There comes a point in your life when you see your friends buying homes and making big steps in their life. It’s common for young people just out of college or high school to rent an apartment as they adjust to “adult living.” But at what point should you consider making the transition to home ownership?
Buying a house for $200,000 seems inaccessible to some renters who are scraping up money to make their $600 paycheck. But you may be surprised that buying a house may be “cheaper” than you think - at least, it’s cheaper than renting an apartment!
Of course, this isn’t always the case. The housing market where you want to live make a big impact on whether it’s cheaper to rent or buy a house. Let’s go over two scenarios: in one, it’s cheaper to buy. In another, it’s cheaper to rent.
Use these scenarios and an assessment of your current financial situation to figure out what is best for you.
When It’s Cheaper to Buy
Even if you are living in a hip and happening city, you will save more money by buying property. A study from the Urban Institute Analysis revealed that it is cheaper to buy property in 17 of 33 top metropolitan areas throughout the United States. These areas include Philadelphia, Miami, and Chicago.
Let’s take a look at Philadelphia.
Data shows that the average cost to buy a one-bedroom house in Philadelphia is around $156,300. If you put a 20% down payment on a home this price and get a 30-year fixed rate mortgage at 4.698%, you will end up paying just over $1,000 each month. This includes the cost of property taxes and home insurance.
Now take a look online and see how many houses you can rent for $1,000 in Philadelphia.
You certainly can find an apartment to rent for under $1,000 in Philadelphia. But after a few years of renting, what do you have to show for it?
Why Buying a House Could Be Profitable
When you purchase a house, you have the chance to make a profit after a few years in your home. Home values generally appreciate over time. Philadelphia is a warm market at the moment, and it doesn’t look like it’s going to cool down any time soon. Data from Zillow suggests that home prices in Philadelphia will rise 14% - just in the next year.
Buying isn’t just “cheaper” than renting; it may also be profitable in the long run.
As you start to pay off your mortgage, you start to gain equity. Equity is the difference between the home’s current market value and any outstanding mortgage payments you have left on the home. Over the years, home values rises and homeowners pay off more of their mortgage - which means they increase home equity.
If you are interested in purchasing an investment property and gaining income through renters, you can use the money you save on your home to get the ball rolling. Buyers can borrow money against their house through a home equity loan or HELOC. This money can help buyers put down a downpayment on a new property and start making mortgage payments.
Lenders will charge interest on the money you take out, but you can offset these costs by renting out your property to tenants.
Interested in purchasing an investment property? Read our guide on how to get started.
When It’s Cheaper to Rent
Buying a house is a long-term commitment. If you’re not ready to make that commitment yet, you will probably save money by renting a property.
Let’s look at another hot market: Austin, Texas. The average price of a home in Austin is significantly higher than Philadelphia: $361,200. If you calculate the monthly costs of a house in Austin, using the same down payment and loan terms as we did before, you’d have to pay over $2,300 each month.
You won’t have trouble finding a house for rent for under $2,300 in Austin, even if you want to live downtown. If you want to live within a few minutes’ drive of Central Austin, you can find a decent house to rent for under $1,500.
And while Austin is certainly a hot market right now, what comes up must come down. Zillow predicts that home prices will rise 3.3% next year. That’s still an increase, but it seems minuscule compared to the increase that Philadelphia homeowners will see in the next year.
If you want to move to Austin for a few years, but don’t see the city as your forever home, you are way better off renting.
Costs of Buying a Home To Consider
It’s easy to see that, in the right market, buying or renting will have significant advantages. But before you buy, consider the following costs of buying a home:
The Down Payment
Down payments scare a lot of potential homebuyers. A 20% down payment for the average house in Philadelphia is $31,260. If you’re looking at the average house in Austin, you’re looking at a $72,240 down payment.
Homebuyers do have options if they can’t afford a 20% down payment. Many lenders will approve a mortgage with just a 10%, or even 3%, down payment. (If you qualify for VA loans or other special loan programs, you may be able to get a mortgage with no money down.)
When lenders decrease down payment requirements, they increase the principal that you will have to pay over the course of your loan. They may also charge private mortgage insurance (PMI) each month. Lending to someone who can’t afford a down payment is a higher risk; PMI covers that risk, but at a cost to the buyer.
It is certainly cheaper to pay a high down payment and get that money out of the way as soon as possible.
Once you are approved for a loan, additional costs will come rolling in. These “closing costs” and additional expenses may cost as much as 5% of the home sale price. These costs include:
- Lender fees
- Attorney fees
- Escrow fees
- Appraisal fees
Sellers will also have to factor in closing costs when they are ready to sell.
Fees for Leaving a Mortgage Early
Mortgages come with 15, 20, or 30 year loan terms. If you don’t anticipate staying in your home for three decades, you’re not alone. Buyers can sell before they pay off their mortgage - but it comes at a cost.
Lenders may charge a penalty for paying off the mortgage early. If the loan includes a due-on-sale clause, the borrower will also have to pay back the mortgage in full within a certain period of time after they sell.
Before you put your house on the market, make sure you can afford all of these payments. These numbers will help you figure out how much you will need to sell for.
The best way to avoid these fees is to pay off your mortgage early (or apply for a shorter mortgage term in the first place.) Buyers with 30-year mortgages may be able to refinance and get shorter loan terms once they are confident that they can pay off their mortgage within 10 or 15 years. Refinancing comes with costs of its own; talk to a financial advisor before you refinance or start to pay off your mortgage early.
For buyers in markets like Philadelphia, the addition of the down payment, closing costs, and other fees may still add up to be equivalent to renting. If you have a hunk of cash saved up and ready to use as a down payment, buying is an even more affordable option. Buyers who don’t have this money in savings might want to hold off for a few years and invest or save up for a down payment.
Ready to buy? Here’s what you should do first.
Before you start shopping, you will need to figure out how much you can afford. Buyers may need to get pre-approved for a mortgage before they do some shopping. Even if you think you can afford a $300,000 house, your mortgage lender may tell you otherwise.
But reaching out to a mortgage lender isn’t the first step that potential buyers should take. Shopping around for mortgages can negatively impact your credit score. Your credit score can have a big impact on the mortgage you can get (and the loans that you can afford.)
Take a look at your credit score and assess whether you are ready to take on a 30-year mortgage. Can you afford a 20% down payment? If you can’t afford a down payment, will you be able to afford private mortgage insurance?
We can give you some advice on how to fix your credit score in just six months. Once you are ready to buy, we can also help you find a real estate agent that offers home buyer rebates. Buyers can use home buyer rebates to get money back on their purchase and make buying even more affordable than renting.
Is it cheaper to rent or buy? It depends on where you want to live. But with the help from Clever real estate agents, you can be sure that buying will be even more affordable.