First-time homebuyers nationwide are deciding whether to rent or own. Below is your roadmap to making an educated decision, and here's a summary of what we learned from our research:
- Buying a home is affordable in the right market with the right loan
- Start by buying small – you can always sell and move
- First homes should cost between 2x - 4x of your annual salary
- Homes have historically gained value over time – some are profitable just 5 years after purchase
- A commission refund of up to 50% on buying agent fees can significantly reduce the upfront costs of buying
You’ve been around the block and seen some things. Shuffling apartments, bouncing around the U.S. and traveling the globe all offer great life experience. But owning a home is a whole new world.
Making moves was—and still is—important, but these days the only right move is what aligns with your goals for the future:
Where do you want to be in 5 years? 10 years? Where is your money going? How can you get a better return for your hard work?
Imagine that golden moment when you get the keys to your own home. Walking through that doorway, the thrill you share with your partner is real. Why? Because it signals a significant shift in the quality of your everyday life.
By comparison, renting feels like hand-holding—like wasting time and money. No one wants to misuse resources, yet the perceived challenges to becoming a first-time homebuyer seem scary. However, it’s totally do-able.
Many avoid taking the step from renting to owning for these exact reasons, simultaneously disregarding financial freedom and security.
Today, we tackle the renter’s dilemma head-on:
Can you save money and achieve a better quality of life by owning a home instead of renting?
To find the answer, we must first understand every relevant factor in the homebuying process. Gathering the facts is the first and foremost important step towards making an informed decision about homeownership, financial responsibility, and real security.
We’ll start by surveying the rent vs. buy prices in a handful of metropolitan cities. Then we’ll discuss all the key considerations in rent or buy decision-making:
- Down payments
- Mortgage rates and details
- Mortgage insurance
- Interest rates
- Closing costs
- Commission rates
- Home equity
- Rent-to-own homes
Rent vs. Buy: What Are The Costs?
To immunize yourself from the cost of rising rents nationwide, first consider the numbers. The national year-over-year growth rate stands at 2.9%, surpassing the 2.6% rate from last year.
Some cities are experiencing a 9% rent growth rate!
Remember: location, location, location. Where you live is a huge factor in whether you rent or buy.
For example, the median home purchase price in San Francisco is $1,200,000 and the median rental price is $3,037. There’s almost no feasible timeline where you’ll be able to own vs. rent and put down a large down payment, that is, unless you're starting a career as a software engineer.
Even in hot markets, buying a home can still make sense. At the end of the day, owning a home outright is its own benefit in the form of tax savings, equity, and fixed mortgage savings over years.
Set yourself up for financial success by finding the right market and the right loan.
Let’s survey a few desirable markets.
Below are median home prices for large national cities, via the National Realtors Association:
San Francisco: $1,204,700
New York City: $685,000 (single bedroom)
Washington DC: $551,400
Los Angeles (Long Beach): $485,000
Yes, homeownership in San Francisco is less realistic than in Chicago, and more space is guaranteed in Los Angeles than in NYC.
When planning ahead, look to live in a place that’s growing steadily, as well as aligns with your lifestyle and career goals for the foreseeable future.
Americans are no stranger to living in cheaper places to realize financial gain. Your first home won’t be your forever home. According to Gallup, 25% of Americans move every five years. Statistics also show that the average American will move 11.4 times in their life.
Now it’s time to see what your money can buy. To do this, we’ll step away from the trendiest places in the country. Let’s look at rent prices around Los Angeles, specifically in Long Beach.
ApartmentList.com shows the median rental prices for a 2 bedroom in the Los Angeles area to be $1,718. We choose a 2 bedroom place because we assume that if you buy, you’ll want at least two bedrooms so you can have a nursery, office, or guest bedroom.
Here’s what a desirable median rental looks like in Long Beach:
This 2 bedroom, 1 bathroom rental apartment in Long Beach is a few blocks off the beach but leaves much to be desired. Just under the median rent of $1,700, you get on-street parking and common area laundry. This is an example of an average, desirable rental in a growing emergent market.
