Is Building Equity Better By Owning or Renting a Home?

Deciding whether to rent or buy a home is one of the biggest financial decisions you’ll make. Many factors go into this choice, but a major consideration for many people is the ability to build equity.

What exactly is equity, and is it easier to build by owning or renting? Let’s take a detailed look

What Is Home Equity?

Equity refers to the portion of your home that you actually own, as opposed to the portion owed to the mortgage lender.

For example, say you purchase a $300,000 home by putting 20% down. That means you pay $60,000 upfront and finance the remaining $240,000 with a mortgage.

Your equity would initially be that $60,000 down payment. Over time as you pay down the mortgage your equity increases. Essentially equity is

Home’s Market Value – Amount Owed on Mortgage = Your Equity

Equity is important because it provides financial flexibility. You can tap into home equity to help cover major expenses or to access funds for other investments.

And when you eventually sell, the equity is what you get to keep as profit. So building equity faster means accumulating wealth faster.

Does Owning or Renting Build More Equity?

At first glance, owning seems to clearly build more equity. After all, renters don’t build any equity since the landlord owns the property.

But you need to dig deeper to get the full picture. Here are key considerations when comparing renting versus buying and their impact on equity:

Upfront Equity

Owning – To buy a house, you’ll need to put anywhere from 3.5% to 20% or more down as a down payment. This immediately creates equity.

Renting – Renters put down a security deposit, but this is returned at move out and doesn’t build equity.

Monthly Payments

Owning – Your monthly mortgage payments chip away at the loan principal. This gradually builds equity over time.

Renting – 100% of rent payments go to the landlord. You build no equity.

Appreciation

Owning – As the home value increases, your equity rises too. Real estate prices often appreciate 1-5% yearly depending on location.

Renting – You don’t benefit directly when rents or property values rise in your area.

Investing the Difference

Renting – If renting is cheaper than owning comparable property, you can invest the difference to build wealth another way.

Owning – While owning has forced savings through the mortgage, you lose out on investing those funds elsewhere.

Transaction Costs

Owning – Buying and selling a home incurs many fees (realtor commissions, loan costs, inspection fees, etc). Frequent moves eat into equity.

Renting – Aside from a security deposit, moving has minimal costs. Easy mobility gives renters an advantage here.

But renting provides more flexibility to invest capital elsewhere or avoid transaction costs from frequent moves. The key is being disciplined about investing those savings from renting.

How Fast Can You Build Home Equity?

While owning builds equity automatically, how fast that equity accumulates depends on several factors:

Purchase Price and Down Payment

The more expensive the home, the longer it will take to build a meaningful equity percentage. Putting more money down upfront cuts this time.

With a $200,000 home and 10% down, it may take 5-7 years to build 20% equity. But a $500,000 home with 10% down could take 10+ years.

Mortgage Term

Shorter loan terms build equity faster but have higher monthly payments. A 15-year mortgage builds nearly twice as much equity after 5 years than a 30-year loan.

Extra Principal Payments

Adding extra to your normal payment reduces principal faster. Making one extra payment yearly can shave years off a mortgage.

Home Value Appreciation

Faster rising property values equal faster equity gains through appreciation. Location and market conditions impact this.

Improvements and Additions

Home improvements like adding a bathroom can significantly increase value. Upgrades build equity through the added property value.

Time and Patience

Like any asset building, growing your home equity takes consistent savings, debt reduction and long-term patience. Avoid tempted shortcuts like riskier ARMs or high-risk lending.

Other Considerations for Renting vs. Buying

Equity is a major factor in the rent or buy decision, but not the only one. Be sure to weigh other considerations as well:

• Mobility – Renting offers more flexibility to relocate. Buying and selling has high transaction costs.

• Cash flow – Rents may be cheaper monthly in some markets compared to owning. But mortgages can provide forced savings.

• Lifestyle – Owning provides more control over your living space. But renting frees you from maintenance.

• Taxes – Mortgage interest and property taxes have tax benefits for owners. Renters don’t get those deductions.

• Other investments – Money saved renting could be invested elsewhere. But owners have forced equity savings.

• Market risks – Owners depend on the real estate market and economy. Renters can follow jobs more easily.

The Bottom Line

At the end of the day, there is no one-size-fits-all answer to this rent or buy question. You need to run the numbers for your situation and assess your own lifestyle needs.

If you want to settle down for the long-term, are ready to handle homeowner responsibilities, and can make the finances work, then buying to build equity directly can make sense.

But renting has its merits too, if you value mobility and want to invest your capital into other assets. Neither option is inherently better or worse for building wealth.

Focus on making the housing choice that fits your life now, as well as setting yourself up financially for the future. With smart planning, you can build financial security over time whether you rent or buy.