Philip, brace yourself.
I’m about to say something controversial...
What is it?
The earth is flat?
Tomatoes aren’t really a fruit?
The Star Wars Prequels were better than the Originals?
Renting isn’t always a bad financial decision...
Say what?
But isn’t renting just throwing money away?
When you buy a home, your monthly payments are going towards something you will eventually own.
Yes, but not for a long time.
Thanks to amortization, the first 5 to 10 years of mortgage payments are mostly interest.
But… but the home is appreciating, right?
So even if you’re not paying down the principal, you’re still making money, right?
True, but not that much more than inflation.
Homeownership might work out for some, but
can become a financial burden for others.
So when is renting a good financial decision?
And is renting viable as a long-term strategy?
This is Kira.
She just landed a job in a new city, and has already started shopping for places to live.
She’s trying to decide if she should take the money she’s saved up and put it toward
a house, or invest it in index funds while she rents.
A great way to find out whether you should rent or buy is to look at the Price-to-Rent
ratio.
Find two similar houses, apartments, or condos in your area; one for sale and one for rent.
Divide the sale price of one by the annual rental cost of the other.
Experts say if the P/R ratio is over 15, it’s probably less expensive to rent.
For example, the P/R ratio for the city of Cincinnati is about 8.3, according to the
U.S. Census Bureau.
In our hometown of Austin, it’s 22.9.
And in San Francisco, it’s 50.1!
Put another way, a $600,000 home in San Francisco would rent for only $1,000 a month!
There are even free “Rent vs. Buy” calculators online that will help you do the math with
your own specifics!
After shopping around, Kira finds an area that she’s happy with.
The average home price is $270,000.
And the average rent is $1,100 a month.
That means her area’s P/R ratio is 20.5, and she’ll get more bang for her buck by
renting.
She also doesn’t know if she wants to live in this city long term, making renting an
even more attractive option.
She decides against buying a home, and will invest the money she saved for a down payment
in an index fund instead.
When it comes to affording a place to live, millennials have an uphill battle.
Baby Boomers spent an average of 36% of their income on rent.
Gen-X spent 41%.
And millennials now pay over 45% of their pre-tax income on housing costs alone!
This makes it especially hard to invest, save, and give to charity.
Experts suggest keeping your total housing costs below 30% of your income.
Kira’s new salary is $58,000 a year.
That would mean her maximum fixed housing expense should ideally fall below $1450 a month.
Since utilities are usually 20% of housing expense, this would equate to $1160 a month
in rent and $290 for utilities.
Now she has a budget to start shopping for her new place.
Kira’s new job is downtown.
But rents in that area are pretty high.
Further out of town, costs are lower… but then there’s the commute.
One study found that every mile she has to drive to work costs $795 a year through depreciation,
gas, maintenance, and lost wages.
For Kira, a 10 mile commute might cost her $8,000 a year!
She makes a mental note to add public transit and carpool meetups to her list of search
criteria.
One often overlooked resource for renters in a new city is to work with a licensed realtor.
That’s right, they’re not just for home buyers!
A good Realtor will know the best areas to begin your search.
They might know about better deals that aren’t widely advertised.
And best of all, their commission is paid by the property owner, not you!
Kira would be smart to engage with one to help narrow her search.
Kira’s starting to get a little frustrated because none of the areas of town she likes
fall within her budget.
She’s momentarily tempted to throw her budget out the window, when a thought occurs to her.
Maybe she can keep her housing costs in line and live in a great area, if she will consider
living with a roommate.
30% of working age adults lived in so called “doubled-up” households.
She could rent out a spare room to offset the higher costs!
And if she wants to cut costs even more, she might even look at “homeshare” networks.
For example, Senior Homeshare or Golden Girls Network pair younger renters with aging homeowners.
Rent is highly reduced in exchange for a little help around the house or rides to a doctor’s appointment.
Another common pitfall renters face is failing to closely read their lease terms.
A lease is a legally enforceable document and it’s your job to arm yourself with the
knowledge of exactly what it says.
For example, if you move out early and don’t abide by the lease-breaking rules perfectly,
you could be liable for the rent of the entirety of the lease!
And if you plan to sublet or rent out the apartment, terms will be covered here too.
Some people are surprised to find out that damage of their belongings is generally not
covered by their property owner.
But renter’s insurance is designed to protect against just that.
In the event of water damage, fire, smoke, or even theft, she can rest easy knowing her
belongings are safe.
The best part?
Renter’s insurance is quite cheap.
For the price of a pizza, Kira can know that her possessions will be fine, even if her
building is not.
Kira is relieved to have found a place at last.
And because she has that index fund, she knows she’ll keep pace with her homeowner friends.
Renting may be the right choice for Kira, but it’s not for everyone.
If you’re not strategic about it, it can feel like throwing money away.
But if you’re careful to keep housing costs low, and invest the money you save, it can
be a viable long-term alternative to owning.
And that’s our two cents!
What's the P/R ratio in your neighborhood?
Calculate it and share it with us in the comments!