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Is It Better to Buy or Rent?

02.23.2010 by Matt Jabs //

Over the last few weeks we have had some good discussions regarding the buy vs. rent debate.  Robert gave us a few solid articles and many of you chimed in with great thought provoking comments.

But who is right? Does the fact that 30 year mortgages double home prices really make renting a better option than buying?

Is It Better to Buy or Rent?

The question is anything but simple, so it’s only logical to assume we’ll wind up with guys-n-dolls going to bat for both teams.

What are others saying? Thanks to help from a couple dinosaur comics and several atrocious years in the housing market, Get Rich Slowly founder JD had a change of heart on the matter.  In his own words,

“One of my beliefs that’s been set on its head is that Americans are better off buying their own homes. I don’t believe that’s necessarily the case anymore.”

A few years back he felt home ownership was always the way of the dragon but now perceives the best reasons to buy are actually non-financial and/or personal, since the numbers often favor renting.  I agree.

If you’re interested in reading more of JD’s take on this topic and many others be sure to grab a copy of his soon to be released book, Your Money:  The Missing Manual.

Aside from JD’s point of view I also checked out several other takes on this topic.  The wise consensus seems to be… neither option is best for everyone.  I agree.

Buy or rent – crunching the numbers…

We’ll start by shooting a hole in the argument that “homes appreciate over the long term.”  The truth of the matter is that home prices over the last 80+ years beat the inflation rate by a mere one percent.  Sheesh, I get better rates in my Capital One 360 Savings account.

Laying aside emotional factors, let’s see if we can help you determine which option is best for your unique situation according to the numbers. After all… numbers don’t lie right?

This is where the bottomless pockets of big companies come in handy.  They pay really smart programmers to dev really cool calculators that make really complicated formulas look really sexy.  Check it out…

Is It Better to Buy or Rent Calculator

I used this awesome WSJ calculator to discover if it would be better for us to rent or buy (for the record, we bought nearly 3 years ago.)  Here are the details of my calculation, complete with a screenshot:

  • Monthly rent = $800 – this would be the maximum amount we would ever spend on an apartment in Lansing, MI.
  • Home price = $165,000 – this was the cost of our home.
  • Down payment = $0 – yeah I know… real smart eh?  😉
  • Mortgage rate = 6% – the combination of our 1st and 2nd mortgage rates would actually be a bit higher.
  • Annual property taxes = $3,200 – which is about 2% of the cost of our property each year.
  • Annual home appreciation = 1% – despite our currently depreciated asset, I chose to go with the long term trend here.
  • Annual rent increase = 3% – to factor in increasing yearly rent costs.

We have owned our home for only 3 years so we are still on the really expensive end of our mortgages, which made my self-audit especially hard to swallow… but I knew that going in.

Renting an $800 apartment for the last three years instead of purchasing our home would have saved my wife and I approximately $24,000.

Another factor worth mentioning, but not covered by the calculator, is the current value of our home.  We’re upside down on our home by an approximate measure of $20,000 which leaves us unable to sell until that deficit is wiped out (either by us or by the markets, but likely by us.) Adding in the cost of our depreciated asset, home ownership, over the course of the last 3 years has cost us approximately $44,000 more than renting.

*sigh* Oh well… this just stokes my motivation to soldier on in passionate debt-slayer mode!

Try placing your numbers into the calculator to audit your own housing situation.

So… is it better to buy or rent?

Does the joy of home ownership outweigh the higher cost?  Is sacrificing home ownership more than you can stand to do, or are you one of the few who have chosen sacrifice immediate wants choosing instead to rent, save up, and pay cash for your a home?

Ultimately, you are the only one who can answer that question… according to your unique situation.

If you are currently contemplating home ownership, I recommend being careful not to make partially educated decisions based mostly on emotion.  Instead, run the numbers for yourself and be sure you have a full understanding of both the short and long term financial ramifications before making your move.

Categories // Debt, Mortgages Tags // home, homeowner, Mortgages, rent

Renting vs. Mortgage and A Solution for Mortgage Free Home Ownership

02.12.2010 by Robert Espe //

The Lie – Renting is throwing money away

Although I am currently debt free I do not own a home, have no immediate plans to buy one, and have been renting an apartment for nearly 3 years now.