So what can you buy for this same amount?
At $469,000, 765 E Janice Dr comes in just below the median sale price for Long Beach. With 1,200+ square feet, this remodeled family home has 3 bedrooms, 1 bath and offers a front and back lawn.
We’ve seen what money buys in Long Beach. Now let’s figure out how much you can afford to buy.
7 Steps to Calculate How Much Home You Can Afford
To understand if you can afford to buy, start by figuring out what you can pay per month. Financial professionals will tell you a home can safely cost between 2x-4x of your annual salary.
This doesn’t consider your existing net worth, but overinvesting in first-time homeownership isn’t recommended either. You can always buy a bigger house later, but it’s impossible to undo a mortgage loan.
The idea here is to avoid overextending yourself and living “house poor.”
Would you want to live on PB & J while paying off a massive mortgage? Better to save more for your initial down payment or shop in a market that won’t tie up all your assets.
Remember these 7 essential factors when deciding how much home you can afford:
#1: Take-home pay after taxes
#2: All other debt and monthly payments (credit cards, auto, and student loans, etc.)
#3: Foreseeable expenses you’ll incur in coming years (new computer, car repairs, etc.)
#4: Cushion funds for potential emergency (job loss, injury, death in family, etc.)
#5: Future uses for home and space requirements (retirement, children, home office, etc.)
#6: Down payment funds available (and whether you should buy or wait)
#7: Expected mortgage cost via a mortgage calculator
What Is My Down Payment?
A down payment is the amount of money you spend upfront when purchasing a home.
Taxes and fees aside, the total purchase price of a home is the sum of the down payment and the mortgage. The amount of your down payment influences your mortgage interest rate and will determine how much interest you pay (or save) over the span of your home loan.
Above, our NerdWallet mortgage calculator shows that a standard 20% down payment on the Long Beach house comes to $96,000.
A rule of thumb is to buy only if you can afford a 20% down payment. Putting down 20% keeps your interest rate low and saves money on interest paid in the long run. It will also keep monthly payments smaller.
Be aware, however, down payments are expected to vary. Buyer finances differ and some feel comfortable putting more down than others.
Figure out what number is comfortable for your budget. Then you’ll have a better idea of whether or not you're close to buying a home.
What if the Down Payment is Less Than 20%?
If you’re not up to a 20% down payment, you’ll need to pursue another type of loan. You’ll also need to insure that loan. Here’s what that looks like:
An FHA loan is a mortgage that’s insured by the Federal Housing Administration (FHA).
These are popular with first-time homebuyers in California because it allows you to put down as little as 3.5% for a down payment, as long as your credit score is above 580. For those with credit of 500-579, a 10% down payment can be made. Certain counties have an FHA loan limit of $729,750, while the conventional loan amount max is $625,000.
The above image shows us our mortgage cost following a 10% down payment. The principal and interest have increased by $222. As we know, a decrease in the downpayment means higher interest rates.
Though riskier, there is an argument for FHA loans. In areas like SF or NYC, homes are so expensive that no one can reasonably expect to put down 20%. Since you don’t want to be house poor, 20% is too much net worth to give up.
In these markets, it makes more sense to put less down and invest the difference at a 6% return over the long haul.
Private Renters Insurance (PMI)
If you’re putting down less than 20%, mortgage lenders require that you buy private mortgage insurance. Lenders do this because it reduces the risk of giving out higher loans. Borrowers who put down less money up front will pay higher monthly PMI rates.
Seen above, private mortgage insurance on a 10% down payment raises the monthly payment in Long Beach by $175.
Once your home equity rises above 20%, you may be eligible to stop paying for PMI. Ask your lender.
What is home equity?
Home equity is the value of your home at current market value, minus the remaining mortgage payments. Properties gain value over time – called appreciation – which also adds to home equity. The less you owe and the better the housing market, the higher the value of your home equity.
