There are few topics in personal finance as controversial as this debate: should you buy a house or rent an apartment?
On one side of the debate, you have people saying "rent is throwing away money". On the other side, you have people saying that you can rent and invest the difference and you'll come out ahead.
Honestly, my take is this: when it comes to your primary residence, it's a personal preference as to whether to buy or rent and they both have pros and cons. Money-wise, they will likely be pretty equal, assuming you are comparing apples-to-apples in terms of size, location, etc.
The truth is, when people buy their own house to live in, they don't treat it as an investment. They put in money and personal touch. They may spend more than they would if they rent. So it's always hard to compare.
However, I'm going to share some very real math on the true cost of homeownership, and compare it to renting the exact same house. For this comparison, I'm lucky enough to use a similar house in the same sub-division that was for-rent as a comparison, so these numbers are about as apples-to-apples as you're going to get.
Let's dive in!
Whenever you have the buy vs. rent debate, it's always essential to look at the variables. But first, we have to start with a basic premise - you have to live somewhere that will cost you money (so, not your parent's house). If you have other free housing options, well, that will always win!
With that out of the way, when you talk about buying a home, you have the purchase price and the selling price. But you also have the down payment, you have mortgage payments (which is part interest, part principal pay-down), insurance, and much more. You also have enormous transaction costs - both to buy and to sell.
So, when it comes time to exit your "investment" you could easily see 5-6% of your gains disappear. It's important to remember that.
It's also incredibly hard to actually realize any equity in your home. If you do sell, you have to live somewhere else. Chances are, housing prices in your area have gone up at all levels, so you're really just going to put your equity back into someplace new to live. The only exception here is geo-arbitrage - where you sell in a high cost of living area, and move to a much lower cost of living area.
When it comes to renting, you eliminate most of these costs. Renting really just has two costs: the rent payment every month, and renters insurance. Things like maintenance, taxes, and more are all covered by the landlord.
For the sake of comparison, we're going to ignore variables like utility costs. Since we're comparing apples-to-apples and the houses are the same size, in the same neighborhood, we can assume that utilities like electricity and water will be the same at both.
True Cost Of Homeownership
For this example, we're going to be looking at a three bedroom, two bathroom house in the suburbs of a higher-cost of living area.
The house was purchased 6 years ago (almost to the day) for $510,000, and sold for $672,500. That's a nice gain of $162,500 in just 6 years. Looking at that number is what people get really excited about in the whole buy vs. rent debate. But when it comes to real estate, there is so much more than price.
To buy this house, we're going to put $103,000 down as the down payment (effectively 20% down), and take out a conventional 30-year fixed mortgage for $407,000.
With that in mind, here's the real cost history of this house for six years. Note, all figures have been added up for the entire 6 years of ownership.
The purchase expenses reflect the one-time fees, charges, and taxes the buyer had to pay out of pocket to own the home. Remember, even when you buy, you typically have to pay some of the expenses to close the deal. This also doesn't include any home inspections that you may have purchased to check out the house - which could add another $1,000 to the expenses.
Monthly Sunk Costs
These are the monthly "sunk costs" of owning the home. We only include mortgage interest as a sunk cost, since the principal portion of the mortgage payment is building equity. These are payments you make every month that go to someone else - not towards equity in your home.
Some may argue that you get to deduct mortgage interest from your taxes, and that may be true. However, the value of this could change, so tread lightly on thinking this is a make or break aspect of your decision.
Annual Sunk Costs
The annual sunk costs of homeownership are basically the property taxes you pay ever year. Again, money you pay as a homeowner that goes to someone else, not equity.
Another potential tax deduction is property taxes, but changes to the SALT deduction may make this a moot point for many.
Maintenance and Upgrade Costs
Lawn and Yard Care
We did need to include lawn and yard care, as this is something that the vast majority of renters won't pay - it would be covered by the landlord.
We also need to talk about repairs. As a homeowner, you're responsible for repairs (most tenants are not responsible for repairs). If you fail to repair your home, it might become a major issue. Furthermore, it can impact resale value if not fixed.
In this section, I would also include upgrade costs. In this scenario no major remodels or upgrades were done, but the older the home is, the more upgrades will be required to get top-dollar on resale. People won't pay top-dollar for a 15-20 year old kitchen and bathroom, old carpets, and more.
You have a choice of upgrading and paying an expense as an owner, or accepting a lower sale price on exit. Either way, upgrading your home, or failing to upgrade will be a cost you incur.
When you go to sell your home (which must happen at some point to get the equity out of it or else this entire conversation is pointless), you're going to face large transaction costs.
Realtor commissions are typically 5-6% in most places. Then you have escrow and other costs of the sale - in this case getting a termite clearance.
Selling a house isn't like selling stocks - it's expensive!
Total Sunk Costs
If you do the math and add up all of the sunk costs of homeownership for this house for six years, it comes out to $210,646.
Look at that number. That's the money you would spend owning this house that doesn't build equity or do anything - it's gone. You paid it out of pocket for the privilege of owning your own home.
And while you do have an asset that has gained value, it doesn't mean you're not spending money on things to maintain that asset that add no direct value.
