When we lived in Tucson, Arizona, my wife and I used to walk past a cute little house we liked. It was for sale for $150,000, which the “market” said was a fair price (early in 2006), but it didn’t seem right to me. I calculated that loan payments, taxes, insurance, water and maintenance (all the things we didn’t pay as renters) would be $1,125 per month. But houses just like this one rented for $700 per month — a savings of $5,100 per year!
You can guess the rest of the story. The bubble burst and within a couple of years, homes in that neighborhood were selling for well under $100,000. I’m glad we chose to wait. Later it made sense to buy. In fact, we’ve owned six homes in the last dozen years, and we prefer being homeowners, but there are times when it makes more sense to be a renter.
Are You Ready to Buy a Home?
With prices lower and rents higher, you might be wondering if now is a good time to stop renting and start shopping for a home. The experts say yes, but base their arguments on assumptions that are not necessarily relevant to your situation, as I’ll explain.
First, though, are you ready to buy a home? Ask yourself if:
- You have enough money for a down payment
- You have enough money for closing and moving costs
- You know what it really costs to have a home
- You can handle the big surprises that come with owning a home
- You are ready for the time and work of caring for a home
OK, so you have some money saved for a down payment, and you budget well enough to replace that heater when it suddenly dies in the middle of winter. You even love to mow grass, clean gutters and shovel snow. You want a home of your own, but maybe you also want it to make financial sense. Read on…
Buy or Rent: What the Experts Are Saying
Trulia’s Rent Versus Buy Report shows buying to be substantially cheaper than renting. For the 100 metro areas used in their calculations, buying is a whopping 38% cheaper than renting. They say, “Buying ranges from being just 5% cheaper than renting in Honolulu to being 66% cheaper than renting in Detroit.”
In other words, right now it’s cheaper to buy in every major U.S. city, and presumably in smaller towns, too. But wait…
It Isn’t Such a Simple Calculation
Every report of this type and every “buy vs. rent” calculator is based on assumptions about things like how long you’ll stay in the home (7 years in this report), your down payment (20%), and your interest rate (3.5%). I found the Trulia report to be fairly thorough. It even provided for maintenance costs, something first-time home buyers often overlook when comparing buying to renting.
On the other hand, some assumptions may not make sense for your situation. For example, Trulia’s methodology involves adjustments for size. The report says:
“It’s NOT right to compare the average rent and average price of homes on the market. Doing that would be misleading because rental and for-sale properties are very different: most importantly, for-sale homes are 47% bigger, on average, than rentals.”
So with some kind of adjustment (the details are scant) it might be cheaper by the square foot to buy. But is that relevant? Your real options might be a great 800-square-foot apartment near downtown for a total monthly cost of $1,000 versus a 1,800-square-foot house in the suburbs with a total monthly cost of $1,500. The apartment would be $6,000 less per year, even though the “square foot cost” is 66% higher. And maybe there are no great 800-square-foot houses to compare your apartment to.
The importance of size depends on layout. The location, type of home, yard size, and quality of construction matter too. But it’s difficult to plug factors like these into a formula. How do you compare a big yard to proximity to a Starbucks, or a garage workshop to being near a bus line? How do you compare the responsibilities of homeownership to the simplicity of renting?
These are personal, situational, and often intuitive calculations. And there could be a lot of them. For example, you might be better off renting if…
- There’s a good chance you’ll move within a few years
- The down payment will take all of your savings
- You never save money for large unexpected expenses
- You hate yardwork and taking care of a home
- Your job situation is shaky
- You love living near the action
And you might be better off buying if…
- You expect your family size to grow
- You want to gamble on rising prices and plan to sell for a profit
- You won’t put aside the money even if you do save by renting
- You want pets, and that makes finding rentals difficult
- You want a home-based business that can’t be run from an apartment
If you’re ready to buy, and even if the financial aspect is very important, you have to do the calculations on a case-by-case basis. So look at homes that meet your minimum personal criteria, and then make the following estimates (using your best guesses):
- Length of time you’ll stay in the area where you currently live: _____.