To stop paying PMI, you’ll need to provide proof that your home equity exceeds 20%. This requires an appraisal. Sadly, you won’t get to choose the appraiser or the price, but you can expect to pay between $300-$500.
6 Factors to Remember When Calculating Your Mortgage
Once you’ve figured out what you can spend per month, now ask what amount you can get for that monthly payment.
A mortgage is a home loan and the gradual repayment of the principal and interest monthly is called amortization.
Monthly mortgage payments are influenced by 6 primary factors:
#1 Credit score
#2 Credit history
#3 Annual income
#4 Total debt
#5 Down payment
#6 Interest rates
Depending upon your timeline, these variables can be optimized to give you the best mortgage rate.
Most buyers pay off loans and save more for a down payment because lenders give the best rates to those who have low debt and can bring at least 10-20% to the table for a down payment.
Many potential buyers wait until their credit improves because lenders will hand out the best rates to those with high credit scores.
"The higher your score, the better the interest rate on your mortgage will be. Good credit can mean significantly lower monthly payments, so if your score is not great, consider delaying this big purchase until you've built up your credit."
– Ramit Sethi, author of "I Will Teach You To Be Rich”
Because interest rates are constantly fluctuating, it’s smart to lock in a low interest rate and save money. A lower interest rate means you save on your mortgage by decreasing the cost of the loan and reducing the total cost of interest over time.
What’s a fixed-rate mortgage?
Fixed-rate mortgages come in either 15- or 30-year allotments.
Unlike adjustable-rate mortgages, fixed-rate mortgages keep your interest rate and monthly payment the same throughout the terms of the contract. This safeguards you against rent increases while moving you towards home ownership.
Our fixed 30-year monthly mortgage in Long Beach comes to $2,314. This includes all property taxes, homeowners insurance, plus principal and interest over time. (Keep in mind, our purchase assumes a 20% down payment and a standard interest rate.)
What About Qualifying for a Loan?
To qualify for this mortgage amount, lenders require you to have a debt-to-income ratio of 28/36.
This means no more than 28% of your total monthly income from all sources pre-taxes can go towards housing, and no more than 36% of your monthly income can go towards total monthly debt of any kind—mortgage included.
For this reason, it’s smart to pay down debts before applying for a mortgage. Lenders use this ratio to see what you can afford, but this number doesn’t account for expenses and other costs.
How Long Should First Time Homeowners Stay in Their House?
"Home ownership, like stock investing, works best as a long-term proposition. It takes at least five years to have a reasonable chance of breaking even on a housing purchase. For the first few years, your mortgage payments mostly pay off the interest and not the principal." – Harold Pollack and Helaine Olen, authors of The Index Card
The affordability calculator shows owning our Long Beach home will be profitable after 4 years and 8 months. We’ve set rent at the Long Beach median, a down payment at 20%, and taken a 30-year fixed-rate mortgage.
The total cost of homeownership after five years is $290,172. By comparison, renting costs total $127,177. This suggests that you should rent because it puts an extra $162,995 in your pocket.
When calculating whether it’s better to rent or own, assume you’ll invest the difference (though many will not). Our rate of return is set at the market average of 6% for general investments.
At this rate, renting allows you to earn another $37,895 in five years. Adding the rent of $162,995 with investments of $37,895, there’s now a $200,890 difference between renting and buying.
But here’s where buying gets good.
Your home accrues value in the form of equity. After five years, the pad in Long Beach will have accrued $254,164 in equity. If you sell, you earn that money back (and perhaps more depending on the market).
Many people use equity to play the housing market, investing in and “flipping” houses. If you plan to stay in Long Beach for 5 or more years, the data suggests buying as the smarter financial decision.
Nationwide economic data confirms our example in Long Beach. According to SeekingAlpha and the S&P 500, 37% of homes in the U.S. were purchased for investment purposes last year.
