Buying a Starter Home vs Renting (making the best choice)

Buying a starter home and renting both achieve the exact same objective.

They provide a temporary, and hopefully desirable, roof over your head until you move to settle down in your “forever home”.

Framed this way, the decision of buying a starter home vs renting is not as straightforward as it seems.

What’s the difference? And how do you go about making sure it’s the right financial decision for you?

And make no mistake, the stakes are high.

Make the right decision and you’ll set yourself up for a more prosperous future. Make the wrong decision, and the adverse impact could be huge!

In this post, I attempt to provide a fresh perspective on this topic, one that will help you make an informed choice and greatly increase your likelihood of success.

And with that, let’s dive right in.

The main reason for buying a starter home instead of renting

If both a starter home and renting achieve the same objective of providing you with housing, then surely you should only decide to buy a starter home, versus renting, if it improves your financial situation.

Your starter home should end up making you money, saving you money or both.

Why else would you want to buy a starter home?

If it’s because you can’t afford your forever home yet, or if you don’t yet have stability in your life (e.g. partner, children, location certainty, job certainty, etc.) then this could easily be addressed by waiting. And renting.

In fact, renting is arguably the ideal scenario because it’s no strings attached (or very little strings attached).

Of course there are other reasons for wanting to buy a starter home.

Maybe it’s because you want to gain experience as a home-owner or because you’re scared of making a huge mistake on a much more expensive property.

Would you go through all the effort and hassle for these reasons alone if you’re certain that it would negatively impact your financial future? I don’t think so.

There’s no two ways about it. You should only decide to buy a starter home instead of renting if it makes you money.

“Gee, thank you Captain Obvious” you may say to yourself reading this.

While it does seem obvious, many people buy a starter home without a concrete investment strategy.  

They do it on instinct. “I don’t want to throw away money on rent”, “real estate values go up over time”, “interest rates are so low!”

And then, when they’re visiting properties, the how do I make money part starts going out of the window.

They start projecting themselves living in the property and end up going for the one that they “fall in love” with. This is normal, they’re going to be living there after all.

So how do you go about choosing a starter home that beats renting?

Choosing a starter home that beats renting 

Well, it’s actually quite simple. You need to approach your starter home as if you were buying a rental property. Period.

Well, with one non-negligible restriction. That you’re happy or willing to live in it.

I will not go into detail in this post on how to evaluate a rental property as an investment, which is very large topic in its own right. Luckily, information on this is widespread online.

You need to ensure that your starter home costs you less money overall than renting an equivalent property.

This essentially means that you would be able to make a profit were you to rent it out from day one.

Make sure in your calculations that you include all costs. And don’t forget to consider any positive impacts from tax deductions that could be available to you if you buy the starter home!

If buying a starter home ends up being cheaper than renting the equivalent property, you’re good to go! That’s all you need.

On top that your exit strategy is taken care of.

If you need to move, no problem! Simply rent it out for a profit. Even if the market has tanked. If the market has gone up, then you have the choice to sell it a profit or rent it out as a profit.

Sounds good right?

Notice how I didn’t compare the rent you personally pay today with the monthly costs of your starter home before making this statement? 

That’s because its apples and oranges. You wouldn’t compare your own rent or personal residence costs with the rental income from a separate rental investment property right?

Here’s a quick scenario to drive the point home.

If you’re currently living in a studio in the city centre, then buying a studio in the next village will obviously be cheaper. But would renting one be even cheaper? That’s what you need to determine.

When it comes to buying a starter home versus renting, you need to compare buying versus renting a property with similar characteristics (size, location, condition, amenities, etc.). Irrespective of your rent now.

Of course, you need to make sure that you can afford your starter home, just as you need to make sure that, as a renter, rent is not taking a huge unsustainable portion of your income.

If you’re looking to save money, then buying a starter home could be an option. Simply find a starter home that will cost you less than your rent now and that still meets the criteria of a good rental property (i.e. you could rent it out at a profit)

Examples of starter homes that beat renting

Let’s assume that your monthly rent today is 1000 USD or EUR all-in (including utilities, renter insurance, etc.). You have decided to look for a starter home that beats renting.

Let’s now go over the main scenarios that will demonstrate when buying a starter home is a good idea.

All scenarios assume that the typical aspects of a good real estate purchase are met (decent location, market demand from both buyers and renters, adequate condition, etc.) and that you would be happy living in the starter home.

