Should I Rent or Buy? The Great Housing Debate

When asking the question “should I buy or rent?”, someone will come up with this claim: “Renting makes no sense. You’re throwing money away by paying a landlord to live in a place when you could build equity by buying a home”.

Things are never that simple. When you take out a long-term mortgage, your first few years are spent paying off the mortgage interest rather than investing in equity. Buying a home can tie you down to a specific city, barring you from exploring better economic opportunities elsewhere. Buying a home comes with countless costs that renters don’t have to deal with.

So should I buy or rent? Well, the debate is more nuanced than just building equity vs. throwing away money. You need to consider the economics of buying and renting as well as the psychological and financial impacts each choice will have on you.

The Economics of Buying vs. Renting

When asking yourself the question “should I buy or rent?”, it’s crucial to weigh the costs involved in both options. This process involves considering the housing market, which not only looks at current home prices and rental costs but also factors in the mortgage rates.

During the pandemic, we had record-low mortgage rates. The average 30-year fixed-rate mortgage went under 3%, something we hadn’t seen since Freddie Mac began keeping records back in 1971^[1]. As a result, people tried to take advantage, and everyone and their mother tried to take out a mortgage and buy a property or two.

This surge in demand caused both home prices and rental prices to spike upwards, but the impact varied for different cities.

📚 Learn more: Understanding the different types of interest rates is crucial for making informed decisions on borrowing, saving, and investing.

Cities Where Renting Is Cheaper Than Buying

When we analyze the numbers in the “should I buy or rent” debate, we find that renting is usually cheaper than buying, at least on the basis of monthly cost.

In December 2021, renting was cheaper than buying in 30 of the largest 50 metropolitan areas. Fast forward to December 2022, and that number goes up to 45 of the 50 largest cities.

According to a report by Realtor.com, an average renter in December 2022 paid 41.4% less per month than a first-time homeowner across those 50 largest American cities. That 41.4% came down to around $792 a month^[2]. 

To bring things into perspective, in the 45 metros where buying was more expensive than renting, first-time homeowners paid $906 more every month than renters. While the average cost of buying was $2,657 a month, the average monthly rent during that same time period was $1,751.

Zooming into the 10 cities that were most favorable to renters, we find that the gap between renting and buying widens to $1,920 a month. Here are those 10 cities, along with the difference between average rent prices and average mortgage payments:

What does this mean? Here is what Danielle Hale, the chief economist at Realtor.com, has to say:

Despite the fact that renting will likely be cheaper than buying in 2023, rental affordability will remain a key issue throughout the year. We expect rents will keep hitting new highs, driven by factors including still-low vacancy rates, lagging new construction, and demand from would-be first-time buyers.

Why Has the Gap Between Buying and Renting Widened Over the Past Year?

Over the past year, the cost of buying a first home increased by 37.4% YoY, while the cost of renting just went up 3.2%.

The main reason for that widening chasm is a dramatic escalation in interest rates imposed by the Federal Reserve in an effort to rein in post-pandemic inflation. Mortgage rates shot up to over 7% within a single year.

Rising mortgage rates pushed home costs higher, and it also dramatically reduced the supply of homes on the market. Homeowners carrying mortgages at 3% were not about to change houses, with new mortgages over 7%, so sales dried up. Reduced demand drove prices even higher.

Cities Where Buying Is Cheaper Than Renting

What about those 5 cities that favored buying over renting?

In those 5 metro areas, buying a home could save you $235 a month. Those five cities are as follows:

• Memphis, Tennessee, where buying a home could save you around $400
• Pittsburgh, Pennsylvania, where buying a home could save you around $350
• Birmingham, Alabama, where buying a home could save you around $300
• St. Louis, Missouri, where buying a home could save you around $100
• Baltimore, Maryland, where buying a home could save you around $70

Not too long ago, Cleveland was at the top of that list, but over the past year, renting has become cheaper than buying there by a relatively small margin.

📚 Learn more: Explore our guide to find out when should you refinance your mortgage to maximize your financial benefits.

The True Costs of Renting and Buying

When considering whether to buy or rent, it’s crucial to compare the ongoing costs of a monthly mortgage against the expenses of monthly rent. In the “should I buy or rent” debate, you have to take into account that buying a house involves additional costs beyond the mortgage, such as insurance, property taxes, maintenance, and repairs. There are also closing costs, which can also represent a significant portion of a property’s value.

📚 Learn more: Dive into our comprehensive guide to unravel the complexities and understand exactly how taxes work for individuals.

You also have to consider the opportunity cost. Purchasing a home involves substantial upfront costs, including a downpayment and closing costs. If you choose to rent, you can invest that money and get some return on that investment.

Over and above, there might be some ancillary fees to consider that come with home ownership, such as monthly HOA fees.

