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  • Writer's pictureDamon C Collins, MBA, AAMS®, CFEI®

Should You Buy Your Home, or Just Rent It?


If it’s an investing question, the usual debate goes something like this: Buying allows for capital appreciation and tax advantages, but renting is cheaper, and you could invest the extra money in the stock market. Both points are equally valid, as far as they go.


But for most people, home ownership is as much of an emotional issue as it is an investment, so you need to factor that in. And the reality is that buying a home isn’t always better than renting, and renting doesn’t always provide every convenience you may believe it does.


There are some key points to consider when deciding between renting or buying, and each has benefits and drawbacks.


Take a Step Back, Evaluate


Before diving into which option makes the most sense, you have to know the answer to one important question:


“Can I afford to buy a home?”


The answer is not so much about if you can pay the monthly mortgage payment. The answer there is about evaluating your other situations. Some key areas to pay attention to are:


Current Savings


Savings are the first step. Before you go into debt, you must ensure the basics are covered. This means an emergency fund. This isn’t just to cover an unexpected expense – it’s to provide for you if you lose your source of income. Without an emergency fund, you might need to take on credit card debt, take out a loan, or sell investments. All of these options harm your financial wellness, so having an emergency fund with 3-6 months of living expenses is essential.


The next big savings goal is the down payment. It’s possible to get a mortgage with as little as 3.5% down (or even 0% in some instances), but this route also requires an additional monthly cost - private mortgage insurance (PMI). Having enough to cover the standard 20% down will save you the cost of PMI and save you money in interest over the length of the mortgage.


Your Credit Score


The better your credit score, the lower the interest rate you’ll receive, which means the less you’ll pay in interest. For example, the difference between a 3% interest rate and a 4% interest rate on a 30-year $500,000 mortgage is slightly more than $100,000. One percentage point difference may not seem like a lot, but it is. Building a good credit score and delaying a home purchase long enough to improve your financial situation can mean saving tens of thousands of dollars on your mortgage.


Debt-to-income Ratio


Debt-to-income is the percentage of your monthly income that goes towards debt payments. It’s used by lenders to determine your trustworthiness and reliability as a borrower. In other words, if 30% of your monthly income goes towards credit card payments and car notes, your debt-to-income (DTI) ratio would be 30%. Lenders want to see as low of a DTI ratio as possible, and it’s generally recommended to stay around 25-35% when trying to get a mortgage.


But if you’re a business-minded entrepreneur, you may approach home ownership a little bit differently. If you’re just starting your business without a partner that has consistent W-2 income, it can be challenging to qualify for a mortgage. You generally need two years of strong financials if you are self-employed and receiving a 1099 income. You may also not want to sacrifice the cash for a down payment when that money could be reinvested into the business.




Your Life, Your Choices


Outside of the financials, you need to consider your feelings and life. Do you enjoy renting because of the flexibility and convenience? Do you feel like you'll be stuck in one location once you buy a home?


Answering questions like these is one of the best ways to get to the root of decision-making. Always ask yourself the “why” behind wanting—or not wanting—to make a certain decision. When it comes to a lifestyle decision like the difference between buying and renting, finances are only one factor to consider.


When Does Home Ownership Make the Most Sense?


You plan to stay in one place - The general rule of thumb is that if you plan to live somewhere longer than 5 years, it can make sense financially to buy. Choosing to move sooner than 5 years can cost you money as you won’t have built-up equity in the home, and closing costs will not have amortized over a long-term mortgage.


You need the tax benefits of homeownership - There are several deductible home expenses. If you are married and filing jointly, you can deduct up to $750,000 of mortgage interest if the property is your primary residence. You can also deduct up to $10,000 from state and local property taxes. Depending on your income level, you may also be able to deduct PMI. If you are self-employed, you can deduct expenses such as repairs, utilities, mortgage interest, real estate taxes, and more in accordance with the percentage of the home that the office space occupies.



The Takeaway


As you can probably tell, there’s no one-size-fits-all answer here. The decision between renting and buying can be as simple as running the numbers and seeing which option is most cost-effective, but we all know decisions—especially financial decisions—require personal consideration. A financial advisor can help uncover some of the deeper reasonings behind wanting to either rent or buy and ultimately help you make the right decision that aligns with your financial values.

 

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All written content on this site is for information purposes only. Opinions expressed herein are solely those of Collins Wealth Management LLC unless otherwise specifically cited. The material presented is believed to be from reliable sources, and our firm makes no representations of another party's informational accuracy or completeness. Before implementation, all information or ideas should be discussed in detail with an advisor, accountant, or legal counsel.


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