Whether to own or rent a home in retirement
A few weeks ago, someone e-mailed me a great question; whether to own or rent a home in retirement.
I think this is a question that many people in retirement come across. Whether someone is currently renting and considering buying, or currently owns a home and will be selling and then considering whether to buy again or rent, this question is rather common.
Like most things in personal finance, there isn’t a universally right or best answer. The answer is, “it depends!”
I figured the best way to walk through my thought process on this is to copy and paste the person’s questions and go one-by-one through them to share my views. Here we go:
“I have a few questions I've been asking myself, which are all really rolled into just one. Should I continue to rent (vs buy) and what considerations--financial, tax, and legacy--should I be considering when deciding? I'm not looking for a specific answer for my situation, but appreciate the manner in which you thoughtfully walk through various considerations on topics.
I'm single with two kids (19/16). I have been renting (in a managed mid-size apartment complex) since my divorce (over ten years) and enjoy the maintenance and landscaping being handled, amenities, having no property taxes, and some of the other benefits of renting.
I plan to move in four years (which will be about five years before I retire). I have been thinking about whether to buy or continuing to rent (also in a large to mid-sized apartment complex). I doubt my children will ever want to live in a home I purchase, so they would be left to sell any home I own upon my death. Sounds like a probate headache for them.
Putting "feelings" of either choice aside, below are some questions I have been thinking about as I work through my decision. Just wondering if these are the right questions and what other questions I should think about?
General:
* What are the potential financial benefits and drawbacks of continuing to rent versus buying a home in retirement?
* How might my decision to rent or buy impact my overall financial plan and retirement goals?
* Are there any tax implications to consider with either option?
* As a single person, is renting vs owning better in the event I require a long term care facility? Why?
* What is the best way for me to think this through as I conduct a comparative analysis of each option?
* What are the potential risks and uncertainties associated with each option, and how can they be mitigated?
Children and Inheritance:
* How would my choice to rent or buy impact any financial legacy left to my children?
* If I choose to buy, what are the potential costs and complexities for my children associated with selling the home after my death?”
This is a lot to unpack here, so I’ll step through one thing at a time:
What are the potential financial benefits and drawbacks of continuing to rent versus buying a home in retirement?
I think the analysis of buy-vs-rent should start with plotting out the expected cash flows of each.
If you are to buy a house, you’ll have to either 1) pay for it in full in cash or 2) get a mortgage but still use some of your cash for a down payment. Either way, you will be tying up at least some of your financial assets as equity in the home. How much cash or other financial assets (that can be sold and converted to cash) do you have and can afford to part with to buy the house?
If, for example, you’d have to use up most or all of your financial assets on buying the house or making the down payment, you probably shouldn’t consider buying. If you did, you may not have enough cash for an emergency fund to cover life’s unexpected surprises.
But let’s assume you wouldn’t be concerningly depleting your cash by buying the house. Which means buying a place isn’t immediately of the table.
Next, I think you’d have to compare the annual cash flows needed to live in each place.
If you buy a house outright, without a mortgage, you’re going to have to pay property taxes and maintenance; two things you almost certainly wouldn’t have to pay if you were renting somewhere. And the maintenance expense could be a big one as a homeowner. You are likely to eventually need to pay to fix or replace the roof, water heater, A/C, heater, windows, faucets, floors, etc. With a rental, all of those things are normally the responsibility of the landlord.
You’ll have to pay for homeowner’s insurance if you own, and you’ll only have to pay for renter’s insurance - which will be cheaper than homeowner’s insurance - if you rent.
If you buy a place in a development with a monthly homeowner’s association fee, you’ll have to pay that too.
You’ll have to pay for utilities (electric, gas, water, Internet, garbage, etc.) if you own. Depending on where you rent and what the terms of the lease are, some of these things might be included in your rent, and some or all may be on you to pay for.
Without knowing the specifics of each property you’re considering to buy or rent, it's hard to say which scenario would lead to the lower monthly cashflow. I’m going to venture to say that having a fully paid for house would typically result in lower monthly and annual cash flow requirements than renting a comparable place. BUT, in the scenario of having a fully paid for house, you also will have had to part with a lot of cash to tie it up as equity in the house, whereas you would have kept that cash if you were renting.
