We are nearing the end of my series on buying a house versus renting an apartment. We’ve talked a lot about financial points that seem vacant from the general discussion. While I’m confident that most bloggers and everyday people are losing money by renting for lifetime, I cannot deny that renting can be the better financial decision. Today, I want to cover the circumstances where renting will save you money.
The Best Buy Versus Rent Calculator
To do so, I must point you to the best buy-versus-rent calculator on the web. It’s done by the NY Times and it’s a solid tool.
It’s not perfect. I’d prefer a longer time horizon than 30 years and the defaults make some big assumptions on remodel and maintenance costs of home ownership. However, the calculator looks at all the investment/cost variables that need to be considered to accurately determine the optimal solution to our housing dilemma.
If you play around with the calculator long enough you find that the main variables that influence whether or not renting is cheaper than buying are time you plan on owning your house and whether opportunity costs exceed a home buyer’s benefits from inflation.
How Long You Own Your House
This is the classic “when renting makes sense” scenario. There are large costs to buying a home; like closing costs. Also, if you use a realtor, you need to pay commissions on selling. You need to own your home over a number of years to recoup those costs. If you are buying and selling frequently, odds are that you are losing money.
As I discussed earlier, you also get to fix a portion of your housing costs when you own a home. Each time you sell then buy again, you lose that advantage and renting can become more cost effective.
Price of a Home and Opportunity Costs of Owning
There are two opportunity costs that home buyers need to recoup by owning. If those opportunity costs are large, renting might be cheaper than buying.
First of all, there is the down payment and closing costs you pay up-front for a mortgage. That chunk of money could be used for other investments like buying into the stock market. Buying a home means that you forgo any interest that can be earned by not investing elsewhere.
The second opportunity cost occurs if rent is initially cheaper than your mortgage. Even though one day you will never have to pay a mortgage, it’s common for your mortgage payment to be more expensive than your rent. The opportunity cost here is similar to the last issue. If you pay more to own a home today, the difference between ownership and renting could be invested for a return.
While there are two different opportunity costs, home price and monthly rent are the variables that have the greatest impact on them. An inflated home price will balloon your down payment, closing costs, maintenance and remodeling bill, and mortgage payment. If renting happens to be a steal in your area, while home prices are particularly high, there is a good chance that renting would save you money over a lifetime.
Obviously there are other factors too, like if home loan interest rates are high or low, but it just doesn’t have the impact that inflated housing prices can have on costs of home ownership.
The Homeowner Benefits of Inflation
It’s simply not enough to have opportunity costs. Those opportunity costs need to be massive. How massive?
Regardless of how pricey the housing market is, if you pay your mortgage long enough, sooner or later you won’t have a mortgage payment and your housing costs will be cheaper than renting. The real factor in whether opportunity costs are large enough to overcome the long-term benefits of no mortgage payments has to do with the future rates of inflation.
Most people know that home value appreciation is an asset to the homeowner, but it’s only half the picture. Rents also increase with inflation and since buying a home fixes a large portion of your housing costs, a home buyer benefits from inflation on the price of his home and the inflation of rent prices. The bigger the spread between these two inflation rates, the more the home buyer benefits.
If home prices are increasing at 3% and rents are increasing at 3%, there’s some serious savings for homeowners. This benefit is what makes home ownership naturally attractive as a housing situation.
However, while the inflation rate spread between home prices and rent prices creates a massive amount of savings for owners, it isn’t an impossible number to overcome with opportunity costs. There certainly markets where this is true and the handy calculator at the NY Times will help you determine if you are in one of those markets. However, most of the nation is not in one of these markets and ought to be thinking about taking advantage of owning a home.