Originally published August 2016; updated January 2019
Is it cheaper to rent than to buy a home? The answer is, it depends on where you want to live and how long you stay in your home.
Determining whether it’s cheaper to rent than to buy a home isn’t just a matter of comparing your monthly rent check to your potential mortgage payment. You need to look at the bigger picture over time. And do a bit of math.
Let’s start with the price tag for your home. The simple rule of thumb is to spend less than three times your gross income. For example, if your household income is $67,000, your target home price is in the neighborhood of $200,000.
Next, how much have you saved or will you be able to save to put toward your home purchase? For a $200,000 home, a 20% down payment works out to $40,000. That’s a big chunk of change.
Some lenders allow down payments as little as 3% of the purchase price. Any amount less than 20% down will put you in a position that requires mortgage insurance (MI). MI protects the lender in the event you default on your loan. Let’s say you’ve saved $20,000. You could make a tidy 10% down payment on your $200,000 home purchase for a mortgage loan amount of $180,000.
Principal & interest payment
Financing with a typical 30-year, fixed rate loan would provide the lowest, stable monthly payment. As I write, interest rates for 30-year, fixed-rate mortgages are around 5%. For a $180,000 loan, the monthly principal and interest (P & I) payment on your loan would be $966.
In addition to principal and interest, your total monthly mortgage payment will also include taxes and insurance (PITI).
Property taxes
The average US homeowner pays about $2,197 in property taxes a year, $183 a month. See your state’s average property tax payment here.
Insurance
Homeowners insurance protects homeowners from loss due to theft, fire or other disaster.
Homeowners pay an average of $1,083 a year – $90 a month – for this protection. See your state’s average annual homeowners insurance payment here.
The cost of mortgage insurance (MI) on a $180,000 fixed-rate loan – based on a 90% loan-to-value ratio, a credit score of 760, a monthly MI premium, 2 borrowers, a debt-to-income ratio of 35% and standard coverage required by Fannie Mae – is roughly $32 a month. (Since Readynest is brought to you by MGIC, I used MGIC rates to come up with this number.)
In many cases, MI is cancellable after your loan balance reaches 78%-80% of your property’s original value. Based on our example, you’d possibly be able to cancel after 6 years and 8 months, at which point your monthly mortgage payment would decrease by that amount.
All told, your monthly mortgage payment would be $1,271.
You’ll also want to take into consideration the costs involved in purchasing your home and what it will cost to sell it when you’re ready.
Discount points
You may have the opportunity to reduce your interest rate by paying discount points. A point is 1% of the mortgage loan balance. Each point you pay on a 30-year mortgage typically reduces the interest rate by 0.25%. In our example, by paying 1 discount point – $1,800, based on your $180,000 mortgage – you could reduce your mortgage interest rate from 5% to 4.75%. The reduced rate sounds good, but is it worth the money?
Here’s a break-even example:
It would take 5 years and 7 months to break even – the point at which you’d recover the cost of buying the discount point with your monthly savings. If you don’t plan on staying in the house that long, paying for a discount point might not be worth the money.
Closing costs
The fees associated with closing your loan are another factor to consider. Depending on where you live, they can include:
Closing costs usually work out to between 3%-5% of your total loan amount.
In our example, 3%-5% of $180,000 works out to between $5,400 and $9,000. Break that down further into a monthly cost: Divide by the number of months in the loan term, 360 months, and it works out to between $15-$25 that you can tack on to your overall monthly cost to own.
Annual home price appreciation
Zillow cites an annual 7.6% increase in US home values in 2018 and a 6.4% increase in 2019. This factor is important because it affects the amount of equity you’ll have in your home as time goes on.
Continuing with our example, at Day One of homeownership, you’ll have 10% equity – your down payment. With appreciation over the course of 1 year, you’ll have that amount plus the principal you’ve paid (approximately $2,600 for Year One), plus 1 year of appreciation. On your $200,000 home, a 6.4% rate of appreciation works out to $212,800.
Selling cost
It seems counterintuitive, but selling costs affect the net cost of owning a home. If you were to sell your house, you would need to factor between 4%-7% of the sales price of your home, depending where you live.
In addition to your base monthly rent, you may want to consider adding these costs:
Add these all up, divide by 12 and tack that amount to your monthly rent for a more complete picture of what you’re paying. And to be completely fair, compare renting a home valued at $200,000.
Based on a lot of national averages I used in the example above, it appears it’s cheaper to buy than rent a home. As I mentioned at the beginning of this exercise, it really depends on where you want to live and how long you live there. Use the considerations and resources I’ve provided to come up with your own answer to guide your decision. To run some quick numbers, try our rent or buy calculator.
