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.

No comments: