There are times when renting is a smarter move than buying. It could be because you are still paying off debt or you may know that your job requires you to relocate often.
It’s important to understand the pros and cons of each choice before making a decision. Let’s talk about the costs associated with each option.
1. Taxes
Everyone knows that mortgage interest is tax deductible, but what about property taxes? Incorporating these costs and opportunities in the rent vs buy calculation can help people make more informed decisions about whether to purchase or not.
People tend to focus on locking in costs when deciding whether or not to buy, but there are other factors that should be taken into consideration. For example, when assessing the cost-effectiveness of renting versus buying, people should also consider the opportunity cost of the money they would have spent on a home and how they could have invested it instead. This is especially true in the current environment with rising mortgage interest rates, inflated home prices, and recent federal rate increases that are making it more expensive to finance homeownership.
Regardless of where you live, there is no question that the tax system has a significant impact on consumer behavior. It influences investment decisions, labor supply, consumption patterns, positive and negative economic spillovers (externalities), and state-building and governance. It is an important part of the economy and provides a way for consumers to exert accountability on their government.
Taxation is the most common form of redistribution, a way for the government to allocate resources in a fair and equitable manner. Depending on the elasticities of demand and supply, a tax can be absorbed by the supplier (in the form of lower pre-tax prices), by the purchaser (in the form of higher post-tax prices) or by a mixture of both.
It is understandable that some people believe that it is better to own a home and build equity over time because of the opportunity for wealth creation, but anyone who tells you that it is always more cost-efficient to own than to rent has either not thought through their decision or is ignoring the impact of taxes. It is unfair to raise other people’s taxes without giving them a chance to spend that money on something else.
2. Equity
The equity you build in your home is one of the best financial returns on investment you can achieve. It is the difference between your property’s fair market value and the outstanding amount on your mortgage. This value is referred to as “home equity.” It’s also known by other terms such as book value and net asset value.
Many people dream of buying their own homes. They may be drawn to the idea of building wealth, having more control over their space, or living in a desired neighborhood or school district. Purchasing a home is usually one of the largest financial commitments most people make in their lifetime. It’s not right for everyone though and oftentimes renting makes more sense.
Considering all the factors that affect whether to buy or rent, it’s easy to see why it can be difficult to answer the buy vs. rent question. Whether you are financially ready for homeownership, or you’re not sure you want to settle down in a specific area for the long term, your lifestyle, age and work situation will all play into your decision.
You might have heard that renting is like throwing money out the window, but this is not true. It’s a myth that renting is the same as buying lottery tickets—it’s just not a good use of your hard-earned money. Housing is an essential expense and it’s important to choose the option that works best for you.
When deciding whether to buy or rent, it’s helpful to run the numbers. A few key things to consider are the cost of owning versus the cost of renting, and the benefits of owning versus the benefits of renting. A few costs to keep in mind when determining whether or not you are ready for homeownership include property taxes, maintenance costs and the cost of capital. To help determine if you are ready to purchase, the 5% rule compares these three expenses against your monthly income to see if owning makes sense for you. If you’re unsure about how to assess your readiness for homeownership, consider reaching out to a local real estate agent for a professional assessment.
3. Depreciation
When you purchase a property, you can deduct its cost over the years as an investment. The accumulated deduction can significantly reduce your taxable income. However, you have to consider the rate of depreciation of a property over time. This is because the property gets worn out after continuous use.
The rate of depreciation varies from place to place, but it usually follows the demand-supply curve. For example, properties in metro cities have a higher resale value than those in rural areas. The reason is that a number of civic amenities like roads and good transportation systems are available in these locations, which attracts the demand. Moreover, the scarcity of land in these areas also leads to the high resale values.
On the other hand, rental properties depreciate due to wear and tear and damage caused by tenants. You can calculate this by dividing the original cost of the property by its useful life. For instance, if you purchased a property for $300,000, and it has been used for ten years, the depreciation would be $10,909 per year.
The rent vs buy debate is an important one to have, especially when you are thinking of buying your first home. Whether it is more practical to rent or buy depends on a variety of factors, such as your time horizon and financial situation. While the conventional wisdom is that buying makes more sense than renting, it is worth weighing all the pros and cons before you make any final decisions. You can also consult with a financial advisor or real estate expert to help you make an informed decision.