Rent vs. buy: Millennials take a different path to homeownership

should-you-rent-or-buyAs more millennials move up the earnings ladder, get married and start families, housing is increasingly taking center stage.

Though millennials have a higher number of college graduates than Gen Xers and Baby Boomers, they’re less likely to own a home, according to the Urban Institute. In fact, their rate of homeownership was about 8 percentage points lower than Gen Xers and baby boomers at the same age.

Among the barriers to homeownership, according to the study: delayed marriage, student debt, and choosing to live in high-cost cities. What puzzles analysts is that in many of these cities the cost of renting versus buying a home is about the same.

An analysis by CoreLogic found that the median rent and median home prices in cities with a significant millennial population didn’t show meaningful disparities. In fact, in many markets, the monthly mortgage at the current 4.5 percent interest rate was around the same amount as renting. Of course, it’s important to keep in mind that buying a house encompasses more than just monthly payments, so things like coming up with a downpayment and maintenance costs can be a barrier.

Bigger cities, bigger paychecks, bigger price tags

People who live in expensive cities tend to earn more but they also devote more of that income to housing.

One financial rule of thumb is to spend under 2.5 times your gross income on a house. That means if you or you and your spouse earn a total of $100,000 per year, you generally shouldn’t buy a house that costs more than $250,000. This could be challenging to impossible in places like San Diego and Boston.

“Your cash flow out should be no worse than what you would pay in rent. Now, if you’re paying 50 percent of your income in rent and 45 percent in a house, then I’d say looking at a house is probably worth it,” says Richard Green, director of the USC Lusk Center for Real Estate.

“Three years ago, when interest rates were lower, buying was better from a cash-flow perspective than renting was. But, now that interest rates have gone up, that’s not the case anymore.”

The up-front costs are tough for millennials

Even if you can afford monthly payments, pulling together a down payment is a problem for many young homebuyers.

In Washington, D.C., where millennials make up 35 percent of the population, programs like the Home Purchase Assistance Program, or HPAP, are popular with young singles and families, says Polly Donaldson, director of the DC Department of Housing and Community Development, or DHCD.

HPAP provides up to $80,000 in gap financing and up to $4,000 for closing costs to eligible residents. These interest-free loans don’t have to be paid back immediately.

The chart below shows the cities with highest millennial populations and median home price and rents.

Millennial Cities: Cost of Buying vs. Renting
METRO AREA PERCENTAGE OF MILLENNIALS MEDIAN HOME PRICE MEDIAN RENT
Sources: The Brookings Institution (population); CoreLogic (home and rent prices).
Washington, D.C. 35% $430,000 $2,200
Austin-Round Rock, Texas 27% $309,000 $1,700
San Diego-Carlsbad, Calif. 27% $560,000 $2,300
Urban Honolulu, Hawaii 26% $570,000 $2,100
Boston, Mass. 25% $504,000 $2,500
Houston-The Woodlands-Sugar Land, Texas 25% $240,000 $1,600
Los Angeles-Long Beach-Glendale, Calif. 25% $615,000 $3,200
Orlando-Kissimmee-Sanford, Fla. 25% $241,000 $1,600
Seattle-Bellevue-Everett, Wash. 25% $550,000 $2,600
Chicago-Naperville-Arlington Heights, Ill. 24% $250,000 $1,900
Dallas-Plano-Irving, Texas 24% $290,000 $1,800
Las Vegas-Henderson-Paradise, Nev. 24% $275,000 $1,400
Minneapolis-St. Paul-Bloomington, Minn. 24% $258,000 $2,000
New York-Jersey City-White Plains, N.Y.-N.J. 24% $465,000 $2,300
Phoenix-Mesa-Scottsdale, Pa. 24% $260,000 $1,500
San Francisco-Redwood City-South San Francisco, Calif. 24% $1,300,000 $4,500
Atlanta-Sandy Springs-Roswell, Ga. 23% 225,000 $1,600
Philadelphia, Pa. 23% $170,000 $1,600
St. Louis, Mo. 23% $160,000 $1,300
Charlotte-Concord-Gastonia, N.C. 22% $230,000 $1,500
Detroit-Dearborn-Livonia, Mich. 22% $95,000 $1,300
Miami-Miami Beach-Kendall, Fla. 22% $300,000 $2,000

Seattle, both expensive and millennial dense, is one of the highest-priced housing markets in the country. Median home prices are $550,000, so finding an affordable home is no easy feat. Although there are down-payment assistance programs, they only go so far in a place where home prices are prohibitively expensive for most homebuyers.

