If you're currently renting or looking to move into a new house you've probably had your mother, brother and Real Estate agent give you this sage advice:
"It's always better to buy than rent!"
You've heard that before, right? It's said often enough it starts to feel like it's true. When a large majority of people purport that renting a home is just throwing money away, it's hard to argue that they may be wrong ... but that's just it.
There is a chance that they could be wrong.
The idea that buying a home is more cost-effective than renting comes from some basic math: compare how much you're paying for rent with how much you're paying for a mortgage payment.
When you compare the two side-by-side, it seems to be obvious that buying a home would be more cost effective. The money you're spending on a mortgage payment is ultimately earning you a home, while the money you're spending on renting a home is only going toward the privilege of living in said home each month ... right? After a few years, you'll own a home if you buy, and if you rent, you'll just throw your money away. Unfortunately, it's not that simple. There's no magical equation you can plug your rent payment versus mortgage payment into and get a solid "Yes! You should buy a home!" or "No! You should keep renting!" answer. There's more math, calculations and assumptions you have to make to determine which is the best option for you, your finances and your future. That's why Landmark Home Warranty has created this comprehensive step-by-step article. It takes you through all of the aspects of renting versus buying, educates you on each element and provides you with the knowledge (and calculation!) you need to determine if you should rent or buy a home. So should you rent a home? Or buy? Read through this article, calculate the numbers, and we will help you determine which is right for you!
WHERE ARE YOU MOVING?
It should be no surprise that where you move influences if you should be renting or buying property. Metropolitan areas like New York and Los Angeles have lower rent prices on average than buying prices. The first step to calculate if it is cheaper to rent or buy is to research the median sale price of a home in the area you're looking to move, and the annual rent for a comparable home. Keep these numbers. You will use them as we move through this article. If you want a quick overview of the buying versus renting ratio you can use these numbers to calculate the price to rent ratio.
Price to Rent Ratio
The equation to find the price to rent ratio is:
Average Price to Buy/ (Average Rent*12) = Price to Rent Ratio.
- For example, if in Houston, Texas the average listing price to buy is $250,000 and the average rent price is $1,500 a month, you would calculate price to rent ratio like this:
Investopedia uses these ratios as a rule of thumb for determining whether renting or buying is more cost effective. Anything less than a ratio of 15 is better to buy than rent in that particular geographical area. However, if you score a 21 or more on the Price to Rent Ratio it's better to rent.
WHAT WOULD YOUR INTEREST RATE BE FOR A MORTGAGE?
Once you've found where you want to live, take a look at your finances. Can you afford a down payment for the average priced home in that area? Can you make a mortgage payment each month? How much money per month could you afford? Your mortgage payment is a factor of if you should rent or buy a home. If you don't have enough money to put a significant down payment on a home, it may be a good idea to keep renting.
Finding a Mortgage Rate
If you need help calculating what your mortgage rate would be for a particular home, this Bankrate calculator can help. Input your credit score, how much the average priced home in your area is, what percentage of that price you'd be able to put down as a down payment, and choose what kind of mortgage you'd want to get. Once you get the interest percentage, calculate how much you'll be paying in interest if you purchased a home. Keep this number to calculate if renting or buying a home is best for you. Also keep the estimated monthly payment that Bankrate calculates.
Assume you still want to purchase a home in Texas. With the average price at $250,000, and you putting down 20% for a down payment, you'll need a $200,000 loan. If you have a credit score like the national average (736), and a 30-year fixed mortgage, you'll be paying around 3.8% interest on your loan. That's $7,600 of interest you'll be paying per year. For this mortgage, Bankrate estimates the monthly payment would be $925.
If you itemize your tax deductions, you may not have to pay taxes on the interest on your mortgage. Depending on what percentage of your income is taxed each year, you will save money based on your interest rate for your mortgage. You can calculate how much you save on taxes by taking your yearly income and subtracting the interest you would be paying on your loan each year. The number you get would be your new "income" for which you would be taxed. You can use these tax bracket calculator to see what percentage of your income would be taxed for each amount of income. By subtracting the modified taxes from the original taxes, you can see how much your tax-deductible interest can save you. Keep this number.
For example, let's continue to use the home in Houston, Texas example. The interest over time would be $7,600. If you make $40,000 a year, you would be taxed at 25%. However, with your $7,600 interest, you can tell the IRS that you don't have to pay taxes on that $7,600. That drops your income to $32,400 and moves you to another tax bracket, where you'll only pay 15% on your taxes. 15% of $32,400 is $4860. Compare that to the original $10,000 you'd be paying before deducting that interest, and you'll be saving $5,140. Remember to keep this number as we continue through this article.
HOW MUCH WOULD YOU PAY FOR PROPERTY TAXES?
