As per the latest Census Bureau numbers, about two out of three households in the US have their own homes, while about 34% rent. Buying a home is part of the American dream, and even though a statistically appropriate number cannot achieve that dream, it’s often by choice. Many individuals and households prefer to rent for a number of personal, lifestyle, and financial reasons.
If you are renting your current home but are ready to make a move and purchase your own place, there are several factors you need to take into account in order to make the right, informed decision.
The most significant hurdle that prevents people from switching from renting to buying is their finances, and it’s more complex than simply swapping monthly rent for mortgages.
The first financial hurdle in purchasing your own home is the down payment. You have to save up enough money to put on a sizable down payment. This shows mortgage lenders that you are ready to put skin in the game and increases your chances of getting approved significantly. Ideally, you should save about 20% of the purchase price. However, this is not a financially viable option for everyone.
The average home price in the US is above $300,000 right now, and the average amount Americans saved in 2022 was about $5,000. So even with two people in a household saving for a down payment ($10,000 a year), it will take at least six years to save up the desired 20% for an average home ($60,000). The prices may rise significantly over that period.
There are other options, like FHA loans that require a 3.5% down payment or VA loans (if you qualify) that may not require any down payment. You have to determine how much you can save, and if it’s unfeasible, look for down payment assistance programs or low down payment options you can qualify for. This will make it easy to determine if you are ready to make the move from renting to buying.
Unless you are buying in all cash, your credit score can significantly impact your chances of buying a home. A good credit score can help you get a mortgage loan at prime rates, making your mortgage more affordable.
A bad credit score will not just make your mortgage more expensive (since you will need to pay a higher interest rate), but it may also limit your chances of getting a mortgage.
If your credit score is not good, focus on improving it before entering the market. With a good credit score, you may have far more lender options at your disposal, and your chances of getting a good rate may increase significantly.
Mortgage affordability is not too different from rent affordability. However, the thresholds are different. Most lenders use what’s called a Debt-to-Income or DTI ratio to determine your mortgage affordability.
This ratio determines how much of your monthly income is going towards paying off your debt, including your mortgage. It’s determined by how much debt you have, your income, and the property value you are going for. If you have almost no other debt (credit card, student loan, auto loan, etc.), you may have more leeway when it comes to DTI.
If you have significant debt and make monthly payments towards it, you can opt for a smaller, more affordable property that may push down your DTI to a safer level. Most lenders look for a DTI of 36% or lower (ideal) but may lend to borrowers with DTIs as high as 43%, though the actual upper cap may vary from lender to lender.
In some markets, like New York City, you may also have to pass the DTI check of the building you are buying in if you are going for a co-op apartment. The boards running these buildings have a vested interest in ensuring that only financially stable individuals/households buy into the building.
It’s quite easy to downgrade when you can no longer afford your rent. But that’s not a viable option when you have bought your property and are paying a mortgage on it. If you don’t have a financial moat or are unsure about your job/primary income source five to ten years down the line, it’s a good idea to think hard before making the switch.
For many people, renting is a viable lifestyle choice for a number of reasons. For example, individuals and people who have to move for their work every few years might be better off renting than buying. Similarly, renting is the only viable option if you want to live in an area for work or school but cannot afford to purchase a property there.
Other considerations apply to a broader set of individuals. For example, many people make the switch from renting to buying because they perceive the value of a home as a major financial asset. However, it takes several years or even decades (if you have a 20-year or 30-year mortgage) to completely own this asset. So many people opt for different investments and divert the additional funds (down payment and difference between monthly mortgage and rent) towards other investments to build their nest egg.
Lastly, buying a home also comes with a lot of responsibility, especially if you are buying a single-family home or another free-standing structure. When you are renting, the responsibility of maintaining the property is with the landlord.
Renting is not necessarily a financially “irresponsible” choice. For many individuals and households, it’s the only viable choice. For others, it’s a better choice than buying a property from both a financial and lifestyle perspective.
The decision is influenced heavily by your circumstances and needs, so make sure you weigh the pros and cons of each option before making a decision. Some macro factors, like low interest rates or buyer’s/seller’s market, should also be considered when you are making your decision.
If you can afford to wait, renting until the interest rates are just one percentage point lower (assuming the property price remains the same) may significantly lower your home ownership cost.
If you have made the decision to buy, working with an experienced agent (especially if you are buying in New York City) can ensure that the decision yields optimal results for you.