Laura reviews the pros and cons of renting and owning a home and which option will likely build wealth for you and your family.
Laura reviews the pros and cons of renting and owning a home and which option will likely build wealth for you and your family.
Money Girl is hosted by Laura Adams. A transcript is available at Simplecast.
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You've probably heard that homeownership is a significant part of the "American dream." While many believe owning a home is still a worthy goal, most Americans say it's increasingly unattainable. A 2024 Harris Poll found that 81% of renters want to own a home but 61% worry they'll never be able to afford it.
According to the Urban Institute, the median wealth gap between renters and homeowners is at an all-time high of almost $400,000. While that's a significant number, renting can also be a smart way to build wealth if you follow some guidelines.
This post will review the rent-versus-own debate so you can consider the pros and cons of each side of homeownership. I'll discuss how to know which option could make you wealthier over the long run.
Welcome back! I appreciate you joining me for Money Girl episode 894! I'm Laura Adams, an award-winning author, on-camera spokesperson, female money speaker, founder of The Money Stack, a Substack newsletter, and host of Money Girl with over 43 million downloads.
If you enjoy the free content we love creating for you, please take a moment to rate and review the show in your podcast app! If you have a question about money, leave it on our voicemail at 302-364-0308. You can also visit LauraDAdams.com to email me and learn more about my books, courses, and the free Money Stack newsletter.
How can renting a home make you wealthier?
While homeownership has many benefits that I'll review, renters also have advantages that can improve their financial lives. If you rent your home, here are four ways signing a lease instead of a mortgage could make you wealthier over the long term.
1. Having more flexibility.
Homes for rent come in all shapes and sizes, from sprawling single-family houses on country acreage to compact high-rise studio apartments in the city. No matter where you want to live, homeowners and property management companies have various properties to choose from.
Renters get the flexibility to relocate for work or family needs more easily than homeowners. Landlords typically require a 12-month lease, but you may also have the option to commit to a shorter term or pay rent monthly.
Being able to pick up and go for your company or to take a higher-paying job in another city or state could go a long way toward improving your wealth. If you're a homeowner, you typically can't move until you sell the property or find a reliable tenant to help you pay the mortgage.
Depending on the state of the housing market and the desirability of your home at the time you want to relocate, selling it could be a winning or losing proposition.
2. Paying less upfront.
Another pro of renting is not having significant upfront costs compared to buying a home. Renters typically must pay a security deposit for potential damages and your last month's rent. Plus, there may be additional fees for a credit check, pet deposit, parking, or renting a washer and dryer.
While those expenses add up, they're much less than what you typically need for a home down payment, at least 3% of the purchase price. Depending on your lender and financial situation, you may be required to put down 10%.
For instance, if you buy a home for $500,000, you may need to pay $50,000 for a 10% downpayment and borrow the remaining $450,000. Homeowners must also pay a long list of closing costs for services like mortgage underwriting, appraisal, survey, home inspection, closing agent, deed recording, prorated property taxes, prepaid homeowners insurance, and more.
In addition, furnishing a rental might cost less than buying a home, depending on the square footage and what you already own. Plus, doing upgrades and renovations are costly endeavors that aren't allowed in most rental properties but can be one of the first things you think about when buying a home.
The bottom line is that keeping more of your cash as a renter may allow you to invest more in a workplace retirement plan, individual retirement account (IRA), or brokerage account. Investing regularly and sooner rather than later could allow you to grow a larger nest egg than you could as a cash-strapped homeowner.
Being "house rich" and "cash poor" is a common struggle for many people who choose to buy a home. When you stretch your budget thin, it can be difficult or impossible to free up extra money to save for emergencies or invest for retirement.
READ ALSO: 8 things to know about investing in a brokerage account
3. Being insulated from market downturns.
Renters can stay protected from potential housing downturns, such as the Great Recession of 2008 when a big real estate bubble popped. Over-inflated housing prices reached an unsustainable level and quickly plummeted. Renters may even come out ahead if rents go down when the economy struggles.
While the average U.S. rent for a two-bedroom apartment climbed significantly in 2021, rents have softened in many parts of the country. However, they're still considerably higher than before the pandemic. So, there's no guarantee that rents will be more affordable than buying a home when the economy is in trouble.
4. Paying less per month (in some areas).
Where you live is a big factor in whether renting or owning a home will be cheaper. But no matter what, renters get to skip many expenses that homeowners can't avoid.
Landlords are usually responsible for all interior and exterior upkeep on their property. In other words, if you're a renter and the air conditioner stops working or you see water dripping from the ceiling, you'll be relieved that the cost won't have to come out of your budget.
In addition to skipping repair expenses, renters save time when a repair isn't theirs. Homeowners must research the right professional, request bids, manage insurance claims, and take time away from work to manage property repairs.
How can owning a home make you wealthier?
Now, let's look at some financial benefits of getting a mortgage and owning a home instead of renting one.
