 Personal Finance PowerPoint Presentation Renting a Home vs. Buying a Home Decision Overview Get ready to get financially fit by practicing personal finance. Most of this information can be found at Investopedia, Making the Rent or Buy Decision by James McWinnie, Updated October 10, 2021. You can go there for more references and resources and continue your research. We're thinking about the cost of the home at this point and first considering the decision as to whether to rent or to purchase a home. Obviously the cost of living is going to be another kind of big item on the personal expenses and if we were to invest in a home, invest in the property, that's going to be a huge kind of personal investment. So we'll spend some time on that decision making process. Clearly, especially with the purchase of a home, we're talking about one of those decision making processes within the finance decisions that's going to be a longer term type of decision. The rent is possibly still somewhat longer term because you're probably going to be locked into the rent for at least a year, but it's clearly not as long term as the purchase of the home. And therefore the more we categorize something as a long term decision, we want to go through a more formal process to make that decision as opposed to the day to day types of decisions where we can kind of hone down our habits, use a trial and error type of method. The more we're getting into longer term decisions, which does include say a rent for say a year because that's going to impact at least a year and of course more so when we're talking about the purchase of a home, the more we want to put down a formal process to make a decision with more forethought involved because we don't have the benefit of the trial and error type of decision making process. We can't tinker. We've got to measure twice and cut once with those kinds of decisions. So keeping that in mind, making the right rent or buy decision, when making the decision to rent or buy a place to live, there are two broad categories of factors to be considered. The first and most obvious category represents the financial aspects of your decision, namely the initial ongoing costs as well as the long term pros and cons. So one of the things we want to look at is the kind of utilitarian calculation. Is it financially beneficial to be renting or buying? That's not the only factors that should be driving our decision because there's a whole lot of other factors that could be on the personal side of things involved. However, those personal kind of factors, including things like how much do you value owning the home versus the renting the home and how much do you value the ability to basically be able to move around more easily from time period to time period as opposed to possibly being more locked down in a particular area. These things are more difficult to quantify in what we're usually going to use as our measuring tool, that being dollars. So once we start to go through our calculations, we can kind of hone down the financial aspects from a financial utilitarian kind of calculation. We also want to see if we can quantify to some degree those tradeoffs and those personal benefits so we can put them into our more formal long term calculations. So the second category is a set of personal and emotional factors which are more intangible. So these are going to be those intangible factors harder to measure, but of course significant. We want to put them in place, we want to account for them and we would like to do it so that we can do it kind of numerically. We want to kind of measure those intangibles against the financials or include them in the financials and try to put a dollar amount on them would be the easiest way to do that from a calculation standpoint. However, these factors play an important role in the decision to rent or buy. The finances of renting versus buying, the first step in the decision making process is to determine whether you can afford to purchase a home. So clearly if you're thinking about buying a home the question is going to be can I afford to purchase a home? Do I have the option of making the choice if you're clearly nowhere near the capacity to be able to purchase the home, the decision is fairly straightforward at that point, you're going to be renting at that point in time. So some issues to consider include your ability to make a down payment generally between 5 and 20% of the home's purchase price and pay closing costs which may come to an additional 5%. So clearly when we're thinking about a home in a particular area then we can start to round down or think about how much home we need, where we want that home to be, what's going to be the costs of the home in that area and typically to purchase a home especially under like a standard purchasing process which is the easiest place to start with which would be financing of like a 30 year fixed loan. Those are going to be the easiest places to start because they're the most standard and you'll have the most you know set kind of prices you can think about from there and then you can deviate with more what they kind of like exotic loans and stuff like with arms and flexible rates and whatnot but typically usually under normal times you need to put that 20% down on the down payment. That's because the lender is going to have the home as recourse meaning if you don't pay off the loan then the lender can have recourse on the home, they can go forward to the foreclosure. That doesn't mean that they own the home, that means you own the home, you have a loan on the home. The bank even if you financed 80% of it, the bank doesn't come to the home and say hey look I would like to vote that we want to paint the house blue. They don't have a say on whether you paint the house blue or anything like that because they don't own the home, they just have recourse in the event that you default say on the loan. Now they don't even want to foreclose on the home because they're not a real estate company, they want you to pay the mortgage because they're earning basically interest on it. So what they're going to want to do to safeguard themselves is get that 20% down because that one commits you because now you've put a substantial investment into it and two if you were to not pay off the loan they have the capacity to foreclose on it and the home is going to hopefully if it didn't go down more than 20% they'll be able to sell it and recover the loan costs as well as the expenses of going through that process. But you can imagine times when that there was like you know the banks whatever for whatever reasons in the economy that that the down payment goes way down possibly you have