To rent or to buy? That is the question

Is buying a home a bad investment or renting a home a waste of money? Learn more about the dynamics between renting and home buying to make a financially sound decision.

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Is buying a home a bad investment? Is renting a home a waste of money?

The deeper questions are: Why exactly are you considering buying over renting? And when is the right time for you, taking into consideration all of your financial goals?

In today's housing market, home prices in many areas have been rising due to growing demand fueled by an improving economy and an extended low interest rate environment. Prospective homebuyers are being confronted by a dilemma: to rent or to buy. Many homeowners find themselves "house-poor" after purchasing expensive homes using large sums of savings and borrowed money—something they might reconsider if they had a better sense of the dynamics at hand.

The key to smart decision-making when it comes to housing is to decouple "investment" from "consumption." While some personal finance experts might suggest that rent is money thrown down the drain since it could have gone toward a down payment on a home, the reality is that paying rent for a period of time can often be a smart economic decision—especially if we continue to see the risks of deflation. When renting, you're buying flexibility (to invest, save or consume elsewhere) and you're paying for a place to live, which provides you high consumption value by satisfying a practical need.

A prospective homebuyer needs to remember that buying a home is not only an investment but a highly concentrated, illiquid, leveraged investment.

When you buy a home you are also linking yourself to the economy of the area in which you buy. For example, if you're buying a home in Cincinnati you're really investing, in part, in the future prospects of Procter & Gamble and other major employers in the area. Now, if you are buying the home in a stable or appreciating neighborhood this investment will still make plenty of sense, plus you're deriving high consumption value from living in the home.

You need to remember, though, that if you buy a home at the top of your price range with a big down payment and mortgage, you significantly lose investment flexibility by tying up all of your potential investment capital in home ownership costs. While ultimately you might turn a profit when you sell the home, the potential lost income from diversified investments over time is something critically important to consider.

Bottom line: Buying a home is a huge accomplishment, and Americans derive a great deal of satisfaction from owning their homes. A home is typically the biggest single purchase most people are likely to make in their lifetimes—and it's also potentially the riskiest. Many prospective buyers are giddy during their home search and can quickly let emotions overrun fiscal sensibility.

My advice to homebuyers is to set a budget in the middle or lower end of what you can afford and stick to it. Explore areas a little further out than the city center and look at up-and-coming neighborhoods to find greater value or consider distressed homes that you can fix up over time. By saving cash on your home purchase, you'll ensure that you have the liquidity and flexibility to invest your remaining capital strategically. The water can be great in the housing pool, but there are no lifeguards on duty, so get informed and educated before jumping in.

Topics:
  • Home Buying
  • Making a Big Purchase
  • Home Buying
  • Making a Big Purchase
  • Home Buying
  • Making a Big Purchase
  • Home Buying
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This article was written by Steve Udelson from Forbes and was licensed as an article reprint from June 29, 2016. Article copyright 2016 by Forbes.
The statements and opinions expressed in this article are those of the author. Fidelity Investments cannot guarantee the accuracy or completeness of any statements or data.
This reprint is supplied by Fidelity Brokerage Services LLC, Member NYSE, SIPC.
The third-party provider of the reprint permission and Fidelity Investments are independent entities and not legally affiliated.
The images, graphs, tools, and videos are for illustrative purposes only.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917.
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