If you are a first-time real estate investor, knowing the difference between rent and mortgage can help you build and grow your portfolio.
Real estate investors can start building their portfolio by buying a house that they can either rehab and resell or rent out. While this is not the only way to invest, a rental property can be a lucrative and reliable source of income if you do it right. However, owning a house may incur more responsibilities and expenses compared to when you were still renting. The majority of your expenses will be the monthly mortgage payment.
While rent and mortgage both need to be paid each month, they differ from each other in many ways. If you are a beginner investor who has never bought a house using financing before but knows how rent works, you might be surprised how unlike these two are.
This article breaks down the differences between rent and mortgage, including:
- The definitions of mortgage and rent
- How mortgage and rent are similar to each other
- 5 major differences between mortgage and rent
- Can rental income pay for mortgage
What Is a Mortgage?
Before you learn the difference between rent and mortgage, you first have to learn what a mortgage is. A house is one of, if not the, most expensive property that a person will buy. Most of the time, they do not have the cash to pay for it in full. So in order to afford the house that they wish to buy, they take out a mortgage. Just like any other loan, a mortgage is a way to finance the purchase of a home. Homeowners can also take out a mortgage as a way to borrow money against the value of a property that they already own.
When you take out a mortgage, you do not completely own the house until you repay your loan in full. This is why the lender has the right to repossess the property in case you default on your mortgage.
When applying for a mortgage, there are seven things that you need to look for:
- The loan amount you will get
- Interest rate and any associated points
- Closing costs related to the mortgage, which includes the lender’s fees
- Annual Percentage Rate (APR)
- Type of interest rate (i.e. fixed or adjustable) and whether you can change it in the future
- How long you will need to repay the loan
- Any risky features of the loan, like a pre-payment penalty, a balloon clause, or an interest-only feature
What Is the Definition of Rent?
Knowing this concept should already give a strong hint about the difference between rent and mortgage. Rent is what a tenant or lessee pays for living in the landlord’s property. Unlike a mortgage, rent is not a loan but compensation for using the landlord’s assets.
As a property investor, rent is your income from leasing out your real estate assets like land or house. When renting out a property in the traditional sense, you as the landlord and your tenant sign a contract that lets them live in your rental for a specific period. While they are living there, they will pay you every month for as long as the contract is in effect.
Renting a residential property can go from one month to one year, though the tenant may negotiate for a longer period in their contract if they prefer. Usually, the tenant pays a fixed fee per month. If the landlord wishes to change the amount of rent, they will have to draw up a new contract.
Is Paying Mortgage Like Paying Rent?
The short answer: yes and no. The reason why many ask this question is that they are thinking about whether to rent or buy a home. And if you are a property investor who has been renting for a long time and is about to buy your first investment property with financing, you would want to know this, too.
Both mortgage and rent are similar in terms of a payment schedule. Usually, you will have to pay monthly toward your mortgage or rent. Doing this lets you live in the house that you are renting or paying a loan against. Other than that, however, the difference between rent and mortgage can be summarized by where the payment is going towards.
When you buy your first property, whether as a place for you to live in or to generate income, you are already investing in something that builds equity and entitles you to tax benefits. Renting has its advantages too, which include little to no responsibility for the property and more flexibility in your lifestyle. This is why many still opt to rent instead of buying a house for them to live in.
What Is the Difference Between Rent and Mortgage?
The one similarity between rent and mortgage involves when you need to pay them. Other than that, they are actually very different from each other.
What You Need to Pay Upfront
The first difference between rent and mortgage is the upfront costs.
When renting: The tenant has to pay a security deposit, which is equivalent to one or two months of rent. They might also have to pay for application fees and a credit check. If they own pets, the landlord might require them to pay a pet deposit. And while it is not required, getting a renter’s insurance gives them similar protections as a homeowner’s insurance would.
With a mortgage: The homebuyer has to make a downpayment, which can be up to 20% of the house’s asking price. This percentage is a lot, so the average downpayment is usually between 6% to 16% depending on the state. They will also have to pay for the appraisal and inspection fees to determine the actual value and condition of the property they are buying. Appraisals can range from $300 to $1,000 while home inspections go from $300 to $500.
There are mortgage-related closing costs that homebuyers need to take care of as well. These include mortgage application and origination fees, which can cost from 1% to 2% of the loan amount, and title and settlement costs, which can go for another 2% of the loan amount.
