Myth: Buying a home is better than renting.
Fact: Renting is sometimes the better option, especially over the short term.
Buying a home is a good way to build long-term wealth, mainly because paying down a mortgage is forced savings. There are also tax breaks for home ownership, and homes tend to appreciate at least as fast as inflation. When you borrow to buy, “you put up a small part of the price, but get appreciation on the whole house,” says Skylar Olsen, chief economist for Zillow.
But there are big one-time, nonrefundable expenses when you buy, and again when you sell. These costs vary, but Zillow pegs them at 3 percent of the purchase price for buyers, 8 percent for sellers, in its buy-versus-rent calculator. You’ll also have ongoing costs such as insurance, property taxes (which may be deductible), and maintenance.
When you start repaying a mortgage, your payment is mostly interest, so you’re not building much equity. Very gradually, your payment will include more principal and less interest.
Suppose you borrow $500,000 at 5.5 percent fixed for 30 years. In the first five years you will have paid a total of about $132,600 in interest and only $37,700 in principal. Even after 10 years, you will still owe about $412,700. Your payment won’t be more principal than interest until year 18. Fortunately, interest payments are tax deductible (but only on your first $750,000 in home-mortgage debt).
When you sell your home, you’ll keep what’s left, after closing costs, and won’t pay any capital gains tax on the first $250,000 in profit ($500,000 if married).
If you rented a home instead, and invested the down payment, closing costs, and any additional savings in stocks, you could still come out ahead of buying, even in the long term. That’s because stock market gains, over the long term, have generally outpaced home-price appreciation. But stocks don’t get the same tax breaks as homes, and not all renters have the discipline, or know-how, to invest those savings.
“Homeowning is a behaviorally friendly savings plan,” says Olsen.
Zillow and other websites have calculators that allow you to plug in variables and estimate what’s best for you, given certain assumptions. Nationally, renting is usually cheaper in the first five or six years; after that, buying usually wins, Olsen says.
Warning: Your results may vary.