Should I Rent or Should I Buy?

June 1, 2022 | Posted in: Wealth Strategies

Given the current, highly competitive housing market and fact that home ownership represents a common goal among younger millennials, now is a good time to consider the tradeoffs of buying versus renting a home.

One should incorporate the points above in addition to personal, lifestyle, and financial goals that may be unique to one’s situation. For example, a young couple with adequate financial resources may plan on having children in the near future, in which case it makes more sense to buy a home in the absence of other important, competing goals. On the other hand, an uncertain employment situation or plans to potentially relocate to a new city in the near term would make ownership a less prudent decision in spite of sufficient resources to make a purchase. These less quantifiable, non-financial factors are often the most important points to factor into the decision-making process.

Considering the local housing market for buyers and renters can add clarity to the decision as well. We have recently seen a dramatic rise in both home sale prices and rents across the US, with the former outpacing the latter in most of the country. In Nashville for example, the median listing for home prices has risen 21 percent over the past year according to realtor.com, whereas rents have risen 9 percent for a three-bedroom space according to Zumper. Furthermore, the average 30-year fixed rate mortgage has also climbed over the past year from slightly below 3% to 5.25% as of May 19 (Freddie Mac). As purchasing a home becomes more expensive, it lengthens the time to break even relative to renting a comparable home over the same time period.

While everyone’s situation is different, there are certain rules of thumb that can be applied in this decision-making process. The 28% rule, for example, suggests that you should not spend more than 28% of your gross income on your mortgage payment (principle and interest). As another example, some experts claim you should avoid buying a home unless you plan on living there for at least five years. If these methods prove unsatisfactory, NerdWallet has an online rent vs buy calculator that enables users to manipulate inputs and determine a more precise break-even estimation.

Using the aforementioned calculator, we can compare a break-even estimate for Nashville from prior to the onset of the pandemic (January 2020) to that seen in more recent conditions (May 2022). While assuming a 30-year fixed rate mortgage and a 20 percent down payment, the variable inputs consist of the following:

As seen in the results below, the average time to break-even when purchasing a house versus renting a similar space in Nashville has increased from approximately three years in January 2020 (Figure A) to five years in May 2022 (Figure B). In applying this analysis to a broader sample of southeastern cities, I looked at the results for Memphis, Greensboro, Atlanta, and Charleston. In both Memphis and Greensboro, the time to break-even remained unchanged at two years. Atlanta saw the time to break-even increase from three years to four. Lastly, Charleston resembles Nashville in that the time to break-even increased by two years, and now sits at four years as of May 2022.

Figure A: January 2020