Should You Rent or Buy a Home? Here’s a Simple Go/No-Go Matrix to Help You Decide

I didn’t think the option was possible. In early 2020, I did some quick math in my head and thought there was no way I could afford to buy a home. Instead, I’d be left paying $2,100 in rent for the rest of my life.

However, that mindset was quickly shattered as I dug deeper into renting vs buying a home. As it turns out, the decision is not as complex as some people (aka me) think.

Homeownership is a major decision that many people make. The benefits of owning your own home are often seen as outweighing the costs, but it’s important to consider both sides before making your final decision.

I recently had the opportunity to sit down with Michael O’Keefe who helped break down his Go/No-Go decision matrix on whether someone should buy a home or continue to rent. But before we get to that conversation let’s first go over some of the factors you should consider when deciding whether or not to rent or buy a home.

Costs of Renting

Renting is a home is a relatively straightforward financial decision. There is, of course, your cost of rent which sometimes even includes utilities, waste management, and security.

A lot of renters also require renters insurance. Just like rent, this is a predictable cost month after month.

However, home repairs are covered by the property owner (or management company) which means any unexpected costs are footed by your landlord, not you.

Now, you might also be asked to cover the first and last month’s rent as well as a security deposit. These aren’t additional costs per see since the first and last month’s rent is, well, rent and security deposits should be returned to you given that you take good care of the place before you move out.

Unlike buying a home, however, you might also have to put down a pet deposit or pay a monthly pet fee if you own pets and want them to stay with you in your rental. If you owned a home you can do whatever the heck you want. You might also have to pay for a parking spot or garage if you are in an area with limited parking.

All in all, the costs of renting across the United States range from $725 (West Virginia) to $1,617 (Hawaii). Of course, urban areas tend to be more expensive than rural areas.

Let’s compare these costs to the costs of purchasing and owning a home.

Costs of buying a home

Before we cover the costs of owning a home, let’s look at what costs are involved with actually buying (and selling) a home.

To buy a home, you will need to put money down to cover closing costs. Closing costs are comprised of loan origination and/or underwriting, title insurance, and other closing costs like broker fees.

You will also need to pay for a home inspection (unless you do it before you put down the earnest money). The home inspection is a good idea because if there are any major issues with the house, then they will be known before you buy it.

You will also need to pay for a survey and title search if the house is in an area without a clear title. These costs are typically paid at the time of closing and sometimes they’re waived if you have a title insurance policy.

Other costs you might encounter when purchasing a home include application fees, appraisal fees, credit check fees, title insurance, and transfer tax (if applicable). All in all, you should expect to pay between 2 and 5 percent of a loan’s principle just on these costs alone.

Costs of Owning a Home

It doesn’t end there. On top of paying to buy a home, you will incur more costs to actually own a home. For example, each month you will pay your mortgage which is a lump sum of your loan principal, interest, property taxes, homeowners insurance, and PMI (private mortgage insurance) which is what you pay when you didn’t put down enough money for a 20% down payment.

Now, depending on the length and terms of your fixed-rate mortgage, when you first start out only a small fraction of your monthly mortgage goes toward paying down your principal. It’ll take a long time before your mortgage payments are majority principal and less of everything else. Why does this matter? Well, because paying down your principal is part of how you build home equity (that and hoping the housing market keeps going up).

However, because you own your home, you will also need to make sure your home is well maintained, which means paying for things like roof and plumbing repairs and other forms of home maintenance. Your home’s value depends on upkeep, repairs and maintenance. Expect maintenance costs when you purchase a home.

The costs of owning a home also differ according to location and size. For example, it is much more expensive to heat and cool a house in Hawaii than the Great Lakes. Some neighborhoods also require that you pay a fee towards a homeowners association.

So, should you rent or buy? Let’s take a look at a 30,000-foot example.

Rent vs Buy example

When I talked to Michael O’Keefe about whether or not someone should buy a home, he offered this example as a way to easily make a better decision. (Conversation slightly edited for clarity and brevity.)

