Renting vs. Buying a Home: Your Financial Decision Made Easy

For centuries, homeownership has been central to the American Dream. Now, many people are reassessing that dream. Americans who survived the housing crisis are more aware than ever of the financial risks, while millennials with college debt often can’t afford to buy—or don’t want to tie up their cash. No surprise, then, that renting is more popular than ever: About 40 percent of U.S. households currently rent, including a whopping 72 percent of those ages 18-34.

Yet for many, buying still retains its allure—in part because mortgage rates, while rising, remain a historical bargain. In 2007, the average 30-year fixed-rate mortgage topped 6 percent; 30 years ago, the average rate was about 10 percent.

So what to do, rent or buy? There’s no simple answer, because everyone’s decision should be based on a combination of financial facts and personal intangibles. But by answering these five questions, you’ll be well on your way to making the best choice for you:

1. How long do I expect to stay?
The longer you plan to stay in one place, the more attractive buying looks. One reason: the significant transaction costs of buying and selling a home. Closing costs average about $2,000 nationwide, and if you’re the seller, you also have to pay your realtor—usually 6 percent of the sale price of your house. Staying five-plus years also allows time for your house value to (potentially) appreciate—allowing you to recoup your expenses and possibly make a profit.

Bottom line: A good rule of thumb is that if you plan to stay less than five years, you might want to rent instead.

2. How healthy is my credit?
If your credit score is below 660, it might make sense to rent until you can improve your score. Home shoppers with a low score will have more difficulty getting a loan, and when they do, they’ll be charged a higher interest rate—incurring significantly more expense over the lifetime of the loan.

Bottom line: It makes sense to put off buying while you improve your credit, if needed. To protect the credit rating you do have, sign up for ProtectMyID, an identity theft monitoring service that’s free for AAA Members.

3. How much cash do I have for a down payment?
Homebuyers need a down payment—20 percent is ideal. Yes, it’s possible to buy a house with less: For as little as 3.5 percent down, you could get a Federal Housing Administration mortgage. But a lower down payment means you’ll get a higher interest rate on your loan and need private mortgage insurance.

Bottom line: It pays to put down 20 percent, but it’s not absolutely necessary.

4. How much cash do I have for up-front costs and monthly expenses?
The up-front costs of renting—first and last months’ rent, pet deposit, etc.—are minimal compared to the up-front costs of buying. If you’re a buyer, you’ll need cash for a down payment, immediate improvements you want to make, such as painting and furniture that fits the home, and more. You’ll also likely have more monthly costs than renters, such as property taxes, homeowners insurance and utilities—which are often are higher for homes versus apartments. Many rents also include water and garbage service, and even high-speed internet service.

Bottom line: Do some realistic math. One of the many buy-vs.-rent calculators found on the internet can give you a good idea of whether buying or renting makes the most financial sense for you.

5. Have I considered the non-financial issues?
The choice to buy or rent doesn’t only come down to dollars and cents. Maybe you can easily afford to buy—but you’d be very upset if you had a great job offer that you couldn’t accept because you couldn’t sell your house quickly enough. Or maybe your number crunching shows that it’s actually more expensive for you to rent than own—but you really want your child to have a large backyard. Ultimately, the choice includes a lot of personal considerations.

Bottom line: Take into account your lifestyle and priorities, in addition to the math, when deciding which route is best for you.