a different kind of loan that you're taking out or something like that or possibly you're just in the cycle of the economy where things have gotten crazy in the banks or for whatever reason due to laws that are in place or possibly secondary market kind of conditions the the down payment could be less you might not have to put as much down payment so it really depends on the timeframe in terms of how much money you can have to put down up front but usually you can have to put something down up front in normal times so these costs are likely to exceed the initial rental cost and security deposit that would be required if you were renting instead of buying so there's clearly going to be some initial costs on the rental side of things as well but that usually includes you know the initial rent possibly a security deposit and possibly the end rent and that's usually far less than 20% of the down payment on a home and the closing costs that take place as well you got you also have a timing consideration if you need to move in somewhere quickly then it's gonna take longer to go through the closing process and the whole purchasing process so of course having enough money to cover the initial purchase of a new home is only part of the total expenses before moving into the new home you'll need to put some thought into how much it's going to cost you to stay in it after you take up residence so when you move into the home typically the costs are you're still gonna have costs for the home you don't have to pay the rent but you clearly have to pay the mortgage on it and you don't have as much recourse for the other kind of things that come up from a maintenance standpoint if you're renting somewhere depending on where you are and what the rent terms are you might be able to say hey something's broken come fix it and you're not really responsible for those kind of things you are responsible if you own the home and you got to take those into consideration many financial experts suggest that your monthly mortgage payment should not exceed 28% of your gross income in addition your total monthly debt payments should not exceed 36% so these are kind of kind of heuristics are kind of just quick calculations that you could use to help you determine whether or not you can afford the home these are also certain numbers that might be used by financial institutions as a way to try to determine how much loan they might be able to give you or how much you might be able to afford on a monthly basis to kind of go towards the home we'll talk more about those in practice problems if you go beyond this limit you may run into trouble that's because in addition to paying the mortgage each month you need to factor in home maintenance such as new appliances and a roof and or a roof right so clearly the home is going to deteriorate over time some of those things that deteriorate can be quite large big costs up front so it's kind of like when you have a car that goes down you got to buy a new car it'd be nice if you're saving up for the car with the home you got the roof is a big factor every you know it's going to deteriorate over time you're going to need a new roof at some point the pipes might be something that that could be a large cost at some point in time so advantages and disadvantages of renting versus buying renting may be a little easier on the pocketbook because it provides a fixed dollar cost for monthly expenses which are paid along with the rent so when you're renting you got a fixed monthly payment it's pretty standardized because you don't have to deal with all these other kind of maintenance things that might come up on a random basis therefore it's easier to budget for often times besides potentially increasing from year to year the rent tends to remain steady so rent is usually fairly steady but it really depends on the economy too because if you if you go into a point at this point in time it looks like we're going into a point of inflation so if you're in a point of inflation the rents could go up and that could be a painful thing because so you're kind of subject to some degree on the whims of the economy if the economy were stable you would think the rents would be fairly stable as well so if maintenance issues arise the landlord pays for the repairs so that's a huge benefit on the renting side of things huge hassle on the on the home ownership side of things it also factors in as to whether you're the type of person that would like someone else to basically take take up the repairs and be content with the level of maintenance and so on that is provided at the facility you are at or if you're someone that likes to do your own repairs and whatnot and possibly you're someone that likes to renovate and do your own do your own thing increase the standard of the place that you're at then you know you you might have some restrictions on the renting that you would like to make different changes to so instead of spending your own money on a new roof you can invest in it or spending it as you like so if you're if you've done the math and can afford to make the initial purchase and service the ongoing debt the next factor you have to decide is on whether this purchase benefits you financially so if you can afford to purchase the home doesn't necessarily mean that you should purchase the home then so obviously if you cannot afford the home purchase that it's an easy choice you're gonna be renting but if you get a home if you can afford the purchase of a home then that doesn't automatically mean that you should do so the next question is well would it be financially beneficial for you to do so and then is it both financially beneficial and when you consider your personal kind of conditions is it beneficial to do so so a rent control department in New York City or a place in a suburban location outside of a major city quite possibly charges a month's rent that is significantly less than the monthly mortgage payment for properties within the city so it depends on your location clearly some places are a lot higher you know cost of living locations than other locations are so you once you take out the loan you can kind of consider what your mortgage payments are versus what the rental amounts are you can also kind of consider this if you were an investing if you were investing in the real estate and you were gonna rent out the property for example you would like to at after you've invested in it get the rent from people that is going to be more than the mortgage payments for example that you be paying to be nice to be more than the mortgage payments and more than the the the the cost of the maintenance and whatnot although of course when you're