Mellody Hobson is the president of Ariel Investments, a Chicago based money management firm as well as the featured consumer finance expert on Tom Joyner’s “Money Mondays,” among other roles. In today’s “Money Mondays” segment, Hobson discusses renting versus purchasing a home. What should you consider when trying to decide which way to go? Take a look…
TOM JOYNER: You are here this morning to help our listeners think about renting or owning?
MELLODY HOBSON: I am, Tom! Since the housing collapse, there has been a lot of volatility in the housing markets, and a lot of discussion about whether it is smarter to rent or own your house. Along with that, new measures have been put in place to help prevent another bubble from emerging and bursting, and they will certainly impact our listeners who are thinking about buying!
TJ: Sounds good! First walk us through the process of deciding which is smarter – renting or owning. How do we know?
MH: There are a lot of factors that go into this, but it is really important to keep 3 key things in mind.
Right now the first thing you need to do when considering whether you should be renting or buying in this new environment is to remember that we really are in a new environment! Before the crash, in the housing boom of the 1990s and 2000s, we all considered buy a home a good investment – a good place to store money that would provide us with big returns over the years. That just isn’t the case now, and in fact it never really was! A number of studies have shown that your return on investment when buying a house is almost always lower than the return you would get in the S&P 500, and most of the time it is significantly lower. So if you are thinking of buying as an investment rather than renting, you might want to reconsider.
Secondly, consider your lifestyle and your future. This is a big factor in the renting versus owning decision-making process. If you foresee some big changes on the horizon – marriage, children, a new job – consider whether now is the right time to buy a house. After all, a house is not just a financial commitment – it’s also geographic commitment. If you are ready to settle down, have a stable job and want to put down roots, that’s great – a house might be the right decision! But if you need flexibility or mobility, it might not be.
Finally, and most importantly, you have to run the numbers to decide whether your budget can best match your needs and wants by renting or by owning. Two of the most overlooked aspects in the debate of renting versus owning are location and amenities. To really compare the two and know which one is better for you, you have to consider ALL of the costs included in each option.
In general, a great rule of thumb is to figure out your Price-to-Rent ratio: take the total purchase price for the house you are looking at or have budgeted for, and divide it by the total annual cost to rent a home or apartment in that same neighborhood. If the sum is under 15, you can start looking at houses. If it is over 15, you might be better off to stick to renting right now.
TJ: Now when you say run the numbers, what numbers specifically? What should we be adding up here?
MH: Great question, Tom. Here is the thing – comparing rent payments to mortgage payments is not the whole ball of wax. When I say all of the costs, I am taking a soup to nuts approach. Let me run through this for you. Beyond the monthly rent or mortgage, you need to consider maintenance, insurance, and taxes. Next, calculate the future costs of owning and renting, taking into account price and rent appreciation, as well as inflation. This will give you a better sense of your financial picture in the longer term. You also need to factor in one-time costs and proceeds, like closing costs, down payment, sales proceeds, and security deposits. And if you want to be really thorough, you should consider the opportunity costs associated with the money you have saved up for a down payment. If you had invested that, perhaps you would have seen returns!
Now that you have the actually housing costs covered, think about the other expenses for each option. If you are renting a place close to your work, will you be able to buy a place close to work? If not, there will be greater transportation costs, either for parking and gas, or your monthly train pass. My point here is that you have to think about the bigger picture financially, not just about the monthly statements.
TJ: When you said all costs, you meant it! Are there any other things to think about?
MH: Yeah, I meant everything! It’s important to really be honest with yourself when crunching these numbers, because 30 years – the normal length of a mortgage – is a very long time. If you aren’t honest with yourself, you can really saddle yourself with a house you cannot afford.
I would also consider whether you are ready for the stress that comes along with buying a house. Beyond financial considerations, the amount of stress that is involved in homeownership can be large. The Holmes and Rahe Stress Scale, a landmark stress study conducted in 1970, ranks many events that go along with buying a home in the top 43 most stressful circumstances in life.
Finally, as I mentioned at the beginning, there are some new measures that are expected to make it more difficult to develop another housing bubble. The Consumer Financial Protection Bureau issued new rules for mortgages earlier this year that prohibit interest-only and negatively amortizing loans and limits the amount of points — fees or prepaid interest on a mortgage — to 3% of a loan’s value.
Lenders will also be required to verify that borrowers have the ability to repay their loan. The ability-to-repay rule says lenders must assess and document a potential homebuyer’s income and assets, employment status, credit score and other outstanding debt levels before issuing a loan. To be considered a qualified mortgage, the loan amount cannot exceed a total debt-to-income ratio of 43%. These measures are meant to protect consumers, but they will also mean that it is more difficult to get a home loan.
It may sound like I am being hard on homeownership, but I am not! Whether you are renting or owning, there are great aspects to both! I just want to make sure our listeners are prepared to make a fully informed decision either way!
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MONEY MONDAYS: Renting Vs. Owning A Home, Which Way Should You Go? was originally published on blackamericaweb.com