The 300 Club

Renting vs. Owning: Which is Better for You?

Despite the conventional wisdom, renting might make more financial sense than you think.

4 Reasons Why Renting a Home is a Wise Decision

By Warren Cassell | Updated April 20, 2016 — 10:57 PM EDT

Homeownership has long been held up as the epitome of the American Dream. And for some people it has been. In other cases, the decision to buy a home can be a financial nightmare – they didn't call that home-renovation movie "The Money Pit" for nothing.

People who advocate for buying a home often insist that renting is the equivalent of throwing your money away. Some argue that homeownership is better than renting because it is possible to make monthly mortgage payments that are equal to and, in some cases, below the cost of renting. Others point to the fact that home values go up over time as a way to suggest that a home is a great investment. And it can be – but not in every market and not for every person.

In fact, many studies point in the other direction, as we'll see below. And more and more Americans are making this choice. "In mid-2015, 43 million families and individuals lived in rental housing, up nearly 9 million from 2005 – the largest gain in any 1-year period on record," according to a 2015 study from the Joint Center for Housing Studies of Harvard University. What's more, 37% of all households are now renting, which is the highest percentage since the mid-1960s, the study reported.

Let us explore four reasons why choosing to rent, as opposed to purchase, a house can be a wise decision.

Owning a House Can Tie You Down

If you have the kind of job that entails frequent relocation, renting is definitely the smarter choice. It is harder to get rid of a house or apartment you own than to get out of a lease. If you're lucky, your landlord will allow you to break your lease as long as enough notice, maybe one to two months, is given to find a new renter to fill the vacancy. Some landlords might also want to keep a portion, or even all, of the security deposit, which is usually the equivalent of one month's worth of rent, as compensation for the early termination. States actually have a protection for tenants who leave before the end of a lease called "the landlord's duty to mitigate damages," according to the legal website Nolo. Click here and scroll down for Nolo's state-by-state information.

Selling a home takes many more steps and often a lot more time – especially during a market downturn. Those who ended up underwater during the last housing crash,had the additional burden of ending up owing more on their houses than what they were actually worth. People in that situation would need to come up with extra cash to not only pay off their loan but also find a new place to live. See Mortgage Options for Underwater Homeowners.

Depending on the area of the country in which the property is located – and the current health of the real estate market – finding a qualified buyer for your home can sometimes take months, even years. To improve your odds, see How to Stage Your Home for a Quick Sale and Take the Pain Out of Selling Your House – Online. (For related reading, see: The Truth About Real Estate Prices.)

Owning a House Can Tie Up Your Money

Radio talk host and financial advisor Dave Ramsey said it best, "When broke people buy houses, it makes them broker. It doesn’t end up being a financial blessing." For the most part, purchasing a house requires a person to make either a large investment, if you are paying for it free and clear, or a large down payment, if you choose to get a mortgage.

Both options will require most people to significantly reduce their liquid cash reserves in exchange for a very illiquid asset. This can leave some individuals or families financially unprepared for unexpected emergencies such as a health scare, car accident or job loss. Renting is a much wiser option for anyone who has not yet built a sizeable emergency fund of the standard 3 to 6 months' worth of expenses.

If you do have the emergency funds and enough cash to invest in a home, then the decision is between whether that purchase is a better use of your money than renting and investing your funds elsewhere. See the next section for a discussion of how good an investment a home actually is.

Compared to Other Options, a House Is a Terrible Investment

Not always, but many statistics in favor of homeownership are surprisingly weak: Depending on when you bought your house, you could be better off renting and investing the money you saved (by not needing a down payment and funds for home maintenance, insurance and property taxes).

From 2005 to 2012, home prices collapsed by 42%, according to a 2014 HelloWallet study called "House of Cards: The Misunderstood Consumer Finance of Homeownership," which pointed out that half of current homeowners (over 40 million households) "purchased their homes during time periods when average homebuyers would have been better off renting than investing." Its conclusion in favor of investing is based on using a tax-deferred retirement account earning a 6% nominal returns, as these are the closest equivalents to the tax benefits afforded to homeowners who deduct their mortgage interest on their federal income taxes.

The study, which incorporated such factors as local taxes and two income levels in 20 cities also concludes: "The cost of renting relative to buying a comparable home (called the "rent-to-price ratio") is almost as important as expected home price appreciation for determining whether a person should rent or buy."

While it is true that home values appreciate over time, the actual costs of owning and maintaining a property can greatly diminish its realrate of return. One of Yale's most renowned economics professors, Robert Shiller, conducted research that found that "Home prices in America rose by an annual average of only 0.4% in real terms between 1890 and 2004."

This figure does not take into account costs like property taxes, closing costs, insurance, mortgage interest and simple maintenance expenses. One factor to include: How long you plan to live in the property. The longer you stay, the more you will amortize closing costs and other one-time expenses.

From an investment perspective, purchasing a home solely for the purpose of having a place to live is a terrible place to put your money. You will be able to make a better return by renting an apartment for yourself, and using the money you would have used to make a down payment on your house to invest in something like rental property that pays you every month. Real estate investor Grant Cardone once described this action as, "rent[ing] where you live and own[ing] what you can rent."

Mortgage Interest: Costly – and You May Not Use the Deduction

The vast majority of Americans do not have the resources to purchase a house without a mortgage to cover the difference between the selling price and what they can afford. Although a mortgage might look good on paper, interest payments, when compounded over a couple of decades, can result in someone repaying a lot more than they had originally borrowed to purchase a home.

For example, a $100,000 30-year fixed rate mortgage at 3.5% interest will cost you $161,656.09 – or $61,656.09 in interest if you don't pay it off early.

One advantage to having a mortgage, prospective homeowners are told, is the federal income tax deduction for mortgage interest. The problem is, in order to take it, you have to itemize your deductions on your income tax and only 25% of homeowners do this, according to the HelloWallet study. The reason: the size of the standard deduction, which, for 2016, is $6,300 for a single filer and $12,600 for "married, filing jointly" taxpayers. A family needs a lot of deductions to do better than the standard amount.

Affluent families with high mortgages in expensive real estate markets, or those with high property taxes, do end up benefiting, but many others don't. In fact, "homeowners with median incomes realize no federal tax benefit from owning in 75% of the major cities in our sample," the report concluded. Wealthier homeowners – with higher tax brackets and often bigger loans – are more likely to be able to use the deduction. It also pointed out that over time, the (tax-deductible) interest portion of your mortgage payment will decline while the standard deduction will likely rise.

The Bottom Line

Buying a house is not always a financially sound decision. There are many disadvantages to owning rather than renting. These include not being able to move easily, having a large sum of money invested in an illiquid asset, paying a lot of money in interest and realizing a low real rate of return.