Sometimes it's better to keep renting, even when a tax credit encourages buying a first home. Renters should consider the freedom and the money that they sacrifice when they buy.
Before buying a home, renters should ask the following questions:
- How long do I plan to live there?
- How important is it to be able to afford to move when I want to?
- Which option costs less every month?
- How much time and money do I want to spend on maintenance and repairs?
The first thing to consider -- even before you think about monthly costs of renting versus owning -- is how long you plan to live at your next address. "If it's less than four years, I would rent," says Elaine Zimmerman, a real estate investor and author who lives in Memphis, Tenn.
Zimmerman is a landlord, so it's natural that she's an advocate for renting. And she lists a couple of reasons for renting if you believe you might move within four years or so. The first reason is a rule of thumb that applies no matter what is happening with the economy: "At least with a rental, if you get an offer for a different job, you can take it," Zimmerman says.
How long should you live in a house?
- How long should you plan to live in a house to make it worthwhile? Many people say four years. The problem with the four-year rule is that most people don't know how long they will spend in their next residence. And there's not a lot of research into the question.
- The National Association of Realtors says, anecdotally, that the typical first home is owned for four years. The Census Bureau asks a different question: How long has the owner lived in the current home? In 2007, one-quarter of homeowners had owned their home for two years or less, and half had owned for seven years or less.
It's impossible to predict how long you'll stay in one place, but you have to come up with your best guess anyway, says Catherine Williams, vice president of financial literacy for Money Management International, a financial and debt counseling service. She suggests renting if you plan to live in the place for less than three to five years, because the benefits of brief ownership are not worth the time and money it takes to sell the house.
"Understand that it isn't going to be as easy as putting a for-sale sign in the front window and waiting for people to come by with buckets of money," Williams says. Monthly payments are still due while the house is up for sale.
After worrying about resale value, the next thing to consider is the comparison between rental payments and mortgage payments.
What's the real cost?
When prospective homebuyers shop for houses, they usually have a good idea of what the mortgage's principal and interest will cost every month, Williams says. But principal and interest are only part of the equation. Property taxes and homeowner insurance typically add hundreds of dollars to each monthly payment.
The easiest way to estimate property taxes and insurance is to find out what the seller is paying. It's also a good idea to get a rate quote from an insurance company or agent.
In some markets, the rent-or-buy decision is a no-brainer after you have finished this comparison. According to the Census Bureau, 11.1 percent of rental housing units were vacant in the third quarter of 2009. That's the highest rental vacancy rate since the Census began keeping records in 1965, and it implies that landlords are motivated to give good deals to renters.
If buying a house, Williams recommends that you spend no more than about 28 percent to 30 percent of your before-tax income on the monthly house payment, including principal, interest, property taxes, homeowners insurance, mortgage insurance and homeowners or condo association dues. Her recommendation is more conservative than that of the Federal Housing Administration, which limits mortgage payments to 31 percent of income. Fannie Mae and Freddie Mac will sometimes go even higher.
When you own a home, the monthly payment is only the beginning of the costs. You have to pay for maintenance and repairs. If you have a yard, you have to keep it up. More than one homeowner has been shocked by the cost of buying cordless drills, ladders, lawn mowers, rakes and other necessities.
"Seriously ask yourself: How truly handy am I, and what can I afford to have done?" Williams says. Without help and expertise, "that less-expensive fixer-upper is going to continue to be a fixer-upper."
Finally, there's the issue of federal income taxes. You can factor the mortgage interest tax deduction into your housing budget, but remember that lenders disregard the tax deduction when calculating debt-to-income ratios.
Then there's the first-time homebuyer tax credit -- a gift of up to $8,000 from Uncle Sam. Like other money gurus, Williams worries that the first-time homebuyer tax credit could push some people to buy houses before they're ready to own. "Any type of incentive has some positives, but it also has an opportunity to bring people who just aren't prepared," she says. "The worst thing for the homeowner, the community and the mortgage holder is to have the homebuyer fall out the back door -- meaning they could get into the house, but they very quickly fell out of the house."
In danger of foreclosure? Find out if you qualify for the Fannie Mae option to rent back your home.