How to Decide Whether to Rent or Buy a Home
How to Decide Whether to Rent or Buy a Home
9:39

How to Decide Whether to Rent or Buy a Home

Mortgages
Speaker 1: To rent or not to rent. That is the question this week, as our friend Sebastian writes in, Hey, Farish, my wife and I have a monthly salary of about $5,000. We're moving to a new city where it's very expensive to rent. We will be paying about 2000 a month in rent or 24,000 a year. Could this money be better off invested in buying an apartment? All right. Now, before I dive into the [00:00:30] pros and cons of renting versus buying, we've all thought about it. Let's take a giant step back and discuss how much we should really be budgeting for housing costs in the first place. Now is $2,000 a month, or in this case, 40% of Sebastian's budget really doable. If you ask the experts and you are asking me the recommended budget for housing expenses, whether you're renting or owning is no more than 30% every monthly take home pay. Speaker 1: That's the max that is recommended. And that [00:01:00] is because the was an assumption that you have a few other needs to cover besides the roof over your head. Things like food, transportation, maybe some outstanding debt. And of course it would be smart to also try in that same month to save your money, to invest your money and maybe buy a latte, you know, optimizing your housing expense, which is the biggest monthly cost. Most of us gives your overall budget, more breathing room and flexibility. So spending 40% maybe pushing it [00:01:30] depending again on your lifestyle. Now, of course, there are exceptions to this rule where spending more than 30%, in my opinion, is justified living in a really expensive city. Like Sebastian means higher than average housing costs more than what most people can easily afford. And I know this well, I lived in New York city for close to 20 years. Speaker 1: And in those early days, admittedly, my friends and I, we spent up to half of our money on rent. We did it because offers immeasurable [00:02:00] value in terms of career growth, building a rich network, access to diversity and culture, not to name drop, but on more than one occasion, I did see Ethan Hawk at our local coffee shop in Brooklyn. We're basically friends now. So before getting into the debate of whether to buy a rent, know your number, what can you afford every month with confidence? If you do to spend 40% of your income on housing, how might your life be impacted? Be honest with yourself. Will it delay [00:02:30] your ability to pay down your debt? Will it leave you with enough to enjoy your life? Right? I mean, that's important now, in my case, when I first moved to New York as a budding journalist making 18 whopping dollars an hour before taxes, I lived in a rent control apartment way, uptown with an older married couple and their cat. Speaker 1: But the rent was just $500 a month. Yeah. Uh, more than 70% savings for what the average studio was going for in the same neighborhood. [00:03:00] So yeah, it meant giving up some of my privacy taking a much longer commute to work living with that cat. But these are what I call trade offs. I say all this to you to encourage you to own your story, right? What is the point of living in an expensive city that costs an arm and a leg? It better be a good point. How will living in this city be an investment in your career or in your relationships, in your personal growth and benefit you in the long run now onto [00:03:30] whether it makes more sense to rent or buy the debate that will never go away. This is a financial question of the century indeed, but a question that is tied to an even bigger life question, let's first talk about the math for owning or what I like to call the homeowners. Speaker 1: Calculus. Our friend Sebastian says he's willing to spend $2,000 a month on rent. And wondering if that same $2,000 can be used to own a home. The answer is drum roll, please. Not really. [00:04:00] This is one of the biggest myths about renting versus owning. Yeah. We assume that for the same monthly expense, we can afford the same type of home. I'm talking same size location amenities, whether we own or buy. We also assume that if we own a home, we get the automatic added benefit of investing our money. We, the house will appreciate and will be able to make a profit when it comes time to sell. Speaker 1: Let's unpack this. Let's [00:04:30] unpack this and look at renting a home for $2,000 a month versus owning home for $2,000 a month. Now, when you rent a house for $2,000 a month, this is usually an all inclusive payment that not just rent, but also the maintenance repairs. You're also not expected to pay the property taxes. And in some cases, utilities like gas and water are included. The landlord covers all of it now to get the apartment. What do you need? You need to show