“The average American Home is around $300,000 and the average person doesn’t put enough down to avoid PMI. The average closing costs to a buyer are about 3% so in this situation, you’re going to spend about $9,000 between actual cash out of pocket and additional monies rolled up in your mortgage, just to step into homeownership.

“Then when you get into that mortgage, you have what most people call a PITI, which is principal interest, taxes and insurance and those number, that number gets escrowed on a regular basis. And when people talk about their mortgage, they usually like to talk about the principal the interest payment, they don’t like to talk about the rolled-up number that includes insurance and taxes. So the average insurance premium on a home is about 1% of its value.

“So you’re spending about $3,000 a year or $250 a month on insurance and you’re also spending about the same money on taxes. And as of today, the national average rate for a 30 year fixed mortgage is 3.2% which means you’re spending an extra $9,600 a year in interest, which is $800 a month.

“And if you add all that up, not counting that initial closing cost I was talking about, but just the monthly, you’re spending $1,550 a month in fees, interest, and other things that you don’t pay when you rent.

“Now, when you add in the fact that the average homeowner lives in a home now for about four years, and it costs about 6% to sell a home on the back end of living there, not taking into consideration appreciation, it’s gonna cost you $18,000 to transact out of the home that you spent $9,000 getting into.

“So for an average American, it will cost you about $2,100 per month to live in a $300,000 home for four years, and that’s not counting any contribution to the principal.

“What that means is over four years, you will spend $101,400, to live in that house outside of paying the principal balance, which is $2,112 a month. And what that tells you is that you need to average an 8.5% per year appreciation on that home. That’s your hurdle rate. So what you need to do is to justify that the home is actually performing better than if you were to say rent and put the additional monies that would go toward principal into an investment account, your home needs to appreciate it about 8.5% a year.

“Because otherwise, you’re better off spending the $2,100 a month to rent and putting the additional monies that would go toward principal into an investment account yielding you more than 8 or 9%.”

What’s More Important To You: Mobility or Roots?

In my personal example, I bought a home because of the priceless intangibles. I knew I wanted to move out of the urban environment and into a quieter neighborhood for my kids. I wanted a backyard and a place to call my own. I had been renting for over 10 years and knew our days of bouncing from apartment to apartment were long gone.

For many folks, renting vs buying is much more than a financial decision.

If you are planning to stay in a particular area for the foreseeable future, buying a home may be your best option. When you are deciding whether to rent or purchase a home, think about your current situation as well as how the circumstances in your life may change over time. If you are thinking about having kids soon, you should not buy a home that is likely to not accommodate your expanding household population in just a few years.

If you know you won’t be in an area longer than four years (for example going to grad school), renting vs buying a home might be better suited for you.

Assess your financial situation when deciding on renting vs owning a home

You have to be honest with yourself when buying vs renting. As I mentioned previously, the cost of renting is predictable. Your monthly rent payments don’t vary too much from month to month. Homeownership, however, requires that you be in a financial situation where things like maintenance and repairs aren’t detrimental in the long term to your financial goals.

Yes, homeownership comes with perks such as tax benefits, but be honest whether you can fund upfront costs. Consider using a mortgage calculator to estimate how much you can realistically cover.

You need to do some prudent planning now so no matter what you do you’ll be a happy homeowner or renter. Plan a careful budget right away so that you can buy and rent again if necessary.

Buying a house can build equity.

Homebuyers can maximize equity built up with their home. With a fixed-rate mortgage your monthly payment is locked in (there are no worries about rising rents.)

If someone can qualify for a home and build equity in the house as they pay off their mortgage, it really makes more sense to buy than to rent. Buying also allows you to get your investment out of the property should you choose to sell while renting means you would have nothing when the time came to move out.

You also can build equity passively as real estate in your area pushes your estimated home’s purchase price higher and higher.

Renting vs. buying doesn’t have one clear answer.

The long-term returns on owning a home are also not so obvious. And renting isn’t always a safe financial bet.

Like any financial decision, it’s best to examine your particular situation with financially sound confidants and come up with a plan that suits you.

Whether you decide to buy a home or continue renting, make sure to do your research and listen to advice from those you trust. And when in doubt, look at the cold hard numbers and decide for yourself.