1. Building equity.
Equity is the difference between your property's market value and what you owe on it. For instance, if your home appraises for $500,000 and your mortgage balance is $450,000, you have $50,000 ($500,000 - $450,000) in home equity.
If you have a fixed-rate mortgage, each payment is made up of principal and interest in amounts that change over time. Each monthly payment helps you get wealthier by reducing your outstanding mortgage balance by a slightly larger amount, which is called amortization.
Every amortizing mortgage payment allows you to own slightly more of your home and owe slightly less to your lender. However, be aware that there are home loans that don't amortize, such as interest-only mortgages.
The benefit of building home equity is that you can eventually cash it out by selling your home. You can also tap a portion of your equity by getting a home equity line of credit (HELOC), a home equity loan, a cash-out refinance, or a reverse mortgage (if you're over 62).
2. Having appreciation.
If you buy a home for $500,000 and the value increases to $575,000 over time, you automatically have $75,000 of additional equity. That's on top of the equity I just mentioned that you build by paying off an amortizing, fixed-rate mortgage.
Historically, real estate has been an excellent long-term investment. The U.S. year-over-year index from 1992 to 2024 is 4.63%, reaching an all-time high of 19% in July 2021 and a record low of -10.5% in November 2008.
You likely took an upsetting loss if you bought a home in 2007 and had to sell it in 2008.
However, home values go up more than they go down over the long term, which is a powerful way to build wealth. So, owning real estate allows you to grow richer from price appreciation, paying down an amortizing mortgage, or both.
But there's no guarantee that a home's value will increase or appreciate as quickly as you'd like. However, you do have a guarantee that paying rent is an out-of-pocket expense you'll never get back.
3. Cutting taxes.
To encourage homeownership, the federal government created various tax breaks to sweeten the deal. The following expenses are tax-deductible when you itemize deductions on your tax return:
In addition to these tax-deductible expenses, you get another huge tax break if you lived in your primary home for at least two of the previous five years before the sale, called the capital gains tax exclusion. It allows you to avoid tax on up to $500,000 of profit, or up to $250,000 as a single.
All these tax incentives are fantastic; however, many costs of homeownership—such as homeowners insurance, homeowners association dues, maintenance, repairs, and local tax assessments—are not tax-deductible.
Renters don't get any housing-related tax deductions, but they typically don't have required expenses, except renters insurance, in some cases. Even if it's not required, I recommend that every renter purchase renters insurance, an affordable policy that costs an average of $170 per year.
READ ALSO: Pros and cons of a home equity line of credit (HELOC)
4. Paying less per month (in some areas).
Another way buying a home can make you wealthier is by borrowing at a relatively low rate. A 30-year fixed-rate mortgage currently costs about 7% APR. While that's more than double the rate to buy a home before the pandemic, it looks great compared to paying nearly 19% in 1981 or 11% in 1990.
Lower interest rates make owning a home cheaper than renting, even with additional costs such as homeowner's insurance and property taxes. Of course, that isn't true in large cities, such as New York and San Francisco, where home prices are notoriously high.
Speaking of high prices, an often-overlooked benefit of owning a home is hedging against inflation when you have a fixed-rate mortgage. That's because your payment is locked in for the term of your loan, such as 15 or 30 years, no matter what happens to interest rates or the economy. Rents may increase during inflationary periods, but a fixed mortgage can't increase.
Should you rent or own a home?
Like many issues in personal finance, the answer to whether you should be a renter or a homeowner is "it depends." Your financial situation, goals, and lifestyle are unique, so there is no right or wrong answer. Also, there isn't a cut-and-dried way to compare the cost of renting to the cost of owning a home.
In addition, non-financial considerations may tip the scales for you in either direction. For instance, the pride of owning a home is something many people want to experience. You may yearn to have your own land, garden, or place to remodel.
However, getting a mortgage is a big commitment that must fit your financial goals, such as investing for retirement and paying down debt. Just because you qualify for a mortgage doesn't mean homeownership is right for you.
A good rule of thumb is never to buy a home unless you're sure you'll live there for at least five years. You never know how long it could take to sell a home if needed. And real estate transactions come with expenses for buyers as well as sellers.
Renting can allow you to avoid the cost and hassle of property maintenance and repairs. Some apartments offer on-site services and amenities such as a 24/7 concierge, dry cleaning pickup, a clubhouse, pool, gym, guest suite, and theater. If you use the amenities regularly, consider what they'd cost if you didn't rent.
If renting saves money and reduces stress so you can accomplish your financial objectives, it may make you wealthier in the long run. The key is investing savings that you would have spent on a home. Using your additional discretionary income wisely and investing the savings can help you build wealth.
But if buying a home has more advantages and you're willing to put down some roots, owning an affordable home is a terrific goal.
That's all for now. I'll talk to you soon. Until then, here's to living a richer life!
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