The Math Of Homeownership
So, let's go back and remember the numbers. We bought this house for $510,000. We sold this house for $672,500. The ending loan balance at sale was $353,713 after principal pay down via the mortgage payments.
That means, over six years, you had $318,787 in equity built up. But don't forget, you came to this dance with $103,000 already. That means in six years your house gained $215,787 in equity. That equity grew from both price appreciation and paying down the loan balance via principal payments.
But here's what hurts. You paid $210,646 in sunk costs over the life of being a homeowner.
That leaves you with just a net gain of $5,141 after 6 years.
That's a total return of just 5% over six years, or an annual return of just 0.815% per year. That's not anything special.
I think it's important to note that any of the above expenses can change too. It could go either direction - maybe you buy a home without an HOA, or lower property taxes. But on the flip side, you could face major repairs or need to remodel it.
So while every situation varies, most primary residence living and ownership situations really don't provide stellar returns.
The Cost Of Renting
With renting, there are far fewer sunk costs. You basically pay your rent, and possibly renters insurance. This house rents for $2,400 per month. The insurance cost for renters insurance would be $12 per month.
For the same house as above, here's what the rent and insurance cost would be. Note, all figures have been added up for the entire 6 years of renting.
Monthly Sunk Costs
This brings your total cost of being a renter in the same house, for the same period of time, to $173,664. You could argue that your security deposit would be a sunk cost, in which case you'd have another $2,400 added to this (but I dismiss this, as in many jurisdictions your security deposit earns interest and, unless you lose it for causing damage, you get it back).
Some landlords are now charging fees for rental applications (usually to cover credit check costs, etc). You could also include a $25 application fee as a sunk cost as well. This definitely varies by area, and many don't charge anything.
Also, this dismisses potential additional costs, such as a pet deposit or extra pet charges. You wouldn't have to pay for that if you own your own home.
Finally, it's important to note that the average two bedroom apartment rent in the United States is only $1,343. That's significantly lower than our example. Keep that in mind.
Where you rent definitely has an impact on price, even in the same cities. So, there are so many variables when it comes to the cost of renting, but this example is apples-to-apples. Personally, if I was renting, I'd focus on keeping my costs as low as possible.
The Pros and Cons of Renting
While the financial costs of renting are lower than that of home ownership, there are definitely pros and cons. In some cases, the psychological costs of renting can outweigh the financial benefit.
Let's look at some of the pros and cons:
- Less expensive
- No need to worry about maintenance and repairs
- Transactions are easier and cheaper (no need to buy or sell)
- Apartment locations may be more flexible to your needs
- You could get evicted for things outside your control (e.g. the landlord could decide to not renew your lease or provide notice to terminate your rental agreement)
- You cannot personalize or customize very much
- You may be subject to community rules or other restrictions (e.g. parking or pet ownership)
- You have to coordinate repairs with your landlord and a repairman, adding another layer of complication
At the end of the day, renting is a viable preference financially, but it does have some serious logistical and emotional cons - specifically the risk you have to move through no fault of your own.
Buy A House vs. Rent An Apartment
Now that we've broken down the math, which is better - buying a house or renting an apartment?
Let's look at the money and other factors.
Comparing Sunk Costs
The first major comparison is the sunk costs. This is what you spend and you're never getting back. For homeownership, there are a lot of them. From buying and selling expenses, to taxes and mortgage interest, you spend a lot of money to own a home.
With renting, you just pay your rent and maybe a few other things. But that money is still gone forever.
Owning A Home
Renting An Apartment
In this example, you're going to pay $36,982 more in sunk costs to own a home than to rent an apartment. That breaks down to a roughly $6,163 per year difference in the cost of renting versus buying.
That's significant for many people - more money than it takes to fund your IRA contribution each year!
This difference would also grow significantly if you invested that difference as well. Which is what's next up.
Comparing Investment Gains
When it comes to both buying a home and renting an apartment, there are also the opportunities for gains. This is the primary motivator for home owners who think that their primary property is the path to wealth. But, as you can see in our example, it might not be net of expenses.
And historically going back to 1928, housing has returned just 3.7% annualized. Compare that with 9.5% annualized for the S&P 500.
But, you might argue, when you rent, you're throwing money away - there is no investment. But what are you doing with your savings of roughly $6,163 per year? Sure, some people aren't investing it, but plenty of people are investing it and it's the savvy way to go.
If you're viewing your home as an investment, then you're putting $103,000 into the investment, and over the course of 6 years, you grew that into $108,141. As we mentioned above, that's a total return of just 5% over six years, or an annual return of just 0.815% per year. You would almost earn more in a high interest savings account.
However, if you're renting, you're already ahead in year one - having $6,163 in savings versus the same person buying. This can get powerful, assuming the 6 year timeframe, and a 9.5% annual return.
If you're dropping your full annual savings of $6,163 in to your investments each year, you'd have $48,966 at the end of the 6 year timeframe.
You would have saved/invested $36,978 and would have had earnings/growth of $11,988. That's pretty sweet for a renter. This also assumes you came to the apartment with no other investments or savings (unlike the home where you had to drop down a 20% downpayment).