Just to throw some quick numbers to this, assume you pay $400k out of pocket to buy a new house with no mortgage. And it will cost you $1k per month just in property taxes and insurance. And then you’ll have to pay utilities and ongoing maintenance as well. Whereas if you rented, assume the monthly rent is $3k, plus you’ll have to pay for renter’s insurance and utilities. It’s clear renting is a larger monthly cash flow. BUT, you also have $400k more in the bank or investable accounts than you would if you bought a place; while renting may use up more of your cash month-to-month, you’d have a larger pot of cash to use than you would if you bought a place.
If, on the other hand, you get a mortgage to pay for some or most of your home purchase, then you obviously have to factor in the monthly cash flow requirements of paying principal and interest on your loan every month. Depending on the size of your loan, the length of your loan and the interest rate of your loan, the monthly payments could be quite substantial. It’s possible that buying a home would then result in a larger monthly cash flow requirement than renting a comparable place. And considering how historically expensive house prices are currently, and how relatively high mortgage rates are, buying and financing a home now definitely isn’t “cheap” by any means.
Maybe now, with the mortgage payments included, it costs you $4k per month (instead of just $1k per month for property taxes and insurance), plus utilities and maintenance. That’s more than the $3k per month it would cost to rent a comparable place. Now the analysis and results looks a bit different.
The other wrinkle to keep in mind is that with a typical amortizing loan (as opposed to an interest-only loan), part of every monthly payment goes toward paying down the loan balance. Those principal repayments are, in effect, you paying yourself back by increasing your equity in the property. However, similar to buying a house outright, having equity in the property means it’s money you have tied up and can’t otherwise use. Unless, or course, you were to borrow against it to unlock usage of the equity that way (which would basically put you back into the same spot of having a larger loan in the first place).
And yet another wrinkle that makes all of this cash flow projecting hard to do is you don’t know the inflationary impacts that will apply to both options. When you have a traditional fixed rate mortgage, your payments are fixed for the life of the loan. But your property taxes and homeowner’s insurance will almost certainly increase over time (unless you live in a state or town that has some sort of age-related freeze on property taxes, often called a “senior freeze”).
When renting, it’s almost certain that your rent will go up over time due to inflation and the landlord’s costs of owning the property going up; expect those increases to get passed on to you in the form of higher rent.
How might my decision to rent or buy impact my overall financial plan and retirement goals?
This is a hard one to answer succinctly as there are so many ways in which this will play into your overall financial picture. But I think a lot of the potential longer-term financial and retirement planning impacts are indirectly addressed in the discussion above; comparing expected future cash flow requirements of each option.
Without knowing how much inflation will increase taxes, insurance or rent payments over time, it’s impossible to know which one will ultimately cost you more.
And then the upkeep and maintenance costs of owning a home are a big wild card. If you have a major required improvement or maintenance costs like replacing the roof a few times while you’re there, repairing a damaged foundation, repairing structural termite damage, etc., owning a home could ultimately be more costly than renting. But there is no way to know for sure without the benefit of hindsight.
Also, you have to somehow account for the opportunity cost of using up cash to fully pay for, or at least make a down payment on, buying a place. Any money you put into a house as equity is money that you don’t have available to invest or potentially earn interest or returns on.
But then if you buy a place, you have the potential for the property to increase in value over time, thus leading to more equity to potentially unlock from selling or borrowing against later in life.
All of the above things will inevitably impact your overall financial picture, which means they will impact your overall retirement picture. But it’s impossible to predict by how much.
Are there any tax implications to consider with either option?
Yes, there are different tax implications to owning vs renting. However, I feel it’s generally not enough of an impact to use tax implications as a determining factor in making the buy-vs-rent decision.
When you own a home, the property taxes you pay are potentially deductible on your federal income tax return. And, in many states, property taxes paid may also have some state income tax benefits.
If you have a mortgage on your home, the interest you pay on that loan is potentially deductible on your federal tax return, and maybe on certain state’s returns, too.
When you rent, there is no direct federal tax benefit. However, some states (such as NJ) have deductions at the state level that can be taken for rent expenses paid.
