To Rent or to Buy?
When a client is moving for one reason or another, a common question we get is whether they should rent or buy their next place. Earlier in my career, I would have started immediately analyzing the options to get to the financial answer, but now, I usually start talking through the non-financial factors to consider. Will you need to move further from work/family/friends to buy? Will your new neighborhood be equally walkable, and if not, is that important to you? How long do you plan to stay in the area? Renting provides benefits of flexibility if you aren’t sure what employment/social changes might be in your future. Also, some people prefer the no maintenance nature of renting. Buying on the other hand, lets you leave your mark on the property. You can paint the walls without worrying about surviving a landlord inspection when you move out!
Then there are the financial considerations. First of all, can you afford to buy? Buying takes up front capital for a down payment and ongoing capital for maintenance. Are you worried about having a big mortgage hanging over your head? I remember it being pretty scary to have a huge liability all of the sudden when I bought my first house.
A client recently asked the rent/buy question and was very interested in the dollars and cents answer, so here’s the example we walked through together.
You must have resources for a down payment and maintenance for a home purchase, so to compare apples to apples, let’s assume we have $210,000 of liquid assets to start. For this analysis we will assume a 7% annual return on liquid assets that aren’t needed for down payment and maintenance. We will also assume a 5% rate of return for real estate.
In the buy scenario, we assume a purchase of a $450,000 townhome, with $110,000 in upfront costs (closing costs of $20,000 and a 20% down payment of $90,000), leaving a $360,000 30-year loan at 6.7%. That results in a mortgage payment of $2,321, and we tacked on an estimated $600 of real estate taxes and hazard insurance.
We will assume utilities of $300 and HOA fees of $300 per month which brings you to monthly housing costs of $3,521. But wait, as the homeowner you have maintenance costs, so what should we estimate? State Farm suggests you set aside 1% to 4% of your home’s value for annual home maintenance1, which we believe seems reasonable, so we will use the average of 2% per year for this comparison. When you sell, we will assume 5% in closing costs.
Also, important for this comparison is how long will you stay in the home? For this analysis we assume you will keep the place for 10 years. In this “buy” scenario, you end up with approximately $415,000 in your investment account after paying off your mortgage.
In the rent scenario, we assume you rent for $2,500 per month and pay $250 in utilities and renter’s insurance for a total of $2,750 of monthly housing costs, which is $771 less than the monthly housing costs of buying.
If you were to rent an apartment for 10 years and add the $771 you save each month to your investment account that is making 7% each year, you end up with approximately $550,000 in your investment account, a difference of approximately $135,000 from the townhome purchase scenario.
By the way, if your rent is actually $3,000 a month instead of $2,500, all other things being equal, you are only $46,000 better off if you rent instead of buy.
This is an oversimplification of a complicated decision. Rents go up, but real estate taxes and insurance go up, too. Also, there’s always a chance that you can refinance a mortgage and a rule of thumb is that you benefit if you can improve your interest rate by 1%, sometimes even less. When it comes down to it, renting or buying continues to be more of a lifestyle choice than a financial choice. This is true of a “buy here or buy there” decision as well. We spend so much time at home, that the bottom line on our balance sheet is rarely the most important consideration when deciding where to lay our head.
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- "Take Advantage of New IRS Rules" by Laurie Kramer, CFP® »
Source:
1https://www.statefarm.com/simple-insights/residence/how-to-budget-and-save-for-home-maintenance.
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