Whether they should they rent or buy a home is one of the toughest financial decisions Americans face. The factors at play in making this decision revolve around not only where you are, but also who you are.
The questions you should be asking yourself are: How mobile do I need to be? Am I a strong saver? Do I prefer a lot of amenities? Can I create more wealth through renting and reinvesting or buying a building equity?
For starters, some self-inquiry is helpful when making the decision of whether to buy or rent a home. Ask yourself a few questions:
How mobile do you need to be over the foreseeable future?
Mobility is very crucial to the buy versus rent question. If you feel that you will be very mobile in the near term, say perhaps to keep up with the best job opportunities or you think that your housing needs will soon change, then you are probably better served to rent, in terms of wealth accumulation, rather than own as the costs of transacting are relatively high for ownership versus those for moving from rental to rental, which are relatively low. All else being equal, high transaction costs from the sale of property tie you to an area and property, while renting allows for rapid changes in location and housing type.
Are you a strong saver?
If you rent a comparable property and reinvest your down payment and monthly payment saving (renting is typically less expensive than owning in the early years), then you are typically better off renting, in terms of wealth accumulation, than owning. If you are not a monastic saver, then housing ownership becomes a forced savings vehicle and is the best wealth accumulation method.
Do you prefer amenities or are you happy with "bare-bones" living?
Housing amenities are expensive to rent but less expensive to own. This is so because tenants tend to be rough on these amenities, while owners tend to carefully manage their upkeep. Thus, landlords charge higher rents for providing and maintaining these housing amenities. Therefore, if you prefer more amenities, then you should seek to own.
After completing this self-inventory, it's time to consider the housing market where you live and ask yourself the following question.
Can you create more wealth through renting and reinvesting or buying and building equity?
Owning your own home has long been a major part of "The American Dream." However, with fluctuating housing prices, whether to buy into that dream is more difficult to answer than ever before.
Historically, Americans have exhibited a mania towards owning rather than renting their homes. Casual arguments such as "don't throw your money away on rent" or "why rent when you can own?" have been regularly offered, and these arguments were generally sound until pricing cycles began to creep into U.S. housing markets. Slow but steady property appreciation has been replaced by housing price cycles that significantly complicate this question.
To give some guidance to people trying to decide whether to buy or rent in different parts of the country, my colleagues and I developed the Beracha, Hardin and Johnson Buy vs. Rent vs. Buy Index, designed to signal whether current market conditions favor buying or renting a home in terms of wealth creation over a fixed holding period in a particular market relative to historical market conditions and alternative investment opportunities. It examines the entire housing market in the United States and isolates the markets of 23 key cities. The index conducts a "horse race" comparison between an individual that is buying a home and an individual that rents a similar quality home and reinvests all monies otherwise invested in homeownership.
While there is no perfect answer to the age-old question of buying versus renting your home, this advice should help in the decision-making process.
Follow Ken Johnson, Ph.D. on Twitter: twitter.com/FAUHousingEcon