The rent versus buy debate is a hot topic with passionate supporters on both sides. But although some believe one is better than the other, the decision may have little to do with financial resources, and more to do with lifestyle.
If you’re on the fence and can’t decide, having a clear understanding of the differences between a mortgage and rent can point you in the right direction.
1. Out-of-pocket cash requirements for a mortgage vs. rent
Regardless of whether you’re paying rent or a mortgage, you'll have to pay out-of-pocket to get into a new place. The difference, however, is that it takes more of your own money to get into a mortgage loan.
You have to save a down payment between 3.5% and 5%, plus there are closing costs which the seller may or may not cover. You're also responsible for a home appraisal and a home inspection at the buying stage. And once you move into the property you're responsible for repairs and maintenance.
Depending on where you live, the cost of renting might be comparable or more than buying. But typically, you don't have to spend as much to move into a rental. Most landlords require an application fee and security deposit. I’ve seen security deposits for luxury apartment homes starting as low as $250, but they can go as high as one month’s rent, which is considerably less than the cost of getting a mortgage.
2. A mortgage reduces what you owe for a house
With a mortgage, your monthly payments gradually chip away at your balance. It might take 15, 20 or 30 years to pay down the balance, but if you hold onto the property, you'll eventually own the house outright and you’ll never have to make another house payment.
Rent, unfortunately, never goes away. Keep in mind that renters still pay a mortgage every month; it's just not their mortgage. The money you give your landlord pays down his mortgage and you get nothing in return—other than a place to lie your head at night, of course. On the plus side, you’re also not responsible for the home’s major maintenance or repairs as a renter, which can be a fair trade-off.
3. Payment fluctuations between a mortgage and rent
Some mortgages have an adjustable-rate, which means the interest rate can change from year-to-year after an initial fixed-rate period. Therefore, the mortgage payment can change each year, either increasing or decreasing. For borrowers with a fixed-rate mortgage, the mortgage rate remains the same, so there aren’t any wild fluctuations with the monthly payment.
Understand that even with a fixed-rate home loan your mortgage payment may increase or decrease a little each year depending on the cost of your homeowner’s insurance policy and property taxes for the year. However, it’s a minor increase or decrease.
The problem with rent is that your payments can jump considerably from one year to the next. If your rent starts off at $1,200 a month and your landlord increases rent by 3% every year, in three years you can be paying an extra $75 a month.
4. Mortgages include homeowner’s insurance
If you're financing a house through a mortgage lender, your lender will require homeowner’s insurance for the property, and this cost is wrapped into your mortgage payment. As a renter, your monthly rent does not include renter’s insurance. This is an optional policy you purchase on your own, although some landlords are now requiring tenants to carry a minimum amount of renter’s insurance coverage. If you don't have renter’s insurance, you're not protected in the event of fire or theft. Your landlord has an insurance policy, but this policy covers the property and not a tenant’s belongings.
5. Tax benefits with having a mortgage
If you've never purchased a property, you might be unaware of the tax benefits of owning. Mortgages include interest payments, which is basically the cost of financing a home. In the early years of a mortgage term, a big chunk of your monthly payment goes toward reducing the interest owed on the loan. In fact, only about $200 to $300 of your monthly payment may actually go to reducing the principal balance.
You can easily pay hundreds or thousands of dollars in interest over the life of your mortgage, but luckily you can write off mortgage interest payments to reduce your taxable income. You’ll either owe less in taxes, or get a bigger tax refund. This deduction isn't an option with rent payments, which means you could end up owing significantly more taxes than if you had purchased a home.