investing in real estate you're not just getting the money from the rent if you were investing in it or get getting the benefit from living in it which is equivalent kind of to the cost of the rent instead you're also hoping for the property to go up in value however the property going up in value is not guaranteed and even if the property does go up in value you haven't locked in that increase in the value that increase in equity unless you were to sell the property or perhaps a refinance it or to at least get some liquidity from that increase in in the equity so you got to keep that there's a difference between your net assets value your assets minus your liabilities which increases with equity and your cash flow which doesn't necessarily increase with equity because you can't tap into the cash flow unless you sold the home or refinanced it which is a tedious and costly process oftentimes so however if renting by the month is cheaper than paying a monthly mortgage there are other long-term factors to consider those that espouse buying instead of renting often cite the ability to build equity the tax breaks and the investment value of a home as solid reasons to buy so this is clearly what you're going to hear oftentimes and note that if you're talking you got to be careful on who you're talking to in terms of what their arguments are going to be if you work in someone who is a real estate broker or a loan broker especially if they're real estate brokers and loan brokers who you are potentially going to do business with then they clearly have an incentive to lean towards home buying because that's their business doesn't mean they're lying doesn't mean you don't want to listen to their information it does mean that you would think that they're going to have a bias towards being a home owner whereas so what you really want to do anytime you make these large kind of decisions is not only talk to the expert that you're going to do business with especially one that's going to that's going to make a commission on the business that you're doing because their bias is talk to someone who is independent possibly like an accountant maybe or a lawyer friend or your other homeowner friends or renter friends or or a CPA from your tax professional and pay them if you need to if it's a professional not based on whether you're going to buy the home but just for advice because then you're looking for neutral advice not advice that you would think would be biased or at least have the parents that it could be biased based on you doing business with them or not so obviously building equity that's going to be the difference between the home value and the loan value you build equity one by paying down the loan because now as you pay down the loan you're decreasing if the home value stays the same and the liability goes down equity goes up meaning assets my aside abilities go up your net value goes up or if the value goes up in value the property goes up in value your net assets go up and hopefully that will happen you hopefully property will increase in value but it doesn't have to it you know the cycle of when property goes up and down is more of a long term kind of thing it might not but but we have seen the property does go down from time to time and then that so you got a kid and then you got the tax breaks again be very careful with the tax breaks because they can be deceiving between the standard deduction and the itemized deductions there also things you want to be quite careful of because the tax code could change that's been changing a lot in the last couple years we're going into a significant where people are more concerned it feels to me like at this point in time at the point of this recording they're more concerned with the national debt and whatnot and so you know you know we don't know what's going to happen with the tax code you would think anyway so you got to be careful with that and the investment value of the home as a solid reason so the investment value is great but again remember that investment value is not liquid you can't really tap into it so there's pros and cons of those of those items you'll usually hear the pros that's why I'm kind of emphasizing the other side because I just want to show both sides of that argument so while these arguments have merit there are downsides to all of them so do the calculations a variety of online calculators are available to help you evaluate the financial aspects of the rent versus buy decision so you can look at tools online to help you with that calculation but keep in mind that you need to estimate a range of variables including the number of years you will stay in the home and those online tools are great as a as a as like a starting point but when you really start digging into it if you're really getting into the decision as to whether you might buy instead of renting then you probably want to use those as a guide but then start building your own Excel worksheets and running scenarios and we'll practice doing some of those you can get an idea how to do that in our practice problems to estimate the investment profit the home will provide assume the yearly rate of appreciation on the home's value the results are only as good as the assumptions used to calculate them so we can assume the the appreciation you can look at professionals to calculate the appreciation but nobody knows the future right and if everybody thought the home values are going to go up then it's likely that some then something's wrong because there's a huge group thing going on most likely and that's usually when a bubble is in place so you can't really completely depend on the market you can't depend on the market going up you can but you can make an estimate about it and you can do your best guess don't forget to consider the cost of ongoing maintenance after you have carefully considered the financial issues it's time to explore the non-financial issues there are however other things to consider beyond the financial aspect when it comes to renting or buying such as amenities and flexibility so amenities if you're renting for example you might more likely have access to something like a pool and like the gym that's in the place and a little park area that's in the middle of your of your place or something like that you might not have those kind of things you can have a like a movie theater and say in your home in your amenities area or like a party space or something where they where you can rent where you can go into that little area and have events or something you don't really have that kind of stuff you might not have as big a property on the home to have that kind of stuff so how important is that