One perceived sign of financial success in America is to buy your own home, a step that is often referred to as the “American dream.” However, home ownership isn’t always a dream for everyone. It can turn into a nightmare for people who are not prepared for the financial responsibilities of owning a home, as the recent housing bust that followed the financial crisis made clear.
In reality, the decision of whether to buy or rent a home is not so much a sign of financial success (or a lack thereof) as it is a financial strategy that should be viewed through a strategic lens. And the term “home ownership” is actually a little misleading: Very few people who buy a home actually own it — rather, the bank primarily owns the home, with the “homeowner” making mortgage payments that are applied to ownership over a number of years (e.g., over 30 years on a traditional 30-year mortgage).
So what are the factors that should go into this strategic financial decision? Here are three to mull over:
- Financial considerations — Owning instead of renting a home is usually considered the smarter financial decision, and it often is — but not always. The main financial considerations are the purchase price of the home, the amount of the down payment, the mortgage interest rate, the amount of the monthly mortgage or rent payment, and ongoing home maintenance and repair costs.
Though home prices have started to rebound from their post-crash lows, there are still great deals to be found in many parts of the country. Meanwhile, mortgage rates remain at or near historic lows, which helps keep monthly mortgage payments down. The question from a monthly cash flow perspective is: how does a mortgage payment compare to a rent payment?
The down payment required to buy a home is another big financial consideration. Banks may require up to 20 percent down, so if you do not have this much money saved up, you might not qualify for a home mortgage. Don’t forget to factor in the maintenance and repair costs that go along with home ownership. Some experts advise creating a repair and maintenance fund to save money you can put toward inevitable expenses like roof replacement, HVAC repairs and exterior painting.
- Tax considerations — One of the biggest benefits of home ownership is the fact that the government offers a tax benefit to many homeowners. Both the interest paid on a home mortgage and real estate taxes are generally tax-deductible. This results in a lower effect interest rate on your mortgage.
However, to reap this tax benefit, you cannot just claim the standard deduction — you have to file IRS Form 1040 and itemize your deductions on Schedule A. The standard deduction for tax year 2013 is $12,200 for married couples filing jointly, $8,950 for heads of households, and $6,100 for singles and married couples filing separately. Therefore, taking out a small mortgage may not provide tax savings at all.
- Lifestyle considerations — Buying a home often involves lifestyle tradeoffs compared to renting that many potential homebuyers do not think about. When you are renting and there is a busted pipe or broken air conditioner, you just call the landlord to have it repaired. The property owner will also take care of major repairs and maintenance like the items noted above.
This is not the case when you are the homeowner: You will be responsible for taking care of all of these things. Of course, there is a financial cost involved in this, but there are lifestyle considerations as well. You could possibly save money by doing some repair and maintenance projects yourself, but if you are not good with a hammer and a wrench, your D.I.Y. attempts might end up costing you even more money in the end.
The bottom line: If you have many hobbies, live an active lifestyle, and do not want to spend time on home maintenance, repair and landscaping projects, renting might be smarter for you from a lifestyle perspective.
There’s a lot more that goes into the buy vs. rent decision than many people realize — and it goes much deeper than just trying to realize the “American dream.” Consider these and other financial and non-financial factors carefully in order to make the right decision.
If you decide that buying a home is the smart choice for you, go for it! However, there is no shame in renting either, if that is what makes the most sense for you and your family. Just don’t let the opinions and perceptions of others shape what is one of the most important financial decisions you have to make.
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