7/17/08

Buying vs Renting Part 2

I debated whether buying a home is better than renting recently. Dorian Wales at The Personal Financier has posted on the topic, and provided a link to a New York Times calculator.

I wish I had known about the calculator before, as it would have saved me the time I spent doing calculations. It lets you manipulate a bunch of variables, including monthly rent, cost of house, down payment, mortgage rate, annual rent hikes or cuts, and annual property value appreciation or depreciation.

The scenario I used before was, "you buy a house for $400,000 with an $80,000 down payment. At current rates, 7% in the NYC metro area, for example, you'd pay around $2,128.97 a month in mortgage payments on a 30 year fixed mortgage (on the $320,000 you borrowed). Adding in reasonable property taxes, insurance rates, and your down payment, let's say you pay $2,800 a month."

Using the calculator, this scenario's values are the following:

Monthly rent: ?
Home price: $400,000
Down payment: 20%
Mortgage rate: 7%
Annual property taxes: 2.013%
Rate of property value increase/decrease: ?
Rate of rent increase/decrease: ?

Whether renting or buying is better in this scenario depends on the three factors that have question marks. The NY Times calculator suggests that the monthly rent figure should be $2,165. This is because the national average home price divided by the national average rent is 15.4.

The rates of increase/decrease on home value and rent determine which is better. To be better than renting, the home's value has to increase annually by 4% or more if rent increases 1% annually (these figures are painted with broad strokes, as it were. That is, it might be less than 4%, but the calculator does not let you manipulate the variable on a finer level, such as basis points). If rent increases 2% annually, in this scenario buying the home is better if its value increases 3% or more annually. If rent increases 3% annually, which is the calculator's default value, buying the home will be better (after 29 years) even if it loses 3% of its value annually. (The calculator does not seem to work for greater losses. For example, it says buying is better than renting after 28 years if the house loses 10% annually. This makes no sense.)

Joe Enos mentioned in a comment that timing is important, as are your holding period and risk tolerance. I agree. Americans move every six years on average. Many won't stick around for the time required to make buying worthwhile in those situations where the house loses its value and/or monthly rent does not appreciate as fast as it did in the past.


Here is an excellent article on housing booms and busts posted on the FDIC site in 2005.