Rent vs. Buy. The fundamental housing decision is whether to rent, or to buy. Buying is a big deal; it comes with high upfront and recurring costs, and can lock you down to a specific property for years. Renting, on the other hand, only ties you to a location for as little as one month, or, in most cases, for up to a year with a standard lease, and you are not the one stuck with maintenance bills.

Everyone should run through their own specific calculations when choosing between buying one home, or renting another, and here are the major cost categories to consider: Buying fees, mortgage interest expense, property taxes, recurring maintenance, opportunity cost of the down payment, and selling transaction fees.

Most of these are straight forward, but I’m guessing most prospective buyers don’t calculate how much they’re giving up in income by putting a down payment on a home. The more you put down, the more you’re giving up in what economists call opportunity costs, income that you could have earned had you placed that money elsewhere, like a certificate of deposit (CD) with a bank.

Buying costs consist of mortgage fees, escrow, and standard transaction services. Only the mortgage interest is calculated as an expense, since the principal, in theory, is recovered at the time of sale. Tax adjustments should be made to account for the mortgage interest deduction, as is the case with property taxes.

Annual maintenance should be budgeted around 0.75% of home value per year. I’ve seen numbers range from 0.5% all the way up to 2%, but for most people and structures these numbers usually end up on the lower end of that range.

Equity opportunity cost is tricky, since it depends on what you consider an equivalent investment with the money you put down on the property. For those that consider a stable, fixed rate savings account to be the alternative use of down payment funds, a 5-year jumbo CD comes closest to measuring what you could have earned on that money. You can check Bankrate.com for current rates.

Financial theory, on the other hand, suggests that we look at an equivalent risk asset for equity opportunity cost. In the case of an equity down payment on a home, the closest asset would be stock investment in residential REITs.

Finally, selling fees can be significant: 5%-6% for agent commissions, and another 1%-2% for escrow, and other transaction fees.

It’s All About Risk. The difference between renting and buying is in the risk. Owning your home usually means holding a fixed rate mortgage, and never having to worry about housing costs increasing. This is especially important these days with inflation risk mounting with each new dollar the Federal Reserve creates. Owning also means you’re assuming the risk of asset value fluctuations-if home values go up, you keep all of the gain (minus the IRS take). If home values continue to plummet then you could be in a bind should you have to sell.

Renting comes with more flexibility, no potential for capital gains, and inflation risk if rents continue to increase. In the last few years those who chose to rent look like geniuses!

Mind you that this entire discussion is entirely based on financial considerations! There are plenty of non-financial, warm-and-fuzzy reasons to own your home. Only you can decide which way the scale should tip!

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