As rent prices soar nationwide, a study by First American Financial Corporation examines how the benefits of homeownership compare to renting in the nation’s top 50 markets.
According to Odeta Kushi, Deputy Chief Economist for First American, growth in rent prices slowed in 2020 but rebounded in the first two quarters of 2021. The average U.S. rental price increased by 4% this year, the fastest pace since 2014. On the other hand, annual home appreciation rate increased to 17.5% due to the demand for homes outpacing the supply.
Breaking Down the Costs
When calculating monthly costs, renters usually pay one bill a month while homeowners pay multiple pieces: the monthly mortgage payment and interest, insurance, taxes, utilities, and upkeep.
"Consider a hypothetical first-time homebuyer taking out the average 30-year, fixed-rate mortgage in the second quarter of 2021, with a 5% down payment on a home at the 25th percentile sale price. We’re using the 25th percentile because first-time homebuyers are much more likely to buy a less expensive home," according to Kushi. "After accounting for the total monthly homeownership cost and comparing it with the median rent by market, renting was a better financial choice in 35 out of the top 50 markets in the second quarter of 2021. Some of the markets where it was better to rent included Boston, Chicago, and Dallas. It was better to own in markets such as Atlanta, St. Louis, and Miami. This calculation, however, leaves out the main benefit of owning over renting—the accumulation of equity."
The analysis found that it is cheaper to own a home in the top 50 markets nationwide, including the top two markets, San Francisco, and San Jose.
However, the monthly homeownership cost was found to be negative in every market. This is possible due to the appreciation of the property, which can be large enough to offset other homeownership costs.
"Consider a potential first-time homebuyer in Dallas, where home prices sat near the median of the top 50 markets. If the homebuyer put a 5% down payment on a $243,000 home (the 25th percentile home price in the second quarter) with a mortgage rate of 3%, the homebuyer would have paid roughly $974 monthly in principal and interest, plus an estimated $749 in taxes, repairs, private mortgage insurance, and homeowner’s insurance costs," Kushi wrote. "That brings the homebuyer’s total monthly cost of ownership to $1,720. The average house price in Dallas increased 17.5% year-over-year in the second quarter of 2021, which is in line with the national pace and equates to an equity benefit of approximately $3,550 each month if the pace remains the same. The resulting total monthly cost is -$1,820, or a net gain. Compared with the median monthly cost of rent in Dallas, $1,310, it made much more financial sense to buy rather than to rent in the second quarter."
"In other words, the home pays you to live in it."
Will the rent versus own dynamic change? Kushi says that mortgage rates are expected to rise in the future, which means higher payments for the same loan amount. However, house prices will continue to appreciate and remain elevated for the foreseeable future.
Nonetheless, First American's analysis demonstrates that the wealth-building effect of home equity is a powerful factor in the homeownership decision. When a home pays you, it makes more sense to buy than to rent.
Affordability was already a challenge before the 2020, but says the pandemic has worsened the challenge for lower- and middle-income families, whether they are looking to rent or buy.
According to Kamaron McNair, a researcher for LendingTree, while a renter may only need three months of rent in order to move into a new space, homeowners have a higher barrier for entry—typically a 20% down payment—which 54% of consumers say is the primary barrier for them to enter the market. For those making less than $35,000 a year, that number jumps to 68%.