So, as a homebuyer, here are some of the variables that go into your calculus:

• The home price
• The mortgage rate
• The rate of home price appreciation
• The property taxes
• The opportunity cost
• The expected maintenance fees
• The closing costs
• The homeowner’s insurance
• The monthly utilities

As a renter, you don’t need to worry about maintenance, but there are a few extra costs that you need to take into account: the 1-month security deposit, the broker’s fee, and annual renter’s insurance. You also have to deal with annual rent increases, which could be exorbitant.

If you crunch the numbers and consider all relevant variables when wondering “should I buy or rent?”, you’ll find that the most crucial factor is how long you plan to stay in the property. The longer you intend to stay at a single property, the more it makes sense to buy it.

Danielle Hale, the chief economist for Realtor.com, says:

For prospective first-time buyers, the key consideration when figuring out whether to buy or rent is how long you plan to live in your next home. If you’re looking for flexibility to move in the shorter term, renting may be your best bet, and still offer opportunities to save if you’re able to compromise on factors like proximity to the downtown area. Whereas buying could be the better option if you’re planning to stay put for at least five years. Market conditions will play a role, but ultimately the timing comes down to your personal situation.

The Breakeven Point

As we’ve just seen, the biggest economic determinant of whether you should buy or rent is the number of years you plan to spend in that home.

To make things more concrete, let’s assume that you are looking at two similar properties, equal in all the ways that matter to you. One is for sale, and the other is up for rent.  The cost of the mortgage payments for one is equal to the rental costs of the other. In this scenario, how long do you need to stay till buying makes more sense than renting?

Well, to answer that question, we need to look at all of the aforementioned variables and to make some assumptions:

• The property tax rate = 1.35%
• Homeowner’s insurance = 0.46%
• Home repairs = 0.5%
• Renovations = 0.5%
• Marginal income tax rate= 25%
• Renter’s insurance = 1.32%
• Buying closing costs = 4%
• Selling closing costs = 10%
• Rent security deposit = 1 month rent
• Home value appreciation = 3%
• Rent appreciation = 2%
• General inflation = 2%
• Annual return on cash = 4%
• Capital gains tax rate = 15%

Under these conditions, your breakeven number is 3 years. In other words, if you plan to stay at the property for more than 3 years, then buying is cheaper than renting after all relevant factors and costs have been taken into consideration.

However, if any of the above factors change, this could alter your math. For instance, let’s assume that home value appreciation was 5% instead of 3%. In that case, you need to stay less than 2 years to justify your purchase decision. Alternatively, if the property tax rate goes up to 2% rather than 1.35%, you need to stay a little under 4 years for the purchase decision to make fiscal sense.

Other Pros and Cons of Renting and Buying

We have been dealing with the question “should I buy or rent?” as a purely economic issue, looking at it the same way an investor looks at a company they’re considering buying.

The Pros and Cons of Buying a Home

Owning a home is a source of pride for many Americans. After all, part of the American dream is owning your own property. Better yet, once you have bought it, you can do what you wish with the home: change its design, alter the look, and do whatever else it takes to make the place feel like a home. 

You will also have a sense of stability that few renters enjoy, and you will be part of a community.

Buying a home ties you to a certain location for a few years. When we were crunching the numbers, we assumed that you would have no trouble selling your place, but that may not be the case.

Depending on the housing market and the mortgage rates, you might have a hard time offloading your property should you decide to change geographies. And, if the market is in a downturn, but you need to sell, then you may have to sell your property at a loss.

We also talked about the costs of repairs, renovations, and maintenance, but we failed to discuss the required time commitment. For instance, if your plumbing breaks, you need to spend time finding the right plumber, waiting for them to show up, standing with them as they replace your worn-out pipes, and paying them.

🔨 Learn more: Before you start your next renovation project, check out our list of home improvements that surprisingly don’t add value to your property.

The Pros and Cons of Renting

One of the best things about renting is the predictability of your monthly costs. As a homeowner, you need to be prepared to lay out some cash and potentially go into debt if the roof caves in tomorrow. As a renter, you don’t have to pay an extra cent if the roof caves because it is your landlord’s responsibility.

Renters also enjoy a sense of freedom in the sense that they can just pick up and leave the minute their lease is up.

The flip side to that coin is that renters have to live with instability. If the landlord increases the rent, there is nothing you can do about it. Obviously, this might not be the case if there are rent ceilings and rent controls, but very few of us are so lucky. Additionally, a landlord could still kick you out should they decide to sell their property or transform their apartment complex into condos.

📖 Learn more: Simplify your monthly payments by exploring these 10 reliable methods to pay rent online, compiled in our latest post.

Putting It All Together…

So, should I buy or rent?

The answer is it depends on your finances, your living situation, and your priorities. If you plan to stay in the same place for more than 5 years, and you value stability and community, then buying a home might make sense for you. If you know that you’re only staying for a year or two, then renting might make more fiscal sense.