenly, you may find yourself looking at real estate apps and wondering whether your coffee machine would look good on that kitchen counter. 

No matter the impetus, you find yourself wondering, “Should I buy a house?” When you find yourself at this crossroads, the sensible thing to consider first is whether buying a house is the right decision for you at this moment in time. 

Here, we’ll consider the true costs of homeownership to ensure you know what you’d be getting yourself into, as well as how to prepare yourself for the next step in your financial life, if you decide it’s a step you want to take.

What does renting actually buy you?

You’ve likely heard someone say that renting is throwing money away because you’re not putting equity into a home. 

But is that money really wasted? 

Think about this. When you rent, you’re paying for some very real lifestyle advantages:

• Flexibility: Depending on your lease terms, you can decide to move more or less when you please. 
• Zero maintenance: If you come home and your kitchen is underwater due to a broken pipe, your landlord or property manager is the first to call to fix it.
• No closing costs: When you decide to move to a new place, there are no massive financial fees you’ll have to pay just to move in.

So, if your primary motivation for buying a home is to avoid “throwing money away,” take a moment to consider if, in your situation, that may actually be money well spent. 

As Shelton Green, Mortgage Loan Originator at Amplify, notes, “Renting isn’t throwing money away any more than paying for car insurance is throwing money away. You’re paying for something — stability, flexibility, a place to live. The question is whether buying makes more sense for your situation, not in the abstract.” 

How much does it actually cost to buy a home?

There are definitely advantages to owning your own home, with building equity making the top of the list. Every mortgage payment goes toward owning more of your home, and with a fixed-rate mortgage, your monthly principal and interest payment won’t increase unexpectedly the way a rent increase could. 

Additionally, homeowners may also enjoy notable tax deductions. For example, mortgage interest can be deducted on your federal return, and property tax payments may be deductible up to certain amounts. 

While these benefits can reduce your annual tax bill (especially in the early years of a mortgage), they don’t necessarily mean that owning a home is the more prudent financial choice. In fact, while the argument for homeownership is usually grounded in wealth building, the wrong home at the wrong time can do exactly the opposite. 

First-time homebuyers usually focus primarily on the monthly mortgage amount, but there are other expenses to consider. Before you’re even able to move in, you’ll have to provide a down payment, which can range between 3-20% of the home price. Add closing costs, usually between 2-5% of the purchase price, as well as an escrow deposit. In the Austin metro area, where the median home price sits around $460,000, that translates to a down payment between $13,800 and $92,000, plus $9,200 to $23,000 in closing costs. Before you even get the keys, you could potentially spend over $100,000. 

On top of that, owning a home comes with ongoing costs. There are property taxes, insurance, HOA fees, maintenance, and unexpected repairs. Many financial experts recommend setting aside 1-2% of your home’s value every year for maintenance alone. 

“People focus so much on whether they can afford to buy the home,” Green says, “but the smarter question is whether they can afford to own the home.”

How To Know If You’re Financially Ready to Buy

Before you tour even one open house, you should closely examine the four pillars of financial readiness: your credit score, emergency savings amount, income history, and your debt-to-income ratio. 

Here’s what you should look for:

• Credit score: When it comes to qualifying for a mortgage loan, your credit score matters. Lenders use your score to determine your mortgage rate, so the difference between a fair credit score (580-699) and a good credit score (670-739) could result in a rate difference that costs you tens of thousands of dollars over the life of the loan. Taking a few months to improve your credit score before taking out a mortgage could be well worth the wait.
• Emergency savings: While the down payment is usually top of mind when house hunting, you still need to have enough in the bank after closing for emergencies. Keeping 3-6 months of living expenses in an emergency fund is ideal if you’re buying a home. If the A/C breaks two months after move-in and you have no cash on hand, you could be in trouble quickly.
• Stable income: As with any type of loan, mortgage lenders examine your income history to determine whether you will have enough cash coming in to pay the monthly note. If you’re in between jobs, have just started a new role, or are considering a career change, it might be a good idea to wait until your income is more predictable.
• Debt-to-income Ratio (DTI): Your DTI ratio tells a lender how much of your total income is obligated to paying off existing debts. It’s one of the tools lenders use to determine whether you can afford a mortgage loan. If a lot of your income goes to monthly debt payments, it may be a good idea to wait until some of those debts are paid in full.

These numbers don’t have to be perfect in order for you to buy a home, but they should be in decent shape. And sometimes waiting a few months can make a drastic difference in the cost of homeownership over time.

“I’ve had people come in with a credit score not very far from a better rate,” says Green. “Sometimes the smartest move is to wait a few months, fix a few things, and save real money over the life of the loan.”

The Lifestyle Question: What Does Your Future Hold?

Even if your finances look perfect, there are still lifestyle factors to consider before you invest in a home. In the rent vs. buy conversation, knowing how long you plan to stay in your next place can be the deciding factor in whether a purchase is financially smart. If you only plan to live in the home for two to three years — which gives the home a limited time to appreciate — you could easily lose any equity gains in the transaction costs of selling (which are between 6-8% of the home’s value).

While staying in a home for 5-7 years is usually a good benchmark if you’re hoping to benefit from equity, it’s always a good idea to compare the financial implications of renting vs buying in your particular situation.

Finally, consider the opportunity cost. The cash you put toward a down payment could potentially be invested elsewhere, allowing your assets to grow while also keeping them liquid. Just consider, if you invested $92,000 in an account with a 6% return, that could turn into over $123,000 in five years. This is where a rent vs. buy calculator can help you determine which path will build you more wealth.

Renting vs. Owning: There’s No Wrong Answer

The rent vs. buy question has no single correct answer. As you’ve seen, there are many factors to consider, both financial and personal, that will help guide you to the right decision for you. Both are legitimate choices that have advantages and disadvantages.

The important thing is to go into such a major decision with clear eyes. Consider the full cost of buying (closing costs, property taxes, maintenance, opportunity cost), as well as what renting really buys you. Be honest with yourself about your financial foundation and your future life plans, and you’ll set yourself up for success.

This article was first published on May 28, 2021.