Renting vs. Buying

Isn’t it always smarter to buy rather than rent?

Many people feel that renting is like throwing your money away, and that you should buy a house as soon as you can. However, this isn’t necessarily true. Although there can be many benefits to homeownership, many people find renting more advantageous than buying. Which is better for you? To find out, you’ll need to evaluate many nonfinancial and financial factors.

The nonfinancial advantages of renting include:

  • Moving is easier: Simply find a new home to rent, give the required notice, pack up, and move (although there may be some complications if you break a lease). This is particularly attractive to individuals who are often relocated by their employers.

  • You don’t need to hire someone to do repairs: Is your faucet leaking, air conditioner blowing hot air, heater blowing cold air? No worries–just call the landlord.

  • You don’t need to maintain the property: Need the driveway shoveled, the grass mown, or the leaves raked? Don’t get up–most landlords include these services in the lease.

Financial considerations

Is renting really a better financial option than buying? Certainly you’ll save some costs associated only with buying, such as a down payment (though if you rent you generally must pay two months up front plus a security deposit), closing costs, and property taxes. You may even save on other expenses of owning, like purchasing new furniture/appliances, landscaping, or remodeling. And, you can generally rent an apartment, house, or condo for less than the monthly cost of buying the same space.

The answer seems easy, doesn’t it? But this is deceiving. Rent payments are not deductible on your federal income tax return (although some of it may be deductible on your state return), but mortgage interest and property taxes are if you itemize. As a result, the effective cost of owning a home may be lower than it appears compared to renting. To get an accurate comparison, you need to calculate after-tax costs. Further, there are other financial benefits of buying (e.g., equity) that you must consider. For more information on the financial benefits of homeownership, see below.

Tip: The rent vs. buy calculation is complicated and many factors come into play, such as the price of the home, the amount of your down payment, current interest rates, the current property tax rate, your income tax bracket, how long you intend to live in the home, and the amount of rent you’re currently paying. You may want to seek the help of a financial advisor to determine whether renting or buying makes better sense for you.

What are the benefits of homeownership?

For many, owning a home represents the American dream–a back yard, privacy, a place to call your own. If you’re committed to fulfilling that dream, you’ll never be happy renting regardless of any advantages doing so may hold. Other advantages of homeownership include:

Stability and flexibility

Owning your own home can provide a certain sense of security. You won’t be faced with the prospect of finding yourself without a place to live if your landlord dies suddenly or decides to sell the building, and you won’t have to deal with increases in rent.

Caution: The price of this stability is a certain amount of risk. If you become delinquent in your house payments, your mortgagor may foreclose and pursue a forced sale of your home–and you may lose money on the sale. Renters are not faced with this possibility because they do not own the property in which they live.

Financial benefits

  • Income tax deductions: As you’re probably aware, federal tax laws strongly favor homeowners. Mortgage interest and property taxes are tax deductible, provided you itemize your deductions. If your total itemized deductions exceed the standard deduction ($10,700 for married taxpayers filing jointly in 2007), this can provide the potential for an enormous tax benefit, especially in the early years of homeownership.

  • For some years, premiums paid or accrued for qualified mortgage insurance is treated as deductible mortgage interest. Qualified mortgage insurance means mortgage insurance provided by the VA, FHA, and Rural Housing Authority as well as private mortgage insurance (PMI). The amount of the deduction is phased out if your AGI exceeds $100,000 ($50,000 if married filing separately). This provision does not apply with respect to any mortgage contract issued before January 1, 2007.

  • Gain on sale exclusion: If you sell your home and qualify, you may exclude up to $250,000 of your capital gain from tax. For married couples, the exclusion is $500,000.

  • Equity: As a homeowner, you can borrow against the equity in your home, using either a second mortgage or a home equity line of credit. The interest on a home equity loan of up to $100,000 is also tax deductible, regardless of how you use the money. Many homeowners use home equity loans to consolidate other high-interest loans, make repairs and improvements, and even fund a child’s education. Lenders will generally allow you to borrow up to 80 to 90 percent of the value of your home.

  • Asset appreciation: You may buy a home with a little of your own money (your down payment) and a lot of someone else’s (your mortgage). However, if the value of your home increases, the profit is all yours when you sell it. You benefit from the increased value of the entire property, even though originally you used only a small portion of your own money to finance it.

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