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Rent or Buy: How to Know Which One is Right for You

By Laura Agadoni · Nov 11, 2015 · Real Estate

Rent or Buy: How to Know Which One is Right for You

Image courtesy of Flickr, Sebastiaan ter Burg

The dilemma of buying or renting a home is something many Americans wrestle with every year. This article will outline the benefits of owning a home and of renting a home to help you decide which may be the right choice for you.

Most Americans grew up with the idea that they'd be homeowners someday. But after the mortgage crisis of 2008, that goal ceased to be a given. People now question whether homeownership is always the right goal to have. In many-maybe even in most-cases, the answer is still a resounding, "Yes."

Buying a house is generally a good investment. Even so, depending on your circumstances, you might be better off renting. In this article, we'll give you some concrete ways to know whether renting or buying is the right choice for you at your stage in life. But first, we'll provide a rundown on the advantages of each.

5 Benefits of Owning a Home

1. You're Building Equity

When you pay your mortgage, some of that money goes toward owning the home, meaning that you'll have something to show for all that money you're putting in, which doesn't happen when you rent. At first, most of your mortgage payment will be for interest your lender charges, but some portion will go to paying off the house. Use this Loan Amortization Schedule Calculator to see the breakdown of your monthly payments over the life of the loan. The more you pay down your loan, the more money goes toward the principal. Another benefit of building equity is that you can generally take out a loan by using your equity in the house as collateral.

2. You Get Tax Write-Offs

You can get tax breaks when you pay mortgage interest, property taxes, and interest payments on a home equity loan. Many people, to take advantage of the tax break, move credit card debt with a high interest rate to a low-interest-rate home equity loan. (Note that tax deductions apply only if you itemize your deductions as opposed to choosing the standard deduction method.) In addition, if you live in your home as your primary residence for at least two years, when you sell, you don't have to pay taxes on any profits you make that are less than $250,000 ($500,000 for married couples).

3. It's an Investment

Although there are no guarantees, your home could appreciate over time. If it does, you can downsize when you retire and supplement your retirement with the profit you made. And even if it doesn't appreciate, the house acted as a forced savings plan for you.

4. You Can Put Down Roots

When you start a family, it becomes increasingly important to provide a stable living environment. While it's possible to have a secure location when you rent, you're only guaranteed a home for as long as your lease term. If the landlord decides to sell, doesn't want to renew your lease, or raises the rent higher than you can afford, you'll need to move. And moving becomes more difficult when you have a family and children enrolled in school.

5. You Can Make the Home Yours

When you own a home, you can paint the rooms any color you like, and you can remodel or make improvements. (Note that if you live in a neighborhood with a homeowners association, you might be restricted on the types of improvements you can make.) If you rent, you cannot alter your environment because you don't own it.

4 Benefits of Renting a Home

1. It's Easier to Afford

To rent a house or apartment, you typically need to pay the first month's rent, a security deposit, and sometimes the last month's rent. That might seem like a big expense, but it's usually less than the amount of money you'll need to buy a home.

2. You're Not Responsible for Repairs

When something breaks or goes wrong when you're renting, you simply need to call your landlord or property manager, and they'll take care of the problem. When you own a home, you're responsible for any repairs.

3. You Pay Less Insurance

Although you might not have to buy renters insurance unless your lease requires it, it's a good idea to buy it to cover your belongings in case of theft or natural disaster. The cost of renters insurance, however, is less than homeowners insurance, which is what you must buy if you have a mortgage.

4. You're More Mobile

If you're not sure where you want to put down roots, or if you think your job will require you to move soon, it's better to rent. When your lease is up, you can go. If you're renting on a month-to-month basis, you need only give the proper notice, and you can simply leave.

4 Questions to Ask Yourself

Now that you know the advantages of both owning and renting but you still want to buy a home, ask yourself these four questions:

1. Can I Afford to Buy a House?

You need to have money saved for a down payment, which is usually between 3.5% for an FHA loan and 20% of the price of the home. Putting down 20% or more is ideal. That way you avoid paying private mortgage insurance, insurance you pay to protect the lender when you don't have much equity in the home.

You'll also need to pay closing costs, which are usually 2% to 5% of the purchase price. Use this Closing Cost Calculator to see a good estimate of what you can expect to pay. Also, you'll probably need to buy appliances, gardening supplies, tools, and furniture, so it's a good idea to factor these in as well.

Consider whether after paying the monthly mortgage-which includes principal, interest, taxes, and insurance-you'll still have enough to live on. A good rule of thumb is that your mortgage payment should not exceed 28 percent of your gross income.

2. How Much Debt Do I Have?

Figure out how much debt you owe in relation to how much income you bring in. If you don't know this figure, your lender will! Your debt-to-income ratio (DTI) is the formula lenders use to determine whether you qualify for a loan. Figure yours by adding all the debt payments you make each month-include what your mortgage payment will be, and don't include what you currently pay for rent-and dividing that number by your gross monthly income: the lower the number the better. You can use this DTI Calculator to help your figure you monthly debt-to-income ratio. The highest your DTI can be to qualify for a mortgage is 43%, but even then you are going to find that the higher your DTI is the higher you rate and overall costs for attaining the financing will be.

3. What's My Credit Score?

Check your credit score before you think about applying for a mortgage. An ideal score would be 740 or higher to get the best interest rate. If your score is low, make sure there are no mistakes on your credit report that are wrongly lowering your score. Then, take steps to raise your score before you apply for a mortgage. In a previous article we have written titled " 14 Ways to Improve Your Credit Score to Qualify for a Mortgage ," we review some tips you can implement to help improve your overall credit scores.

4. How Long Do I Expect to Live There?

The longer you think you'll live in the home the better. Five years or more is usually best. If you move before that, you might lose money when you consider all that you've invested in the home and all that you have paid out of pocket and through the loan in closing costs to attain financing.

The bottom line is that you need to live somewhere, and we hope that you now have a good idea of whether buying or renting is right for your current needs.

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