This is significant if you have the diligence to invest your savings of renting versus buying. It significantly shifts the math in favor of renting, but sadly most renters won't do this. That being said, just because they won't do it (or can't do it), doesn't mean it's not a valid option and something to consider when evaluating like items.
If you have the means to both rent or buy the same house, it also means that you have the ability to do this.
Long-Term Transaction Costs
We also need to discuss long-term transaction costs of buying a home versus renting.
When it comes to renting, there aren't many transaction costs - maybe an application fee, that's it. Yes, you need a security deposit, but it will be refunded if you leave the rental in good condition. So, when it comes to renting, we can effectively write-off transaction costs.
That's not the case with homeownership. When it comes to buying and selling a home, the costs are very high. And Americans move. The average homeowner will own three homes in their lifetime - but that number is increasing as Americans move more frequently.
In our example above, the buying cost was $2,079 and the selling cost was $45,439. These costs combined were 22.5% of the total sunk costs of homeownership. If you're doing that multiple times over your life, it will put a significant dent in the overall growth of equity you'll see in your primary residence as an asset.
Comparing Psychological Costs
You can't have this discussion about renting versus buying a home without covering the psychological costs. I use that word broadly, but I want to make sure things like the threat of eviction are thought about as a real cost.
The biggest drawback of renting is simply the fact you don't own it - and as such, you're at the whim of a landlord. If you're a month-to-month renter, there is a risk of eviction for no reason. That means you could have to pack up and move within 30-60 days, which could be traumatic.
There are ways to mitigate this risk (such as signing long-term leases, renting in a complex/building versus a home with a small landlord), but the risk remains.
Also, you cannot typically customize a rental very much. When you own a home, you can do anything you want to it - remodel, upgrade, or simple things like paint and flooring. With a rental, you cannot do most of that. And even small things you are able to do (like paint), you'll have to return to it's existing condition when you leave.
Finally, there are restrictions imposed on renters that may not apply to homeowners. Things like not being able to own a pet, or certain parking restrictions for complexes. These can have a major impact on your emotional or psychological feelings about renting. And they are one of the big perks of homeownership.
How To Boost The Return Of Homeownership
I want to clarify something here: real estate can be a great investment. But your primary residence isn't a real estate investment. You're going in and buying this property with a completely different mindset, and a completely different purpose, than you would with investment real estate.
That's not to say that you can't boost the return of homeownership. For example, you can house hack - which we've covered in-depth here: How To Get Started House Hacking. This is where you leverage areas of your home to earn revenue. For example, renting a bedroom, renting spare space in your garage or yard, or even renting your entire house if you're on vacation.
However, these unconventional living situations aren't for everyone. But I think that's a common theme in this article. Unconventional - you can rent an be better off financially if you invest the difference. Or understanding that primary home ownership isn't a straightforward path to wealth.
Now that the math has been laid out, in the big scheme of things, it's pretty neck and neck. Yes, renting has some potential monetary benefits. But there are other costs to consider, and preference is huge.
I think homeownership has some big perks, but it's not the "greatest investment" that too many people portray it out to be. Real estate as an asset class can be a good investment, but your primary home isn't an investment - it's where you live.
I also think that a lot of the stats about homeowners being better off financially has to do with behaviors and demographics as well, not just the fact they own their own home. Homeowners also ten to be older than renters. According to the American Community Survey, the median age of renters is 40, while the median age of homeowners is 53.
Furthermore, four out of every ten renter households are under 35 years old, compared with just one in ten for homeowners.
Yes, after 30 years of paying off your mortgage you're left with an asset you own outright - but how much sunk cost did you spend outside of building equity, and what was the opportunity cost of it? Could you have built a larger net worth doing something else?
So, the next time someone tells you "rent is throwing away money" or "rent is paying someone else's bills", you can leverage this article to show them that there are just as many sunk costs with homeownership as there are with being a renter.
Note: This article was inspired by a lot of the comments on our TikTok video here. Check it out and subscribe to our channel if you have TikTok.
Here are some studies on the topic you may find interesting:
- Arizona State University - Buying vs. Renting A Home: A Financial Study did a case study and found buying to have approximately a 5% better return over renting in Scottsdate.
- New York Times - Is It Better To Rent or Buy is an interactive calculator where you can find the inflection points of when it makes sense to rent or buy.
- CBC - Renting vs. Buying in Vancouver is a unique study looking at similar metrics to our study, but of a Vancouver condo.
What do you think in the buy versus rent debate?
Robert Farrington is America’s Millennial Money Expert® and America’s Student Loan Debt Expert™, and the founder of The College Investor, a personal finance site dedicated to helping millennials escape student loan debt to start investing and building wealth for the future. You can learn more about him on the About Page, or on his personal site RobertFarrington.com.
He regularly writes about investing, student loan debt, and general personal finance topics geared towards anyone wanting to earn more, get out of debt, and start building wealth for the future.
He has been quoted in major publications including the New York Times, Washington Post, Fox, ABC, NBC, and more. He is also a regular contributor to Forbes.