proof of income. You have to pass a background, check credit scores in the 700 S are higher, [00:05:00] do best. And having a reference or two is helpful. Runner's insurance while nice and recommended is not required in most cases. And even if you get it, it's nominal 12 to 15 bucks a month. Meantime, a home with a $2,000 mortgage. What kind of house are we talking about here? Speaker 1: That is a $600,000 home in today's market to qualify for that mortgage. You're gonna need a lot more. You're gonna have to show bank statements, tax returns, proof [00:05:30] of income, maybe a letter from your employer, cash liquidity to at least afford the down payment, which can be as high as 20% of the homes value in many cases right now, and enough for the up front closing costs. Usually another two to 5% of the sticker price. Now let's say you've got all of that. All your ducks in a row, you qualify for the 30 year fixed mortgage. You get that nice 3% interest rate. And that gets you to about $2,000 a month in your home loan payment. But my [00:06:00] friend, you are not done. You have many more out of pocket expenses to account for including, but not limited to property taxes. It's another two to 3% of your home's value. Speaker 1: In many cases here for Sebastian, that would be at least another thousand dollars a month. Sometimes you have to account for private mortgage insurance. What is this PMI? So if you put down less than 20%, the bank might require a special insurance called private mortgage insurance to protect the bank in case you default. [00:06:30] And this can be up to one and a half percent of the loans value. You'll also need homeowner's insurance, just usually more than renter's insurance, because it covers not just your personal belongings, but also the physical structure of the home. And as a renter, of course, your landlord's homeowner's insurance covers that stuff. Your utilities are all on you as well. Maintenance costs prepare for this. I like to set aside about 1% of my homes value for things like new appliances, [00:07:00] plumbing, repair, lawn care, and other work that might happen over the course of the year. Speaker 1: In Sebastian's example, that would be another 500 bucks a month to set aside. So what appears to be a $2,000 month housing expense is really more like 3,500 to $4,000 a month. When you factor all, all of these out of pocket homeowner related expenses. So if you're set on keeping your housing budget as an owner to know more than $2,000 a month, well, you may need to look at very [00:07:30] different homes than you would as a renter in the same area. Or you gotta look at new locations that might give you more bang for your buck. Now, whether or home purchase adds up to be an investment, that's hard to say too, if you happen to sell the house at a later date for a price that exceeds what you paid for it, that's fine. That's great. That's awesome. But after factoring in all the mortgage interest, the property taxes, the insurance maintenance, all the things you went through, not to mention the sales commission that you're gonna pay to your broker. Speaker 1: [00:08:00] Are you still smiling all the way to the bank? See, this is the more involved math that we sometimes fail to do. And when we see charts like these, that show the long term appreciation of homes over the decades, well, it can make home ownership seem like the smart financial choice every single time. Now beyond the math, an equally important consideration is you, do you really wanna be a homeowner and take on the responsibilities that come with keeping the home in good conditions. [00:08:30] Some people take a lot of pride in this, but some others don't. And then you have to add to that all the financial requirements like the down payment, the property taxes, and if you're really debt, it said on turning a profit. And if you don't, you won't be able to sleep at night. Well, you need to prepare for owning this home for many years to allow for that value of the home, to appreciate to give it a good chance to grow in price. Speaker 1: Are you committed now renting on the other hand might afford you more flexibility to move on a whim. If you wanted, [00:09:00] you don't need to pay for all the home repairs, maintenance and owner would do that. I'm not here to discredit home ownership. Not at all. I own my house. I've owned how in the past. And that is because I've always wanted down roots wherever I was in summary. Don't buy a home because renting is expensive or just because your friends did it, or your parents are telling you it is the huge building wealth and renting is just money down the drain. We've all heard that instead do review the math. Be honest with [00:09:30] yourself and very important just as you do the math, do you I'm Farish Torabi until next time.

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