stuff to you and the flexibility clearly renting if you're doing it on a year-by-year basis or you could rent month-by-month then you could move after the year when you're a lot when you're purchasing the home if that's a huge investment to you you're less likely to be able to cover the home investment and move unless you rented it so you could have some flexibility if you were going to rent it but you're going to be kind of locked in to some degree on the home so are you putting the roots down is that where you want to be for a long period of time or possibly not so rented advantages it's easy to move if you're renting you're kind of locked into the lease for whatever the lease term is but once it's up you know you could move feel fewer responsibilities so you're not really locked into the maintenance and so on and that kind of stuff you just you just live in there still just don't tear anything apart and call the rental company if there's a problem minimal financial commitment so you're not locked into a 30-year loan or anything like that you're not really worried about the market going up and down except for the fact that you might be saying hey the housing market's doing good and I should have locked in my loan right no matter what you do you're worried about something right if you're renting you're saying I should have bought because everybody says it's the best investment ever and I'm not doing it and if you're if you buy the home then you're always thinking I don't have any money because I put all the money into the home but my home is them is going up and it's going to be the best investment ever and then whatever decision you make of course you're gonna you're sitting there rationalizing it right it's gonna be a good decision after a lot of thought about it but in any case renting disadvantages so these are the disadvantages you don't get the tax benefits for renting so you can argue whether or not the tax benefits are like good law or not obviously when they put the tax benefits in you've got things like the mortgage interest possibly being deductible and the property taxes those are huge tax benefits that could people push people over from itemizing I mean from standard deduction to itemizing but they might be less impactful for low to moderate income people because they increased the standard deduction a few years ago so you really have to do a tax projection to see how beneficial those are they're also kind of funny items and that they're items that are personal personal items that are deductible and you normally under an income tax the natural things that you would think would be deductible would be things that you needed to expand in order to generate revenue because they're not going to an income tax shouldn't tax you on the top line gross income but on net income and so these things are kind of unusual that they're deductible because a personal home is a personal thing that's deductible and possibly part of the reason it's deductible is because of lobbyists and the home owner you know whoever is is in the market of home construction clearly wants that but the other the other reason people say that they're the need those laws is that it's going to incentivize home purchasing which was thought to be a virtue in and of itself over and above renting so you may or may not you know agree with that but you also got to just realize that it's a you know it's a little bit funny that a person on the tax laws probably won't change that they pull those away but they did they did like cap off the amount of state taxes a couple years ago and so it's possible that those laws could change we don't know which way they could change but you can't you can't rely on them completely because the tax law will change from time time frame to time frame so limitations on remodeling so you can't obviously if you're renting and you're the type of person that are like I don't like this just square box I'm living in and my sink is too plain and my kitchen needs a bigger well if you like to remodel and do that kind of stuff you're you're limited to whatever the stock thing is on the rental so that would be if you're into that kind of stuff to have in your own home would probably be the way to go so you can you can play with it so restrictions on restrictions on pets and other activities so if you're renting you know you probably can't have that dog that's like as big as a horse because that renters they don't like that as much but maybe someplace is buying advantages so if you're buying then a lot of people put in the pride of ownership of course into the buying it's you know they kind of marketed owning a home as part of the American dream to own the home and so there is of course a sense of pride and being able to own the home and if you like to like I say if you like to actually change things in the home if you like to you know work on the home yourself and whatnot then owning the home could be a very good option financial benefits of course there could be financial benefits to owning a home including the home possibly increasing in value over time hopefully and you have some hedges possibly against other types of investments because it's more of a fixed investment although less liquid lifestyle flexibility you could change the home to whatever you know you want to change it to as opposed to if renting then they have to they have to hone the renting to what they think the population of the renters that they're aiming at will like most likely buying disadvantages financial commitment so clearly if you're going to be purchasing something that's a long-term commitment you want to make sure that you're going through the formal process of of the decision-making process and thinking about the pros and cons in some systematic way because it's going to impact multiple periods into the future higher living expenses possibly could be higher costs limited mobility clearly you can't you know just move if you own the home you might be able to sell the home that's going to be a long process and if the market is down then which you know usually you want to move when things are bad if things are bad in your area you're not going to be able to move because the home because no one's going to want to buy the home and when things are good you're probably not going to want to move but that's when the home value would be high right and so so there's going to be limitations on moving now you can always rent the home and then move but then you still have to take care of the home and in the rental component capacity possibly yourself or possibly hiring a rental company to do that so that's still going to you know take some time and some effort in that instance