The housing crisis of 2008 has made people question housing as an investment, and more and more Americans today are considering renting.
So how do you determine whether to rent of buy?
First, housing can’t be thought of as an investment in the traditional sense. It is something we use and enjoy in the here and now, and it generally costs us in terms of a mortgage, maintenance, insurance and taxes.
Our house doesn’t pay a dividend, doesn’t have huge appreciation, and many of us will hold onto our homes in retirement so they won’t be liquid — we can’t pay groceries with the bricks from our house!
In fact, historical data show that you can only expect roughly a 1 percent real return on your personal real estate. From 1890 to 1990 real housing prices in the US did not rise at all. So, at best, the increase in value will be roughly equal to inflation.
Here are some guidelines to help you decide whether or not to rent or buy:
Generally it is better to rent if you…
- Will stay in the home fewer than five years
- Expect higher return in stock market
- Believe rental prices are stable
- Can’t qualify for a loan
- Don’t have a decent down payment
It is better to buy if you…
- Will stay in the home five years or longer
- Expect lower stock returns
- Believe rental prices will rise steeply
- Can qualify for a low interest loan
- Have cash for a down payment
If you do decide to buy, make sure you don’t overpay for your home.
A good rule of thumb is to not pay more than the equivalent of 15 years annual rent for your house.
So, for example, if the home you are looking at would rent for $1000 a month, its value would be roughly $180,000.
Ex. $1000/mo. x 12= $12,000 x 15= $180,000
If you are looking for homes and they are consistently priced higher than this you will be buying in an overvalued market.