As biased as this may sound, (after all, I have a vested interest in people's decision to buy or sell a home) I can think of very few reasons why renting a home is a better alternative to owning a home. Of course you can make the obvious arguments for renting like mobility, paid maintenance, less out-of-pocket expense, but assuming one could qualify for a loan, why would anyone prefer to rent rather than own? 

Fulfilling the American Dream

Most people consider homeownership as the fulfillment of the American Dream. Buying your first home is like graduating into adulthood. It's an achievement in one's life that ranks up there with finishing college, getting married, and having a child. For most Americans, the equity they build in their home is their greatest source of wealth. 

But other than needing a place to sleep at night, what are the benefits to owning a home? If you had the option to rent or own, (assuming you could qualify for a loan) why, in most cases, are you better off owning?

The Benefits of Home Ownership

When I ask first time buyers why they want to purchase a home, I usually get the following two replies:  To build up equity, and for the tax write off. 

Overtime, real estate has proven itself to be one of the best performing investments available. In fact, real estate has created more millionaires than any other asset. When compared to other assets, the privileges that are inherent to real estate are astounding. What other asset allows you to borrow more than 100% of its value, write off the interest against your taxes, provide strong appreciation over time, and keep you warm at night? Real estate can truly be one of the most attractive investments available today. 

Appreciation

We expect our home to be worth more tomorrow than it is today. We expect to build equity in our homes over time. But what's the big deal? A lot of investments appreciate. What makes the appreciation of real estate so significant?

Leverage. Simply stated, leverage is making money off other people's money. 

Let me explain: Very few of us own our homes outright. Most of us own only a relatively small portion of our home with the balance loaned to us by a bank or lending institution. Today, you can buy a home with as little as nothing down, but for the sake of this example, let's say you put 10% down on a $300,000 home (loan amount: $270,000, your equity: $30,000). Assume your home appreciates 10% the following year. Your home is now worth $330,000. For simplicity, assume your loan amount stays the same ($270,000), what is the rate of return on your $30,000 investment? 

$330,000 (new home value) - $270,000 (loan amount)    $60,000 (equity). 

Your rate of return is 100%. In other words you doubled your money on an only 10% move in the market. Compare that to if you had put that $30,000 in the stock market that also returned 10%. Your $30,000 would now be worth only $33,000, a $27,000 difference. 

As you can see, leverage magnifies your gains. Of course the opposite is also true. In the same example, a 10% downturn in the real estate market would mean a 100% loss of your equity. In the long run, most people expect real estate to appreciate which is what makes leverage such an attractive element of owning a home. 

Taxes

It's sometimes surprising to me that most people are aware that owning a home provides a nice tax deduction, but few people really understand what that means. When I teach my home buying classes, one of the first things I cover is the real cost of home ownership when you consider taxes and appreciation. 

Take a look at this example of the real cost of home ownership.  All of the interest and taxes that you pay are completely tax deductible. For the first several years of your loan, most of your payment is made up of interest, and in this example, a zero downpayment is assumed and appreciation is estimated at a very conservative 1% (the California Association of Realtors forecasts 8.5% appreciation for 2001). When you consider taxes and appreciation and compare that to the cost of renting, you can see how owning can be much more attractive. Try to find a $300,000 house for rent for $1,200.

One of the newer tax benefits of real estate is the $250,000/$500,000 exclusion. The $250,000 exclusion is available to a single taxpayer and the $500,000 exclusion is available to married taxpayers. To qualify, the taxpayer (both spouses, if married) must reside in the home as their principal residence and own the home for two out of the last five years. When the home is sold, no capital gains taxes are due up to $250,000 for a single taxpayer and $500,000 for married taxpayers. This tax law alone has allowed many people with huge amounts of equity to sell their home and completely avoid any taxes; yet another perk to owning a home. (For more information on this subject, consult your tax accountant or lawyer). 

The One Argument For Renting

With all that's been said, you may think that I always suggest buying a home versus renting.  That's not always true. There is one very valid reason for choosing to rent a home. If you may be transferred or move out of the area in a short period of time, renting definitely makes more sense. The cost to buy and sell is significant enough that it can take a relatively strong market to offset those costs, and there's never a guarantee on how long it will take to sell. If you believe that you may need to move in less than a year, it's probably not a good idea for you to buy a home.

The Bottom Line

There is an obvious trade off between renting and owning. Owning a home can involve more financial risk than renting (although an argument could be made for the opposite opinion). However, owning can also offer more financial benefits as well.

Of course there are no guarantees that the real estate market will continue to appreciate. There are no guarantees that an earthquake won't destroy your home tomorrow. As black and white as I may have made it seem, there are benefits to both alternatives. 

But the bottom line is this: Before you make the decision to rent or own, you need to give careful consideration to the benefits of both alternatives and make your decision based on your particular situation. You need to consider your timeframe and the stability of your life and make a sound decision that will make the most sense for you for the years to come.

Copyright Michael Rice