Renting or Buying a Home: How to Run the Numbers

"Renting is throwing money away" is one of the most repeated pieces of financial advice, and one of the most misleading. Owners have unrecoverable costs too: mortgage interest, property taxes, insurance, maintenance and the money tied up in a down payment. Whether buying beats renting depends on local prices, interest rates, how long you'll stay and what you would do with the money otherwise. Working through the comparison step by step makes the trade-off clearer than any rule of thumb.

Step 1: Count the costs you never get back

When you rent, the unrecoverable cost is simply the rent, plus renter's insurance. When you own, the unrecoverable costs are less obvious:

Mortgage interest, which makes up most of each payment in the early years. The principal portion is not a cost, since it builds equity.
Property taxes, which vary widely by location, from well under 1 percent of a home's value a year in some states to more than 2 percent in others.
Homeowner's insurance, which has risen sharply in some areas exposed to storms, wildfires and flooding.
Maintenance and repairs, often estimated at roughly 1 percent of the home's value a year on average, though it comes in lumps, such as a new roof or water heater.
The opportunity cost of the down payment: the return that money could have earned if invested instead.
HOA fees, if the home is in a homeowners association.

Step 2: Try a rough comparison

One widely discussed shortcut, popularized by the Canadian financial planner Ben Felix, is the "5 percent rule." It estimates the yearly unrecoverable cost of owning at around 5 percent of the home's value: roughly 1 percent for property taxes, 1 percent for maintenance and 3 percent for the cost of capital, meaning mortgage interest and the return given up on the down payment. Divide by 12 for a monthly figure and compare it with the rent on a similar home.

For example, for a $400,000 home, 5 percent is $20,000 a year, or about $1,667 a month. If a comparable home rents for less than that, renting and investing the difference may come out ahead financially. If rent is much higher, buying may make more sense. The percentages are assumptions, so adjust them for local taxes, current mortgage rates and the condition of the property.

Step 3: Add the one-time costs

Buying and selling are expensive. Buyers typically pay closing costs of roughly 2 to 5 percent of the loan or purchase price, covering lender fees, appraisal, title insurance and taxes. Selling has historically involved agent commissions and other costs that can add up to several percent of the sale price. These costs mean buying usually only makes financial sense if you stay long enough for appreciation and equity to outweigh them, often estimated at around five years or more, though the break-even point varies with local prices and rates.

Step 4: Consider how long you'll stay

If a job move, a growing family, a relationship change or uncertainty about the area makes you likely to move within a few years, renting offers flexibility that is hard to put a price on. If you expect to stay put for a decade or more, ownership has more time to pay off.

Step 5: Weigh the non-financial factors

In favor of owning: stability, freedom to renovate and decorate, protection from rent increases with a fixed-rate mortgage, a forced savings effect as you pay down principal, and the possibility of a fully paid-off home in retirement.

In favor of renting: flexibility to move, no responsibility for major repairs, lower upfront costs, easier access to neighborhoods where buying is out of reach, and the ability to keep savings diversified rather than concentrated in a single house.

Step 6: Check your readiness to buy

A stable income and job prospects in the area.
An emergency fund separate from the down payment and closing costs.
A credit score high enough for a good mortgage rate, since even a small rate difference changes the monthly payment substantially.
A total housing cost you can comfortably afford. Many lenders look at a debt-to-income ratio, and a common guideline is to keep housing costs at or below about 28 percent of gross income, though lower is more comfortable.
A down payment. Twenty percent avoids private mortgage insurance on conventional loans, but FHA loans and many conventional programs allow much smaller down payments, with added mortgage insurance costs.

Tools that help

Detailed rent-versus-buy calculators, such as the long-running one published by The New York Times, let you enter local prices, rents, rates, taxes and how long you plan to stay. Housing counselors approved by the US Department of Housing and Urban Development offer free or low-cost advice for first-time buyers, and many states and cities run first-time buyer assistance programs.

The bottom line

Neither choice is automatically smarter. Renting and investing the difference can build as much wealth as owning, but only if the difference is actually invested. Buying works best for people who plan to stay a long time, can afford the full costs comfortably and value the stability of owning. The right answer depends on your numbers, your market and your plans.