As a single person, is renting vs owning better in the event I require a long term care facility? Why?
Maybe, maybe not. I feel like I can make a case for both sides here.
If you rent, you in theory have more cash or other financial assets available because you didn’t plop down a bunch of money on buying a house. So, if/when the time comes where you need to enter a long-term care facility, you potentially have more financial assets available to help pay for the care. And that may mean getting you into a better facility than you otherwise would have been able to get into if you had less financial assets available (because my understanding is many facilities base admissions on the person’s ability to pay).
However, depending how much equity you have in your home, you could use that equity to help pay for long-term care costs through something like a reverse mortgage. But I frankly don’t know if long-term care facilities give as much credit to home equity as they do actual financial assets when deciding whether they’ll accept you into the facility.
Also, as a renter, there will be much less process and headache for your kids in the sense that if/when you enter a facility, you simply stop renting, give back the keys the landlord and walk away from the rental.
If you instead own a home and have to enter a long-term care facility, your kids (or other family or friends) will need to get involved to help sell the property and maintain it prior to it selling. Or, if there is an expectation that you’ll potentially be able to leave the facility and return back home, someone will need to help maintain your home while you’re gone, you’ll have to continue to pay its taxes, insurance and utility costs while in the facility, etc.
On the other hand, maybe owning a home is actually the better financial scenario when the time comes for long-term care. Like I mentioned above with the reverse mortgage scenario, having home equity to tap into to help pay for long-term care could be a great way to utilize otherwise idle home equity. And maybe by having owned a home vs rented, you will have more home equity available from owning than you would have cash or other financial assets available from renting.
This is all a long way of saying I don’t think there is an obvious better option here, as it relates to long-term care.
What is the best way for me to think this through as I conduct a comparative analysis of each option?
Like I mentioned in the first point above, I think the analysis should start with mapping out as detailed of a cash flow comparison as you can.
If you find a place you’d like to rent, figure out what the monthly rent would be. And also get quotes for renter’s insurance. And try to get good estimates for what utilities will cost, such as by asking neighbors what they typically pay for utilities. Add up all of these things, and that’s the total monthly cash flow cost of renting. Plus add in some sort of inflation increase to all of those things; figure roughly 2.5% to 3.0% (which is a decent guestimate based on historical long-term inflation trends).
As for buying a place, the cash flow analysis is a bit harder, because you have multiple choices for how you finance it, if at all. At one extreme, if you choose to pay outright for the place with no mortgage, then you don’t have to worry about figuring out the expected loan payments. But you’ll have to keep in mind the amount of cash you’ll have to fork over and tie up to buy the place. What’s the opportunity cost of no longer having that cash available to earn interest, invest, etc.?
The other monthly ongoing costs of ownership are relatively straightforward; you should easily be able to find out what property taxes are for the place. And if it’s in a development that has an HOA fee, you can find out what that fee is. As for property insurance, you can get a few quotes to use for estimates.
However, the big unknown cash flows of owning are the repair and maintenance costs. It’s impossible to know how much, and when, you’ll have to lay out money to fix things. But, all else equal, the bigger and older the property, the more you can expect things will need to be fixed or replaced.
Up until now, I’ve only talked about the financial aspects of owning vs renting. When doing a comparative analysis of each, you have to also weigh the non-financial aspects, which can greatly influence the decision making.
For example, with renting, you generally have more flexibility to move, downsize, etc. Perhaps you’re in the early stages of retirement and aren’t yet sure where exactly you want to settle down. Perhaps your kids aren’t yet geographically anchored or settled down themselves, so you don’t want to permanently settle yourself near them yet. Perhaps you want to travel and spend months at a time in different areas of the country to see what you like best. Perhaps you want or need a larger residence now than you will in a few years, etc. Renting could be a better choice for you in these scenarios, as it’s generally much easier and cheaper to change rentals than it is to repeatedly buy and sell properties.
Also, with renting, you generally have less headaches in terms of having to fix and the maintain the place. Not only do you not have to pay for repairs, but you don’t have to do it yourself or find someone to do it. Simply call the landlord and let them take care of it!