- Rental housing costs (rent, utilities, etc.) for that time-frame, based on your current rental rate and a guess about future increases, for your total cost to rent: ______.
- Total expenditures on the home you’re considering (closing costs, payments, taxes, insurance, utilities, maintenance, etc.), for the same time frame: ______.
- Your projected down payment: ______.
- Price you’ll get when selling your home, based on a reasonable rate of appreciation for your area (historically it’s been 3 to 5% annually in the U.S.): ______.
- Closing costs; you can use Trulia’s figure of 8% of the sale price: ______.
- Remaining balance you’ll owe when you sell your home; you can use a remaining balance calculator: ______.
- Subtract the amounts on lines 6 and 7 from line 5, to arrive at the net proceeds from closing: ______.
- Subtract line 4 (your down payment) from line 8 to arrive at how much equity you will have gained: ______.
- Subtract line 9 from line 3 to arrive at your total cost to own: ______.
- Compare line 10 (cost to own) to line 2 (cost to rent) to see which is lower.
To be precise, you have to do these calculations for each home you look at. And yes, there could be a housing crash a year after you buy. Then again, prices could rise so fast while you’re renting, you won’t be able to buy again for decades.
You take risks buying or renting, and the calculations above involve a lot of guessing. But they give you a place to start. Let’s look at one example, just to see how to run the numbers…
You expect to stay in town for six years, and you’re paying rent of $800 per month. You figure utilities will average $100 per month in the future, and rent will increase to $850 and $900 two and four years out. You pay $200 annually for renter’s insurance. Your cost to rent:
- Rent: $61,200 ($800 for 24 months, $850 for 24 months, $900 for 24 months)
- Utilities: $7,200 ($100 times 72 months)
- Insurance: $1,200 ($200 times six years)
Total cost to rent: $69,600
You can buy a house you like for $180,000 with $36,000 down, borrowing the $144,000 balance at 4.5% on a 30-year mortgage loan. The payment would be $730 per month and you expect 3% appreciation, for a sales price of about $215,000 in six years.
It’s bigger than your apartment and you pay your own water bill, so utilities will run $260 per month, insurance $950 annually, and taxes about $2,500. You figure repairs and maintenance at about $200 per month. Here are the numbers:
- Closing costs: $3,600 (including loan costs)
- Payments: $52,560 ($730 per month times 72 months)
- Property taxes: $15,000 ($2,500 per year times six years)
- Insurance: $5,700 ($950 per year times six years)
- Utilities: $18,720 ($240 per month time 72 months)
- Maintenance: $14,400 ($200 per month times 72 months)
- Total expenditures before equity gain: $109,980 (all of the above)
- Sale price: $215,000 ($180,000 times 3% annual appreciation compounded for six years)
- Closing costs: $17,200 (8% of the sale price of $215,000)
- Remaining balance owed: $128,360 (after 72 payments)
- Net at closing: $69,440 ($215,000 minus loan balance and closing costs)
- Net equity gain: $33,440 (net closing proceeds minus initial down payment)
Total cost to own the home: $76,540 (total expenditures minus equity gain)
To keep it simple, these calculations don’t include the “opportunity cost” of your down payment (you could have invested it elsewhere if you continued to rent), so the cost to own is even a bit higher than this example suggests.
Also, small changes in your assumptions can make a big difference. For example, if the home appreciates at 4% annually, instead of 3%, your cost of owning would be just $65,500 — less than the cost of renting.
One last suggestion: If you really aren’t good at saving money and it costs a little more to buy instead of rent, go ahead and get the house. The equity you build will be a kind of forced-savings plan, so at least you’ll have something in the future.
Your Turn: What do you think about buying versus renting, and which way are you likely to go?
Steve Gillman is the author of “101 Weird Ways to Make Money” and creator of EveryWayToMakeMoney.com. He’s been a repo-man, walking stick carver, search engine evaluator, house flipper, tram driver, process server, mock juror, and roulette croupier, but of more than 100 ways he has made money, writing is his favorite (so far).