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Rent or Buy? 2 Truths and 3 Tricks to Help You Decide

Some insist that renting is like throwing money away, but others say buying is too big of a risk. See for yourself how renting compares to buying.

Some insist that renting is like throwing money away, but others say buying is too big of a risk. See for yourself how renting compares to buying.

Benefits of Homeownership

The greatest benefit of owning a home is having the good old-fashioned American freedom to do whatever you want with your living space, but the icing on the cake is that homeownership can be great for your finances, too. You can save a fortune by fixing your mortgage payment and building home equity, and there are easy ways to determine whether owning is actually cheaper than renting in your area.

Truth #1: When You Own, Inflation Is on Your Side

The pesky thing about rent is that it usually rises every year when you have to renew your lease. If you get a mortgage with a fixed interest rate, though, your monthly home loan payment will stay the same until the loan is paid off. If you’re still paying the same mortgage 20 years from now, inflation will make it vastly cheaper for you, which is one primary reason it’s good to settle down.

Truth #2: Paying Off a Home Is Like Saving Money

With every mortgage payment you make, you are building equity in your home. You could almost think of your home as a savings account. Historically, home values rise at the same pace as inflation, so even though inflation will make your mortgage payments cheaper, your home’s rising value will protect the value of the money you’ve put into it. And this is just what happens when we look at the long term — in the short term, your home’s value could very well rise faster than inflation, turning it into a lucrative investment.

Of course, you have to make sure you don’t buy during a ridiculous housing bubble like the one that peaked in 2006. (Hint: If home values are rising way faster than inflation, be a little suspicious.)

You also need to make sure that owning is more affordable than renting in the area you want to live in. There are three tricks for doing this.

Trick #1: Multiply the Rent by 200

One rough-and-ready rule is that the price of the home you are looking at should not be more than 200 times what it would cost to rent it.

Say you’re looking at a humble 3-bedroom, 2-bathroom house in a quiet suburb. The list price is $170,000, and you can see that renting a similar house in the same neighborhood would cost you $1,400 per month. Multiplying $1,400 by 200 gives you $280,000, which is significantly higher than the list price. In this case, buying looks cheaper than renting.

This one-step formula is a crude way of looking at the price-to-rent ratio for the area, which we can explore next.

Trick #2: Find the Price-to-Rent Ratio

You calculate this ratio by dividing the home’s list price by the annual rent you would have to pay for something similar. For buying to be a better deal than renting, the ratio should ideally be lower than 15 (or 20 if you really like the home).

If $1,400 is the monthly rent, then we multiply that by 12 months to get the annual rent: $16,800. Divide the $170,000 list price by the annual rent, and the ratio comes out to about 10.1, which is much lower than the benchmark 15. (Indeed, the “multiply by 200” trick is based on a price-to-rent ratio of 16.6.)

This is the sort of math you can scribble on the back of a napkin at a coffee shop — it’s simple, straightforward, and a good place to start. There are many other things to consider than just the list price of the home, however.

You also need to plug in what the likely interest rate of your mortgage will be, how long you expect to keep the home before you sell it, and a host of other variables that would easily fill up several napkins. Fortunately, there’s no need to do this level of calculation by hand.

Trick #3: Use an Online Calculator

The New York Times and Zillow.com both have online calculators that can factor in just about every financial detail you can think of (and probably many details that never would have occurred to you).

  • The New York Times calculator is designed to tell you how low your monthly rent would have to be for renting a home to be a better deal than buying it.
  • Zillow’s calculator takes a different approach and tells you how long you would need to live in the home you buy in order for it to be a better financial decision than renting.

At the end of the day, deciding whether to rent or buy is a very personal matter. A lot of it depends on how attached to a particular location you want to be, as well as how willing you are to take care of your own home maintenance. When it comes to affordability, though, these two truths and three tricks will show you how to run the numbers for yourself.

Check out Loanwise’s Learning Center for information about Understanding Mortgages.