On the other hand, the flexibility of renting could actually be a liability, as it’s not guaranteed that the landlord will always be willing or able to rent to you. This is typically less of a concern if you rent in a large multi-unit dwelling, where it’s obvious the place will likely continue to be used as rentals. But if you rent a single family home or condo from someone who personally owns it, it’s possible they decide to sell it and the new buyer will want to live in it. Which would mean you’ll need to leave in relatively short order. Whereas if you own a home, it’s yours and always will be (so long as you keep up on paying taxes, insurance, mortgage, etc. and don’t get foreclosed on!)
Also, when you own a home, you have more ability to “make it your own.” You can paint it whatever colors you want, you can make whatever improvements you want, etc. (so long as local building codes or homeowner association bylaws allow it). When you rent, there will be restrictions around your ability to alter the place.
What are the potential risks and uncertainties associated with each option, and how can they be mitigated?
I think I already hit on the main risks and uncertainties of both. Some of the risks can be at least partially hedged or mitigated, others cannot.
For example, there is the risk of the landlord deciding to no longer rent to you after your lease is up. To help mitigate this, you can perhaps enter a multi-year lease to lock things in for longer. And that may even save you some money in the form of locking in the current rent amount for longer.
However, even this isn’t ironclad. Again going back to the scenario of the landlord selling the place, that will almost certainly be a condition in the lease that would be an allowable exception for the landlord to terminate the lease early.
Some of the potential costs of fixing and maintaining a home can be partially mitigated, but not in a bulletproof way. For example, you can buy some sort of home warranty and/or utility repair service contract that may cover a lot of the normal maintenance costs that may occur. But how do you know you’ll ultimately not pay more in warranty or service contract costs than what you would have paid had you just paid to fix things on your own if/when necessary?
How would my choice to rent or buy impact any financial legacy left to my children?
It’s tough to say. If you find a rental with reasonably low costs to rent and the payment increases over time don’t get too carried away, it’s possible that you ultimately end up with more legacy left for your kids than if you buy a house. Especially if the money you keep in your financial accounts from NOT having to buy a house are invested well and grow a lot.
But, on the flipside, if you live a really long time (well into your 90s, for example) and continue to have to pay rent every month for the rest of your life, it may end up that buying a house would have ultimately been cheaper, since you wouldn’t have had the never-ending monthly rent expenses. Also, if the house you bought appreciated a lot if value, it could mean more legacy value to leave to your kids.
Finances aside, if you buy a house, there will be more work and process involved in administering your estate after you’re gone. Assuming your kids won’t want to keep your house, they’ll have to get it cleaned up and sold. Whereas if you rent, when you die, you simply stop paying rent and that’s it; there is no house for your kids to have to maintain or sell.
If I choose to buy, what are the potential costs and complexities for my children associated with selling the home after my death?”
As I mentioned above, it will definitely be more work and process for your kids if you own a property.
Whomever your executor is will be responsible for making sure the taxes and insurance continue to get paid on your house. They’ll also have to physically maintain the home after you’re gone; they’ll need to cut the grass, repair any damage that may occur, keep the utilities on, etc. They’ll also have to work with a realtor to get the property listed and sold.
All things considered, I have to believe it will much less work and hassle for your kids to deal with your rental after you’re gone as opposed to dealing with owning a property. With the rental, all they really have to do is clean out your stuff and turn over the keys to the landlord. So long as they’re not on the lease, I don’t believe the landlord can try to shake them down for rent on your behalf. Which means they can basically just walk away from the place and that’s it.
That’s that. Hopefully you found this helpful. Honestly, I really struggled with trying to answer this question and write this; it’s a very complicated topic with LOTS of different things to consider. I think everyone’s unique circumstances will lead to different answers as to whether it’s better for them to buy or rent. I wish I had some sort of more concrete and tangible points of consideration to share with you all to help you more easily make this decision, but I don’t. At least not without knowing ALL of the financial and non-financial specifics of each of your situations.
If nothing else, this summary is a glimpse inside my head to understand the types of things I would look at and consider in trying to make the buy-vs-rent decision. I hope you enjoyed taking a look around inside my noggin!