Buying or renting a property is often the largest expense for most people and one of the most important financial decisions they’ll make. This is a dilemma I am currently running into in my own personal life, hopefully through my research I can also help you come to a better decision.
How Much to Spend
A general rule of thumb is to not spend more than 28% of your pre-tax monthly gross income on living expenses and no more than 36% on total debt. Total debt would include things like your car loan, student loans, etc. If you are married, you would consider your combined monthly income for this formula. If you have roommates, you would only factor in your cost and not the total cost for your rent.
For example, if you have $5,000 in monthly income you would multiply that by 36%. In this scenario you would have a budget of $1,400 on living expenses and $400 for other types of loan repayments. If you don’t have any debt and don’t plan on adding any, you would have $1,800 to budget for living expenses. Remember living expenses includes mortgage payment, property taxes, utilities, homeowner’s insurance, and other miscellaneous maintenance.
Estimated mortgage payments based on price:
$150K: Down payment $30,000 and $703 monthly
$200K: Down Payment $40,000 and $916 monthly
$300K: Down Payment $60,000 and $1,341 monthly
$400K: Down Payment $80,000 and $1,765 monthly
*Assuming 20% down and a mortgage rate of 3.5%. Check here to estimate your costs.
Putting 20% down isn’t always required but the benefits are: no PMI fees, payments will be lower, and you’ll likely earn a better interest rate. PMI is Private Mortgage Insurance and it protects the lender it you stop making payments on your loan. If you pay PMI, you’re essentially paying insurance on yourself for the lender and it doesn’t benefit you in any way.
The 28/36 rule is a standard that many lenders use before advancing any credit. It’s better to use this rule before applying for a loan so you don’t have to run your credit score multiple times. When you apply for a loan and they run your credit, it a counts as a hard inquiry and having multiple in a short period of time can actually hurt your credit score.
Rent or Buy
The main reason for renting is the flexibility and knowing exactly how much you will spend during the length of your lease. It’s good for young people who are still unsure about their living situation and are not ready to make a commitment. This calculator is a great way to see the costs and how long you would need to live there for it to make sense to buy.
The main questions you need to ask yourself before making this decision are:
- How long do you plan on living in the area?
- How important flexibility is to you?
- Are you prepared financially to own?
However, a benefit of owning is the possibility of turning it into a rental. By doing this, though, you take on the risk and headache of being a landlord. It most definitely can be done, but it may not be as easy as many think. Before doing this, make sure you have enough income or money saved up to cover periods without a tenant. I recommend reaching out to someone who has experience renting and ask for their opinion.
If you think you are ready to buy, a great site to start your search Zillow. They are great for finding homes, apartments, condos, or townhouses that are available in your area. It’s good to shop around and make sure you’re not overpaying whether you decide to rent or buy.
Property Costs
With any property you will have expenses outside of your rent or mortgage payment. Generally, when you buy a property you will have more expenses than if you rented.
One of the fees from buying a property would be closing costs. On average it will run between 2% and 5% of the loan amount. If you have a $300,000 loan, you can expect to pay from $6,000 to $15,000 in closing costs.
Another large expense is property taxes. In Cook County, the average rate for property taxes is 2.10%. So if your home is worth $500,000 you will likely be paying around $10,000 in property taxes. If you were to rent, that cost would be included in your monthly payment.
Maintenance and utilities are another large expense for property owners. This can include things like a new roof, landscaping, gas/electric bill, and more. For example, one of the largest one-time expenses could be a new roof. According to HomeAdvisor, the average cost for a new roof in Chicago is $8,975. It varies depend on the size or your house and what material you choose to use. It can be anywhere from $2,000 on the low end and $307,000 on the high end. I don’t know about you, but spending $10,000 on a roof doesn’t sound fun.
A general rule of thumb is to expect to pay 1% of your home value per year in maintenance costs. Utilities will depend on where you live and how much you use. Property taxes and closing fees can be calculated upfront. Below are some of the other expenses you may have and a rough estimate on what to expect.
Example of buying vs renting:
Renting
$2,000 Monthly
($24,000) 1 year cost
$200K House/Townhome/ Condo (% of total price)
$1,679 monthly
($27,000) 1 year cost
Monthly
$696 Mortgage
$333 Property taxes (2%)
$167 Maintenance expense (1%)
$83 Homeowner’s insurance (0.5%)
$400 HOA fees*
Other
$10,000 closing costs (5%)
$40,000 down (20%)
+$3,200 in equity after 1 year of payments
*HOA fees vary based on property size, value, and amenities provided. Not all properties have HOA fees.
These costs are not intended to give you an exact figure, prices will vary. Use this as a general estimate to help give you an idea of the cost of ownership. You may also have some tax savings for deducting interest expense if you itemize your taxes. The main benefit of purchasing a property would be to build equity. By doing this, you will have property that you can potentially sell or rent. If you plan to own a property long term it makes more sense to buy it.
Useful calculators:
Mortgage payments Here
How much house you can afford Here
Rent vs Own Here
Sources / Disclaimers:
Average roof costs from HomeAdvisor Here
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