“The city has remained really committed to helping first-time homebuyers, but we’ve also recognized that even our down-payment assistance programs is a challenging model,” says Jennifer LaBrecque, program manager for the City of Seattle Sustainable Homeownership & Weatherization program. “We provide $55,000 in deferred down-payment loans to buy a home, but if you look at what a low-income person can afford and what a house costs, that money goes toward closing that gap but not all the way.”

The down payment is just the beginning. Buyers should also factor in property taxes, insurance, applicable association fees and repairs. The average homeowner’s insurance premium, for example, is about $1,000.

Although homeownership is alluring for a number of reasons, Green says, it’s not right for everyone. Here are some questions would-be homeowners should first ask themselves:

Where will you be in the next 5 to 10 years?

If you’re not planning on sticking around in the same house for at least five years, then you should consider renting, says Ilyce Glink, author of “100 Questions Every First-Time Home Buyer Should Ask.” This is a real estate principle known as “the 5-year rule.”

“It’s really hard to break even in less than five years, unless you buy a really ugly property, fix it up and the market is right, then you might get lucky and make money. But you can’t count on it,” says Glink.

It typically takes five years to get ahead because selling a house is expensive. Home values typically don’t increase fast enough to offset closing costs if you sell too quickly. These costs can eat away at your bottom line if you don’t have sufficient equity built up.

“In the end, buying and selling is going to be about 10 percent of the value of the house right there — it could even be more than that,” says Green.

The five-year rule is especially important for young buyers who aren’t sure if they’re going to change careers, want more space or start a family.

The opposite is true for millennials who plan to live in the same house for many years. These folks should consider buying because, over time, the house will likely appreciate in value.

“You still have to pay to live somewhere. For most Americans the biggest portion of their net worth, where their retirement cash will come from, is in their house,” says Glink. “And the way they get there is by paying down their mortgage every year, the faster the better. What they do — without even thinking about it — is they stockpile this huge amount of savings.That’s where homeownership becomes a better deal.”

Do you have an emergency fund saved?

Renting is advantageous because the fixed costs are relatively inexpensive compared to owning a house. When you rent, you don’t have to worry about costly repairs.

“You need to make sure you have some money put away if a furnace or an HVAC system dies. That could be $10,000 right there. Boom,” says Green.

“You have to ask yourself: do I have access to that kind of money? The driveway needs paving. The roof needs replacing. And even in good homes these systems wear out every 15 to 20 years.”

Homeowners who don’t have rainy-day funds run the risk of accruing debt by using credit cards or taking out loans. This could cut into  the financial benefits of owning.

Millennials have to ask themselves, says Glink, what are they willing to sacrifice to be homeowners?

“Owning a home costs money and millennials are very focused on experience. That’s eating out or traveling to everybody’s weddings or international travel. Are you prepared to give that up? Are you prepared to give up your weekly massage? Where are you willing to trade off?” says Glink.

Do you want flexibility or stability?

Your lifestyle is another factor in whether you’ll be happy as a homeowner. People who don’t want to be pinned down to one city might find homeownership a burden. It’s difficult to accept a job offer in another state when you have to sell your house first.

Conversely, people who want to live in a particular area for many years will likely find comfort in knowing they can’t be evicted by a landlord and that their monthly housing payments will remain constant.

“When I talk to millennials about renting or buying there’s an issue of timing and there’s an issue of money. And timing is everything. They have to ask themselves: ‘Am I going to be switching jobs and moving cities? Do I want that kind of flexibility? If they do want flexibility because they’re still figuring out where they want to live, then renting is a good solution,” says Glink.

~Natalie Campisi, Bankrate

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