When deciding between renting and buying, individuals often fret about missing out on home equity if they do the former.
In other words, for all those years they choose to rent instead of own, they’re not gaining any sort of ownership, and their money is simply being thrown out the window.
Of course, that rent money is providing shelter and a roof over their head, so it’s hard to say it’s all for nothing.
And while the argument has some truth to it, it’s often blown out of proportion. Or skewed in favor of buying as opposed to renting.
Imagine if someone bought a home and prices went down. Would they still be talking about throwing away money on rent?
Has the Housing Market Gotten Ahead of Itself?
- When things start to feel bubbly prospective home buyers seem to get even more desperate
- This can lead to bad decisions, especially when it comes to a major purchase
- Make sure you’re buying a property for the right reasons and not throwing out your own rules
- It should never be a rushed decision or one in which you make too many sacrifices
Lately, there’s been a lot of talk about bubbles and a potential housing market crash. But home prices have only surged due to a lack of inventory, not because of bad mortgages.
The low mortgage rates on offer have also made the housing market hot, perhaps too hot.
And after some really stellar home price gains, they’ve begun to moderate a bit, or at least decelerate.
Now there’s even talk that home prices could pull back in places where appreciation got a little ahead of itself. Or a lot ahead of itself, depending on how you look at it.
So is it possible to rent for a while during this period of uncertainty and still come out ahead? Let’s break it down.
Buy Now, Even If Prices Drop
Say home prices in the area where you want to buy are hovering around $250,000. You pull the trigger and get your offer accepted, pledging to put down 20%, or $50,000.
That leaves you with a loan amount of $200,000. Let’s also assume your mortgage interest rate is 3% on a 30-year fixed-rate mortgage.
Your monthly mortgage payment would be around $843, not including property taxes and homeowners insurance.
After five years of on-time payments, your loan balance would fall to around $177,813.
Put another way, you would have paid roughly $22,187 toward the principal balance, which is one of the great benefits of owning a home. The accrual of home equity! Wealth building!
But what if home prices fall in the next couple of years, even slightly. Would it actually be better to rent for a couple years and then buy a property at a marginally lower price?
Rent Now, Buy a Home Later?
- It’s perfectly okay to rent instead of own until you find a home that suits you
- You’re not necessarily “throwing money away” despite what people always say
- You could actually be saving yourself money and headache by renting
- It’s certainly less stressful to rent than own (though it can be well worth it to own!)
Now let’s consider a scenario where you hold off on buying until things settle down, assuming they do.
Say you decide to rent for $1,000 a month for two years (around the same cost of the mortgage sans taxes/insurance), spending $24,000 during that time and earning nothing in the way of home equity, not to mention any tax breaks.
After two years, you find a house for $237,500 and decide to put 20% down. That leaves you with a $190,000 loan amount and a mortgage payment around $800.
Let’s assume you go with the same loan program (30-year fixed) as our prior example and get the same interest rate (3%).
After three years of holding the mortgage, you would only pay $12,266 toward your principal balance, but in doing so it would drop to $177,734.
This would actually be slightly below the balance of the aforementioned mortgage at that time, which began two years earlier.
So after five years, two years renting plus three years owning, you’d be ahead of the person who decided to purchase a home right away at a higher price.
After 10 years, the early buyer would have a principal balance of $152,039, compared to $144,437 for the renter-turned-buyer.
If we consider the down payment, $50,000 on the $250,000 home purchase and $47,500 on the $237,500 purchase, the renter is even more ahead.
And the late buyer would enjoy a monthly mortgage payment around $50 lower thanks to that five percent home price drop initially.
If they were to make the same monthly payment as the early buyer by putting that extra $40 toward principal each month, they’d actually pay off their mortgage in about 27.5 years, or 29.5 years counting the two years when they rented.
It’s Not About Timing the Market, It’s About Not Rushing In
Of course, my little scenario above banks on mortgage rates staying in place and home prices dropping about five percent. If both go up, the equation changes quite a bit.
And that’s certainly not out of the question. I still believe this housing rally has a few more years left, and with mortgage rates near record lows, there’s mostly only way to go from here.
Still, it’s okay to rent if you can’t find a suitable home to purchase. You won’t necessarily miss out on anything. And you can always make slightly higher mortgage payments to play catch up if need be.
There might also be a better selection of homes in a year or two, once this housing frenzy settles down again.
By waiting, you’re actually not timing the market. You’re taking your time and being prudent as you would any multi-hundred-thousand or million-dollar purchase.
After all, those who rush in often make mistakes, and may also have regrets. But with market conditions so tough right now, I don’t blame anyone for whatever decision they make.
Lastly, let’s also remember that a home purchase is about more than money.