Whether to buy or rent a home is among the biggest financial decisions most of us make. It is basically a complex math problem in which the reward for getting it right can be tens or hundreds of thousands of dollars — and the punishment for getting it wrong similarly enormous.
Fortunately, there are many tools to help you work through the math, including The New York Times’s excellent calculator. But as someone who worked on that calculator and who has spent a lot of time examining the economics of homeownership, I have a confession: There are some dimensions of rent versus buy that are really important but difficult to account for in dollar terms.
These dimensions have inherent but hard-to-calculate value. They have to do with how owning a home lets you stop worrying about rent increases, forces you to save money and gives you certain tax benefits, and on the flip side, how renting means you don’t have to worry about the unpredictable costs of maintaining a home. Anyone trying to make a housing decision should at least think about them a bit before taking, or not taking, the plunge.
Protection Against Rising Rents
Suppose you live in a city that you find desirable and could envision living in for a very long time. Suppose you work in a field in which you can’t plausibly expect your income to rise significantly in the decades ahead.
That makes a case for buying over renting.
We don’t know the future of rents and home prices, either nationally or for any particular region. But one thing we do know is that sometimes rents and prices will skyrocket in a particular place. It has happened in New York and San Francisco since the 1990s; the same happened in Los Angeles from the 1960s to the 1980s, and a century ago one could say the same of Chicago and Detroit.
Buying a home is a way of locking in an affordable place to live, essentially an insurance policy against escalating rents. If you rent, you are forever at risk of your region’s becoming newly popular, attracting an influx of people and high-paying jobs that drives up your cost of living beyond what your income can support.
Of course, your region may not be one of those new boom areas, in which case this insurance policy would prove unnecessary; you could even end up in a place with falling rents and home values, like Detroit in the last couple of decades. But that’s the nature of insurance: You may pay for it but turn out not to need it.
Oh, and some places have rent control laws that might protect a long-term renter. But keep in mind, those laws can always be changed — and they can create inflexibility, making it impossible to move to a more suitable home in the same location without seeing a steep rise in rent.
Howmuch is this insurance policy worth? If taken to an extreme, it could
lead you to make bad decisions. During the housing boom at the middle of
the last decade, people used “If I don’t buy now, I won’t be able to
afford to buy tomorrow” as a rationale to overpay for homes.
Two factors that might help shape your decision:
How disruptive would it be for you to move somewhere else? The more disruptive, the more you should value this insurance against higher rents.
How freely does your city allow new home building? Rents are less likely to increase sharply if the housing supply can rise to meet new demand.
Forced Savings
Sometimes people say that renting is “just throwing money away,” which is a little misleading. You could just as easily say that when you buy a home, the mortgage interest and property taxes you pay are throwing money away.
But that line of thinking does get one dimension of home buying right: When you buy a home with a standard mortgage, you gradually pay off the balance — slowly at first, faster as time goes on. Someone who takes out a $500,000, 30-year fixed-rate mortgage at 4 percent has paid down about $8,000 of debt after one year, and $47,000 after five years.
In terms of a personal balance sheet, less debt is equivalent to more savings — assuming the value of the home is stable or rising. People who buy houses while in their early 30s with a 30-year mortgage and stay in it will own a valuable asset free and clear when they hit retirement age. They could either live rent- or mortgage-payment free during retirement, or sell the house, move somewhere cheaper and have a nice pile of cash savings.
Theoretically, one could construct the same strategy while renting, putting money away into a savings or investment account while paying a landlord for a place to live. The beauty of owning is that it happens automatically, by virtue of paying your mortgage. That means less temptation to spend the money instead of saving in a given month; you can get access to it through a home-equity loan, but that requires making the active effort of going to a bank.
So if, psychologically, you find it hard to save and are always tempted to take a vacation rather than plow money into a brokerage account, buying a house with borrowed money is a way to trick yourself into doing so and help ensure you have a meaningful net worth when retirement rolls around.
Owner’s Hidden Tax Benefits
Suppose you had plenty of cash and were trying to decide whether to buy a home outright, or invest most of the money in stocks and bonds and use some of it to pay rent on a home.
At first glance, renting might make sense. The stock market, for example, has a higher return than real estate historically, so in theory that portfolio could pay the rent and keep growing rapidly.
But a quirk of the tax code tends to obliterate that advantage. When you invest money in financial assets, you have to pay taxes on the returns they offer — the interest paid by corporate bonds, for example, or the dividends from stocks, or the capital gains when you sell either for a profit.
When you buy a home for your own use, the return it pays you — namely, giving you a place to live, not interest or dividend payments — is tax free. This is what economists call “imputed rent,” and it is one of the subtle advantages to buying that is hard to account for in standard buy versus rent analysis.
It’s a little more complicated if you buy a home using a mortgage, but the same dynamic applies. Your down payment could earn a fully taxable return as an investment, but give you a tax-free return — free rent — if used to buy a home.
That’s not the end of the favorable tax treatment, though. If you buy a portfolio of stocks and then sell them at a profit 10 years later, you pay capital gains tax on every dollar of what you made. But when selling a primary residence at a profit, the first $250,000 in profits for a single person and first $500,000 for a married couple is tax free.
The home mortgage interest deduction gets a lot of attention as a distortion of the tax code that makes home buying more attractive, but these more subtle dimensions can be just as significant.
Volatility of Maintenance Costs
These have all been quirks of homeownership that tilt the economics in favor of buying. But here’s an important one that points in the other direction.
Both renters and homeowners pay costs for maintenance on their properties; they just do so in different ways with very different implications.
If you rent and the dishwasher breaks, your landlord is on the hook to repair or replace it. You may ultimately pay the bill in the sense that expected maintenance costs are built into the rent you pay, but you have no risk of that number varying depending on luck.
Homeowners, on the other hand, face not a set monthly payment covering the costs of repairs and maintenance, but a great deal of volatility.
An urgent $2,000 air-conditioner repair bill, or even a $15,000 roof repair, might arise at any time. Other things, like replacing a shabby carpet or applying a fresh coat of paint, allow the homeowner more control over when the transaction happens, but still, it’s a lumpy pattern of expenditures.
Most rent versus buy calculators ask users to put in an estimate of monthly maintenance costs for the home they would purchase. But the issue is not the expected average of those costs but the possibility of their lumpiness and unpredictability. That can be especially problematic for a person who empties savings to buy a home only to need to pay for an expensive repair a few months later.
None of these factors alone should be decisive, and the basics that you plug into online calculators — like the monthly mortgage payment, rent on a comparable place and closing costs — are more important. But when it’s a close call, weighing these factors carefully — and how much they apply in your particular case — can help you make a smarter housing decision.
