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Home Ownership vs. Leasing: What's the Difference?

written by: Deborah Rose•edited by: Jason C. Chavis•updated: 10/12/2010

Can't decide if home ownership or leasing is a better option for you? This article discusses the advantages of each, and offers some basic rules of thumb to help you decide on home ownership versus leasing.

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    Lease or Buy?

    Which is better: home ownership versus leasing? In what ways are they different, and how can you know which option is best for you? The decision isn’t strictly a financial one. Whether one option might be better than the other depends on many factors.

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    Advantages of Home Ownership

    Home ownership has long been a part of the American Dream. There is a sense of pride in owning your own home. People tend to feel a stronger sense of community when they own the home in which they live. Knowing that they can’t lose their lease helps provide a sense of stability.

    One advantage of home ownership versus leasing is that home ownership gives the owner freedom to make whatever changes to the home he would like. Pictures can be hung and walls can be painted without fear of losing a security deposit. Changes can be made to the home or to the landscaping without obtaining a landlord’s approval or permission. In most cases, there are no restrictions on having pets.

    There are financial benefits to home ownership versus leasing. Unlike lease payments, each monthly mortgage payment builds equity in the home. Real estate taxes and a portion of your mortgage interest are tax deductible on federal income tax returns. If the home increases in value, you could actually make a profit when you sell.

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    Advantages of Leasing

    One of the greatest advantages of leasing a home versus home ownership is the flexibility leasing provides. If a renter receives a job offer in another location, he can accept the offer without worrying about selling a house first. If a renter decides he needs a larger home, or a smaller rent payment, or more amenities, it’s easy to move to a different home.

    A second advantage to leasing a home is freedom from home maintenance. Renters don’t have to spend their weekends repairing plumbing or painting the house. They can enjoy perks such as swimming pools and barbeque areas without the weekly maintenance.

    Allowances for property taxes and insurance are typically built into the lease payment, so renters do not have to worry about paying these bills directly. Further, renters do not have to worry about large unexpected repair bills.

    It is not necessary for a renter to tie up a large amount of capital for a down payment, as with a home purchase. As long as the property is left in good condition, any security deposit paid will be returned to the renter at the end of the lease.

    A final advantage to leasing versus home ownership is that renters avoid the risk of losing money if the value of the property declines.

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    Some Rules of Thumb

    All other factors being equal, there are few rules of thumb which can be used to help determine whether home ownership versus leasing might be a better financial decision. It is necessary to consider whether a person can afford to purchase a home, and whether it is cheaper to lease or to buy.

    A guideline used by banks is that a buyers should be able to afford a home with a purchase price of no more than 2.5 to 3 times the buyer’s annual income. Landlords who purchase homes as investments say a safe purchase price is a maximum of 15 times the house's annual rent. Patrick Killelea, who runs the website Patrick.net, offers the following rule of thumb to determine whether purchasing or leasing a home makes more financial sense: Divide the annual rent by the purchase price for the house.

    • If the annual rent, divided by the purchase price, equals 3%: Do not Buy
    • If the annual rent, divided by the purchase price, equals 6%: Borderline
    • If the annual rent, divided by the purchase price, equals 9%: OK to Buy

    For example, assume the purchase price of a home is $160,000. The monthly rent for that home is $1,200. $1,200 x 12 = $14,400 annual rent, divided by $160,000 = 9%. According to the Patrick.net formula, it would make financial sense to purchase rather than rent this home.

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    Summary

    The decision of whether home ownership vs leasing is better doesn't have a one-size-fits-all answer. This article has discussed the advantages of both options, and some rules of thumb to help determine which might be a better financial decision. Before making the decision, it is best to consider all the different factors that apply to your own situation.

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    Reference

    • Rent vs Buy Calculator: http://calculators.interest.com/content/calculators/rentvsbuy.asp
    • New York Times - Is it Better to Buy or Rent?: http://www.nytimes.com/interactive/business/buy-rent-calculator.html