When you rent you don't have to pay property taxes, but when you buy, the state you live in determines how much you'll have to pay for property taxes. Each homeowner has to pay a certain percentage determined by how much the property is worth. It's different for every state, but let's assume a homeowner in Texas has to pay 1.5% for property tax. For a $250,000 home, you would be paying $3,750 every year for taxes. Calculate this for your desired home, and save it for later in this article.
HOW MUCH WOULD YOU PAY FOR MAINTENANCE COSTS?
With a rental property, if a home system or appliance breaks down, needs repairs or has to be replaced, the property manager or landlord foots the bill and gets it done. When you own your own home, you pay for every repair and replacement. According to US News, a homeowner can expect to pay between 1 and 4 percent of their property value on maintenance, repairs and replacements of systems and appliances within a home. To calculate an estimate of how much the maintenance of the fictitious home in Houston, Texas would cost, let's assume it would be 2%, which would be $5,000 a year in repairs and replacements.
Why Homeowners Get Home Warranties
This cost is one of the main reasons homeowners purchase home warranties. A home warranty costs between $300 and $600 a year, and covers most of the repairs and replacements that fail in a home. As long as the failure was caused by normal wear and tear, the home warranty company will cover it, and a homeowner will only have to pay a service call fee. Depending on what a homeowner wants covered and what homes and appliances fail in the home, the cost varies, but is much less than 1-4% of the home's value each year.
Choose a home warranty protection plan or not to determine how much you'll pay for maintenance.
Calculate how much you would pay on maintenance costs if you bought a home depending on if you want a home warranty or not. If you don't want a home warranty, calculate 1 to 4% of the property's value per year and keep that number as we continue with this article. If you think you would purchase a home warranty, use this form to compare home warranty plans. Input the zip code of the area you will be moving to, and see what kind plan you would want to purchase and how much that would cost per year. Then assume three items failed during the year and add $180 to that price. Take this price on through the rest of the article.
HOW LONG WILL YOU STAY IN YOUR HOME?
The length that you plan to stay in your new house is a huge factor in deciding to rent or buy. Obviously, if you're going to be settling down for 60 years, it's an obvious choice to buy because after 60 years, you'll have paid off your mortgage payment. If you're only living in a home for six months, you're probably not going to buy a home and then sell it within that short period of time without losing a lot of money, so you'd most likely rent. What if you're only going to be staying for five or six years, though? It depends on a number of factors. Do you have all of the numbers we've told you to save up to this point? This is when we're going to take those numbers, combine all your data, and really tell you if it's cheaper to rent or buy depending on where you're living, your mortgage rate, property taxes, home maintenance and how long you'll be living in your home.
To begin, multiple the average rent for the geographical area where you want to move by 12 to get an accurate annual rent figure. This is what you would be paying in rent per year. Leave this figure alone to compare with the buying figure later.
- Take your estimated monthly mortgage payment and multiply it by 12 to get an accurate yearly cost figure.
- Now, add the interest you would pay from your home's mortgage each year, property taxes for each year and maintenance each year.
- Subtract the deduction you would get with taxes.
- Now, compare the rent and buying figure per year. This is will show you which option you should choose if you're only going to be living in the home for one year.
- With our Houston, Texas example, it seems to be cheaper by only a margin to purchase a home:
However, most people aren't going to be planning on living in a home for only a year. Determine how long you would by living in the home and multiply both numbers by that. If you were going to be staying in the home for 10 years, you would pay $179150 for buying and $180,000 for renting, but you'll have almost paid off half of the home, so it would be better to buy.
The longer you live in a home, the more worth it is to buy the home. This is what is known as the Breakeven Horizon, as described by Zillow's chief economist Stan Humphries. The Breakeven Horizon is how long it takes to "break even" on a piece of property, when the costs of buying a home are outweighed by the benefits a homeowner is receiving. The national breakeven horizon average is 2.3 years. After those 2.3 years a home begins appreciating in value, and it's more cost-beneficial to buy than rent. Of course, this comes back to where the home is located, as some breakeven horizons are longer and some are shorter, depending on the geographical area of the home. Look at the Breakeven Horizon Depending on how long you will be living in your home and where it's located. For the Houston, Texas example, the average breakeven horizon is 1.5 years, so any time longer than that spent paying rent would be losing a homeowner money.
So, in the end, should you rent? Or should you buy? It depends on many different factors, but it's something you can easily find out using Landmark Home Warranty's step-by-step guide.
If you want to download this Rent or Buy guide, along with a printable cheat sheet that will help you calculate if you should rent or buy property, click here.
http://www.trulia.com/vis/rentvsbuy-winter-2014/ http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html?abt=0002&abg=0 http://www.trulia.com/rent_vs_buy