How Long You Will Have to Pay Rent or Mortgage
The second difference between rent and mortgage is the agreement terms.
When renting: The lease agreement can range from one month to several years. The tenant can negotiate how long their lease will last to suit their needs and circumstances. Because of this, they will have more flexibility to move to a different residence should they not find a better apartment.
With a mortgage: The homeowner’s mortgage may last up to 30 years depending on how much they can afford to pay per month. 10-, 15-, and 20-year loans are available as well, but real estate experts do not recommend short-term mortgages unless their budget truly allows for it. An alternative would be to take a 30-year mortgage then pay additional amounts to their monthly dues to reduce the total timeframe.
What Is Included in the Monthly Payment?
The third difference between rent and mortgage is what you are paying for.
When renting: The monthly rent usually includes the price that the tenant pays to live in the home that they are leasing. Although some rental agreements may include utilities and other bills as part of the monthly fee. This is not standard, though. The inclusions in the rent will depend on the location and the landlord.
With mortgage: The monthly dues toward the homeowner’s mortgage include the payment towards the loan itself and the interest. Depending on their lender, they might also pay for taxes and insurance, which would be averaged out over 12 months. They might also be required to pay mortgage insurance until they have reached 20% equity in their home. This insurance protects the lender in case they default on their mortgage.
How the Property’s Appreciation in Value Affects You
The fourth difference between mortgage and rent has something to do with the income property’s market value.
With a mortgage: The homeowner benefits when their home appreciates in value. This usually happens over time depending on the market and the upkeep of their property. And when its value increases, so do their equity. So if they decide to sell the house after some time, they may be able to sell it at a higher price than they paid for.
When renting: On the other hand, any increase in the value of a rental property will not benefit the tenant. Instead, it benefits the landlord who owns it. Tenants do not usually care for this until it directly affects them. For example, if the property has appreciated in value that the landlord decides to sell it, the tenants living in that residence might worry about losing their shelter.
Tax Benefits You May Be Entitled to
When first-time investors ask what’s the difference between rent and mortgage, they sometimes wonder about the tax benefits.
With a mortgage: Homeowners are entitled to several tax benefits. One of them is the ability to deduct their mortgage interest from their taxes. They may also deduct their property taxes from their federal income taxes. If they install solar panels on their property, they may also be able to deduct up to 30% of the cost, including the installation fee, from their taxes. they may also do tax deductions for points on their mortgage and mortgage insurance.
When renting: Tenants, meanwhile, are not entitled to tax benefits related to the property where they live. But they may be able to claim tax deductions if they work or do their business at home. The rules for this are not clear-cut, however, so they might have to consult with a tax professional regarding this.
Can Your Rental Income Pay for Your Mortgage?
If you are planning to buy a house using financing and put it up for rent, you would also want to learn if the rental income would be enough to pay for your mortgage. The answer to this question depends on two main factors:
- Your rental strategy (traditional or Airbnb)
- Monthly mortgage payment
If your monthly mortgage payment is lower than the average rent (whether traditional or Airbnb) in the neighborhood, then it should be covered by your rental income. However, you also have to consider your initial and running expenses, as they will affect your bottom line.
To make it easier for you to calculate these, you can use Mashvisor’s Investment Property Calculator, especially if you are still looking for a rental property. Aside from displaying thousands of properties for sale, we can help you analyze their income potential depending on your rental strategy and mortgage.
A mortgage is a loan that you get when you wish to buy a property but cannot afford to pay for it in cash. Meanwhile, rent is an expense that you pay to use or live in the property. Both require monthly payments, but they are different from each other in several ways:
- How much you will need to pay upfront
- For how long you will have to pay
- What is included in your monthly dues
- How does the property’s value affect you
- Any tax benefits you are entitled to
Knowing the difference between rent and mortgage is a great first step for beginner property investors. But you must also learn if your rental income is enough to cover your mortgage. To answer this question, you have to determine if the average rent in your property’s neighborhood is higher than your mortgage.
And if you have not bought a house yet, you can also try to calculate how much downpayment and loan terms you can negotiate to lower your monthly payment. This involves a lot of math, so you are better off using a tool like Mashvisor, which specializes in helping investors like you to find lucrative rental properties in their preferred area.
To get access to our real estate investment tools, click here to sign up for a 7-day free trial of Mashvisor today followed by 15% off for life.