Following the housing downturn of 2008, investor and consumer confidence has returned, and wages have increased. This is fueling the housing market back up. This housing index chart of the S&P 500 depicts the continuing trend.
4 Fees To Watch For as a First Time Homebuyer
"The longer you stay in your house, the more you save. If you sell through a traditional realtor, you pay that person a huge fee — usually 6% of the selling price. Divide that by just a few years, and it hits you a lot harder than if you had held the house for ten or twenty years."
– Ramit Sethi, author of “I Will Teach You To Be Rich”
Real estate transactions levy some of the highest fees on consumers in the world—5-6% of the purchase price. Both the buyer and seller are required to have licensed real estate agents to represent them and the commission is split between buyer’s and seller’s agents. This commission is built into the price of the home, and results as the highest fee you’ll pay when buying a home.
However, the commission refund on the Long Beach home comes to $5,863.
Unique to leading real estate brokers, this is a 50% savings on the standard 3% buyer’s agent commission fee.
Effectively, commission refunds allow you to pocket thousands of dollars instead of handing it over to real estate agents on either side. Apply this refund directly to closing cost fees to save cash.
Watch for these 4 fees, none of which are avoidable.
#1 Mortgage Application Fee
Lenders charge you to apply for a mortgage. This costs a few hundred dollars.
#2 Home Inspection Fee:
An inspection (not to be confused with the home appraisal) establishes the value of a property. This protects buyers from existing issues with the home and gives the owner time to correct any issues in time for the sale. This costs several hundred dollars.
#3 Closing Costs
Closing costs are fees associated with your home purchase and paid at the close of your transaction. These may include deeds, land transfers, legal fees, and titles. At this point, the title of property is transferred to you, the buyer. Closing costs can be negotiated to be paid by either the buyer or seller.
#4 Variable Fees
Expect a range of attorney fees, escrow fees, courier fees, credit report fees, Homeowner's Association Transfer fees, transfer taxes, and others depending upon your specific home, mortgage, and financial situation. Ask a complimentary real estate professional to get a sense of what your costs might be.
What About Rent to Own Homes?
Rent-to-own agreements can be ideal for potential buyers who want to buy a home but haven’t saved enough or lack the credit for a down payment.
A rent-to-own arrangement allows the potential buyer to rent for a set amount of time (usually a few years) before exercising the option to purchase when the lease expires. The would-be buyer moves into the house immediately, using the years on the rental lease to boost their credit score or save for a down payment.
Rent-to-own contracts start by offering option money; a one-time, often non-refundable fee that establishes future intent to purchase. This is a negotiable amount but usually ranges from 2.5-7% of the total purchase price. In some cases, this fee will be applied to the final purchase price.
Rent is often negotiated to be higher on these contracts in an attempt to comfort the potential seller for taking their home off the market. Lease-option contracts are also popular, which give the potential buyer the right—but not the obligation—to buy the home at the time the contract expires.
It’s essential to involve a real estate lawyer in rent-to-own contracts. This will ensure everything comes out beneficial for both parties, resulting in a fair and smooth transaction.
Begin Your Journey Now
First-time homebuyers nationwide are deciding whether to rent or own by weighing the factors we’ve discussed today.
You now understand that home buying is affordable in the right market with the right loan. As rents continue to climb, buying smartly and increasing home equity quickly is the best move.
Start by calculating your home affordability budget based upon income, savings and expenses. Remember that down payments can be between 3.5-20%, but you’ll need insurance for the lower rates. Make sure your debt/income ratio is solid before applying for a loan. Also, remember that you’ll want a good credit rating and interest rate to lock in the best mortgage rate.
Watch for those unavoidable fees in the home buying process. Be sure to save on closing costs by securing your commission refund of up to 50%.
Our example 3 bedroom house in Long Beach shows that home equity beats the opportunity costs of renting after just five years – so homeownership a viable option.
Create an account today and start researching your ideal market. Where to live is a choice everyone makes. How to live is a choice a select few accept. Live your own homeowner success story.