Rent vs. Mortgage: Understanding the Difference
Jim Geymont on 02 May 2019
If you’ve always rented your home and are now about to take the plunge into home ownership, there are a few things you should know when it comes to making the transition from renter to homeowner. While you have probably compared your current monthly rent amount with your expected mortgage payment, there are more financial differences between renting and owning than just a monthly payment. Here are a few things to keep in mind when exchanging a rent payment for a new mortgage:
One of the reasons renters opt to save up for their own home is the ability to grow equity. As a homeowner, a part of your monthly mortgage payment typically increases the equity you have in the home. With each mortgage payment you make, a portion goes toward interest and another portion goes toward reducing the unpaid balance on the loan principal. The amount by which your principal is reduced from the original amount is the amount of equity you have in your home. Over time, the part of your payment that goes toward interest will decrease and a greater portion will go toward the principal, helping to build equity in your property. As a renter, on the other hand, your monthly payment is simply a payment, which goes to your landlord. There is no opportunity to build wealth through your payment.
When you apply for a mortgage, your lender will require you to purchase homeowner’s insurance as well. While your lender will be concerned that you get enough insurance to at least cover the dwelling, you will also want to cover all of your belongings. As a renter, on the other hand, you only need to cover your personal belongings. Your landlord insures the actual dwelling, though he or she has likely factored the cost into your rental payment. Because you must cover both the dwelling as well as your belongings, you can expect your homeowner’s insurance to cost you more than your renter’s insurance.
In addition to building equity through your monthly mortgage payments, you can also expect your home’s value to appreciate over time. Under normal market conditions, depending on your neighborhood and how well you maintain your property, you can expect your home’s value to increase every year. How much your home’s value appreciates over time is very specific to your particular market. Under some circumstances, it’s possible your home’s value could decrease. But under normal market conditions, you can expect appreciation to build wealth twice as quickly as your mortgage payments build equity. Combined, appreciation and equity enable you to build wealth in ways not attainable through renting.
When you plan to buy a home, it is important to also plan to set aside some money on a regular basis to cover maintenance and repairs. You might also consider a home warranty. When you are a renter, you just called your landlord when your home needed repairs. But as a homeowner, the responsibility falls entirely on you, so be sure you are financially prepared.
Property taxes vary by location. As a homeowner, you will be responsible for paying your property taxes. However, as a renter, you can expect that your landlord has factored property taxes into your rental payment. The real tax difference between those making rental payments and those paying a mortgage shows up at income tax time. Currently, interest on mortgage values of up to $750,000 are deductible.
While there may be some reasons to rent rather than buy, such as your need to move frequently, home ownership is more often the better financial choice. There are a number of reasons people decide to make the move from renting to home ownership, including stability, pride in ownership, or the ability to make whatever changes in their property they choose. These are all good reasons to buy a home. But even if the financial benefits don’t top your list, it’s important to understand these advantages of home ownership. While you will need to cover some additional costs associated with home ownership, it still offers a pathway to building wealth that renting can’t match.