1)     The “ideal” starter home

The ideal starter home purchase fulfils the following conditions:

• A starter home that will result in average monthly cash outflows that are less than or equal to your current all-in rent (1000 USD or EUR monthly in this example)
• Renting that same starter home would be more expensive than buying it (more than 1000 USD or EUR all-in rent cost)

This basically is equivalent of finding a positive cash-flow rental property (at a relatively low deposit of 0-20% of property value), and then living in it. For less than your current all-in rent.

When looking at it from the cash-flow perspective, you are including the equity portion of your mortgage as a cost because it is a cash outflow, even though you’re actually paying yourself.

However, if the mortgage for your starter home costs you 700 USD or EUR per month and the equity repayment portion is 200 USD or EUR on day one, then the starter home will actually only be costing you 1000 minus 200, so 800 USD or EUR all in. Since you’re paying yourself with that 200.

So even if it costs you the same from a cash perspective as your rent, can you see how the equity repayment portion of your mortgage becomes a guaranteed way to beat renting?

The extra bonus is that over time your equity repayment grows as proportion of your total mortgage cost (versus interest) since mortgages are front-loaded with interest.

This means that a few years down the line you’ll be paying yourself 250, then 300 and so on, while maintaining that 700 mortgage and 1000 USD or EUR total monthly cash outlay.

Congratulations, you have now implemented a wealth building engine, simply by buying a starter home and living in it. 

2)     The “you still win” starter home

This scenario is similar to the previous one except for the fact that your average monthly cash outflows from buying your starter home would exceed your current all-in rent costs now.

“You still win” if it nevertheless costs you less overall when you factor in that equity repayment portion of your mortgage.

Let’s say, that same starter home ended up costing you 1100 USD or EUR monthly. 

Deducting that 200 USD or EUR equity repayment, from the same mortgage as in the previous scenario, would bring your actual monthly cost down to 900 USD or EUR. So still overall 100 cheaper than the current all-in rent.

3)     The “you really need to upgrade” starter home

In this scenario, you’re focused on upgrading your lifestyle by buying a starter home that will cost you less than renting an equivalent property.

Your starter home will cost you more than your all-in rent costs now but it would be even more expensive were you to rent it.

For example, you’ve been living in a tiny studio for the last several years and it’s really starting to wear you down. You really need a bigger place, in a similar area.

It’s OK if you want to upgrade to reasonably improve your lifestyle, even if your overall costs will increase. Just make sure that you’re doing it for the right reasons, that the upgrade will truly make you happy and that you can comfortably afford it.

4)    The “I’m feeling lucky” starter home (capital appreciation)

If you buy a starter home at the right time, in hot a market, then it practically doesn’t matter what you buy as a starter home. You will beat renting.

However, since capital appreciation is far from guaranteed, I would recommend considering it as a secondary factor in your decision. A nice bonus.

You may disagree, and want to focus on the capital appreciation potential of your starter home. That is perfectly fine.

If you’re confident in your ability to catch a capital appreciation wave, then who am I to tell you not to go for it?

Just note, that most of the starter homes with the highest capital appreciation potential will cost you more than renting the equivalent property.

If this is the case, you need to make sure that whatever happens, you have a clear exit strategy in mind.

Are you prepared to live in your starter home longer than foreseen? Can you comfortably cover the difference between your rent income and costs if you’re forced to move and rent it out?

If so, then speculating in your starter home could be a calculated bet you make.

Just remember, you definitely don’t want to be forced to sell your starter home at a loss or, worse, foreclose. And you definitely don’t want to be forced to continue living there against your will because you can’t afford to rent it out at a the loss.

When renting is better than buying a starter home

Let’s now look at the choice from the perspective of renting being the better choice.

If you’ve been paying attention so far, then needless to say that renting is better than buying a starter home if your starter home will end up costing you more.

If you want to be prudent and avoid having to depend on capital appreciation for buying to be the better choice, then you should continue renting.

Even if you are willing to pay more in the short term to benefit from capital appreciation in the long run, you need to make sure that you have an exit strategy, particularly in case of real estate crash. 

If your exit strategy involves being forced to stay longer than foreseen, selling at a loss or covering a shortfall if you have to turn your starter home into a rental property, then make sure you’re comfortable with it.

If not, then you should continue renting.

Finally, don’t buy a starter home just because it makes financial sense if the starter home will make you miserable.

If you’re renting somewhere you love and can’t find a starter home in your area that would beat renting in a financial sense, don’t move somewhere that will make you miserable just so you can buy a starter home. Continue renting and preserve your happiness.

And this concludes this post. I hope that you’ve found it useful and that you are now armed with knowledge that will help you make the right choice.

So?  Buying a Starter Home vs Renting, what will you go for?