2. Estimate how long you intend to stay put
While the opportunity to build equity is a strong argument for homeownership, it only makes financial sense if you intend to own the house for the long term — say five to seven years. This allows plenty of time for your home to increase in value and for you to pay down your mortgage.
But if you intend to move within a year or two, renting rather than owning a home is the wiser choice — because building equity takes time.
For starters, in the beginning, the majority of your monthly mortgage payment is going toward the interest rather than paying down the principal loan balance.
Let’s say you buy a $290,000 house by taking out a $232,000 mortgage with a $1,500 monthly payment. Only around $230 a month is going toward paying down the principal balance in the beginning. So, in one year, you’ll only have paid off $2,760 of your principal loan balance.
Let’s also imagine that your home does manage to appreciate by 5% that first year to a value of $304,500. If you sell for $304,500 after that first year, you’ll only net $17,260 in equity proceeds — after paying off the $232,000 mortgage and recouping the $58,000 you paid out on the down payment. And you’ll still owe a chunk of that $17,260 to the government.
You see, in most cases the IRS offers tax breaks on home sale proceeds if the property is your primary residence — but only if you’ve been living there for at least two consecutive years.
But if you sell within one year of owning your home, you’ll have to pay a capital gains tax on any proceeds from the sale. For that income of $17,260, you will need to pay a 12% capital gains tax rate — so in the end, you’ll only get $15,189 in equity proceeds.
That’s assuming your home rose in value by 5% in the first place — which is unlikely.
You see, while home values do trend upward in the long term, the real estate market typically fluctuates like a roller coaster in the short term.
“If you’re planning on moving within a few years, you’d have to buy in a neighborhood that has high turnover,” says Beams.
“Plus, if you only plan to own for the short term, the property needs to have some existing equity in case the prices go down. Otherwise, you’ll become upside down in the mortgage.”
The verdict:
Rent: When you’re planning to relocate within a few years
Buy: When you’re settled in an area for the foreseeable future
3. Assess how local market conditions affect your decision
Your personal readiness isn’t the only area you need to assess when you’re considering buying a house. You also need to look at whether or not your local real estate market is ready for you.
While home values trend upward in the long term, in the short term, real estate markets fluctuate between buyer’s, seller’s, and balanced market conditions.
In a seller’s market, there are a lot of buyers and few homes listed for sale — leading to higher home prices and bidding wars over even the most undesirable homes. In a buyer’s market, there are lots of homes available for sale but few buyers — so there are many good homes to choose from at great prices. A balanced market falls somewhere in between, with reasonable home prices and healthy competition.
While it seems straightforward that it’s best to buy in a buyer’s or balanced market, remember that real estate markets are fluid and always changing — so it’s not only current conditions you need to consider but also the trends.
“If home prices are on a downward trend, then it might make sense to continue renting until that market bottoms out. Then you can buy at a great price,” explains Beams. “But if home prices are on an upward trend, then it might make sense to buy now before prices reach the top of the market.”
And remember, researching national real estate trends can’t tell you what your local market is doing. While the majority of the country may be experiencing a sluggish buyer’s market, your local area could be experiencing a red-hot seller’s market.
The same holds true for different neighborhoods in the same city.
The only way to know for sure if it’s the right time to buy in your desired neighborhood is to consult a top-notch real estate agent.
The verdict:
Rent: When it’s a strong seller’s market with limited inventory
Buy: When it’s a buyer’s market and there’s lots of inventory
4. Research current mortgage interest rate trends
It’s true that the majority of your monthly payment goes toward the mortgage interest rather than the principal balance for the first few years — which is why the rate you get is so important.
Current rates — and the duration of the loan — directly impact exactly how much you’ll pay each month. Let’s look at that $232,000 mortgage loan again.
If you take out a 30-year mortgage for $232,000 at a fixed interest rate of 6.625%, you’ll pay around $1,750 a month (not including taxes and insurance) — depending on other factors, like your credit score and your down payment amount.
Take out that same $232,000 as a 20-year mortgage with a fixed interest rate of 6.625%, and you’ll pay around $2,000 a month.
Of course, interest rates are what they are, so you need to take what you can get, right?
Not exactly.
The process that determines mortgage interest rates is commonly misunderstood. While mortgage-backed securities and the federal reserve rate impact mortgage rates, each lender actually sets its own interest rates.
That’s why it’s important to shop around to find the lenders who’ll give you the best interest rates.
Did you catch that? You’re not looking for lenders that advertise the best rates, but lenders who will give the best rates specifically to you.
It’s easy to mock up a few numbers to get a broad-stroke look at what your mortgage payment might look like compared to rent. However, you need hard figures to really determine if it’s smarter to rent or own a home.
In order to find those solid numbers, you need to look at the factors that influence the interest rate you’ll get that are unique to you — including your credit score, the location of the house, your down payment amount, and the loan types you qualify for.
“As long as interest rates are on the low side, buying instead of renting makes sense,” says Beams.
“But if the interest rates are on an upward swing, buying becomes cost prohibitive for a lot of people because they can’t qualify for a rising interest rate mortgage.”
So, if you see that the interest rates have just started on an upward swing, then it might be motivation to buy now instead of rent — because in the future, you might not be able to afford it. Interest rates fluctuate between 6% and 7% in the current market.
The verdict:
Rent: When mortgage interest rates are too high (but trending downward)
Buy: When mortgage interest rates are low (and starting to trend upward)
5. Evaluate your financial stability
In one regard, the question you need to ask yourself isn’t whether it’s better to buy a house but whether you can actually afford to buy one.
Many people mistakenly believe that you need a close-to-perfect credit score and a 20% down payment saved up before buying a home is even a possibility. Luckily, that’s not true.
“The mortgage process when buying a house can be daunting for some people. One reason that renters put off becoming first-time buyers is because it’s so difficult to come up with the money for a sizable down payment in addition to the closing costs,” explains Beams.
“However, there are financing programs available that will help first-time buyers buy a house with a very low down payment, such as FHA loans that only require 3.5% down. There are also some conventional loan programs that have low down payment options, as long as you pay a mortgage insurance premium.”
But just because you can get a loan with significantly less than a 20% down payment doesn’t mean you should.
When you get a mortgage, your lender is taking a risk and betting that you’ll honor your debt by paying it back in a timely manner. Lenders are more comfortable taking this risk when the buyer has something to lose, too — namely their down payment.
The less money that buyers put down, the less they have to lose. So naturally, lenders require buyers with less of a down payment to lose to buy mortgage insurance.
Your monthly payment is destined to increase when your lender requires you to purchase private mortgage insurance, which will typically cost you between 0.5% to 1% of the entire loan amount annually. That’s an extra $193 a month on that $232,000 loan.
But in some cases, buying a home before you’ve saved up a 20% down payment does make sense, especially when interest rates are low and you’re house shopping in a buyer’s market.
While you may not get quite as good a deal, you’re still building equity instead of losing those monthly payments to your landlord.
Plus, you can always refinance into a better deal in a few years when you’ve improved your credit, established a record of on-time mortgage payments, and built up equity in the house.
The verdict:
Rent: When you’re building (or rebuilding) your financial standing — or you don’t have enough savings for a decent down payment
Buy: When you’re financially stable enough to negotiate a good deal on a home — or market conditions are too good to pass up