You may remember a past discussion on the topic of renting before buying a home, and while there are many factors involved in the renting vs. mortgage debate, today let’s hone in on one common misconception that often drives people into the arms of mortgage lenders:

“Renting is just throwing money away”

Well intentioned friends like to remind hapless renters like myself how much we have “thrown away” in rents over the past several years.  They are also quick to point out that had we only bought (a.k.a. mortgaged our lives for) a home, some of our rents paid would now be counted toward our net worth calculation as equity.  In reality this is misleading at best.  Actually, avoiding a mortgage has provided us an opportunity to build more equity while renting.  To prove my point let’s compare a hypothetical mortgage against my current rental housing situation.

The Truth – Renting cost vs. mortgage cost

According to Bankrate.com borrowers in Laredo, TX with credit scores over 700 can borrow $165,000 on a 30 yr fixed note for about 5% – if they put 20% down.  I don’t know a lot of first time, prospective mortgage slaves with $33,000 in their pocket.  Heck, many may be hard pressed even to have credit scores of 700 or higher.  So we will go with the default numbers in Bankrate’s payment calculator: $165,000, for 30 years, at 7%, with no down payment.  That is enough to buy a house about twice the size of my current apartment in the same neighborhood.

I currently pay $700 for a 626 sq ft, 1 bedroom apartment in a gated community, with a pool and a gym.  We are trading up to a larger house in this example, because that is what most people do.  Few go looking for a 600 sq ft house, as they usually leave apartments for more space.  Feel free to run these numbers with a more expensive apartment or cheaper house; the results should be similar.

Here is a snippet of the Amortization Schedule (click image to see the full amortization schedule.)

Our imagined loan results in monthly payments of $1,097.75.  At the first payment, only $135.25 goes toward principal. After one year of payments the equity, according to amortization schedule, would be $1,676.09 not $13,173.  As you can see… that’s not a whole lot of equity.

We THREW AWAY almost $12,000 in the first year with a mortgage; my apartment only costs $8,400!

Also, by the time the loan is paid off, $230,189.68 has been thrown away in interest paid to the bank.  That is more than the price of the house!  Mortgages steal from your future standard of living. Sure… you will get into a house sooner, but think of all the things you could buy with $230,000 if your house was already paid for!

The Solution – Build more equity while renting

The snippet amortization schedule above shows the initial & final payments on our imagined loan.  It also shows the turning point where the money I through away on interest is less than the money through away on rent.  Notice it is 15 years in the future.  That means I could rent for 15 years before buying a house and still come out money ahead, and maybe save enough to buy a home with cash.

The loan payment is $397.75 more than my current rent.  Instead of making the larger payment to a bank, I continue to pay my rent and put the difference into an Capital One 360 savings account labeled “Personal Equity.”  At the end of one year, I will have $4,773.  That is more than double the equity I would have with a mortgage, and it is also a liquid asset in MY bank account… accessible without having to sell my home or qualify for a HELOC loan.  You build your personal equity faster as you save money, I like to think of this as mortgage pre-payment.  🙂

My own personal equity grows by $875 with every paycheck.  I will have $22,000 by the end of the year.  I am also looking for a cheaper apartment, and probably will spend less than $165,000 on a house.  If I maintain my current standard of living, as my income increases so will my savings.  Eventually I will be able to buy a house with cash in the time it takes most people to pay off a car.

Final Details

You might notice I didn’t account for the mortgage interest tax deduction.  I wanted to keep the math simple, so I also left out costs for home maintenance, property taxes, or private mortgage insurance that more than offset the tax break.  These forgotten expenses will only add to the savings a renter can accumulate while those paying mortgage continue to pay, pay, pay.

For this to work you will need to secure housing below your means while you save to afford something better a few years down the road. This concept of sacrificing now to benefit later is a fundamental building block of sound personal finance.  Renting indefinitely without saving will never get you into a house, but paying a mortgage guarantees that you throw away money on interest.

There will always be a few areas with no available rental housing, but most people should be able to find a decent rental while they save for a home.  However, most people choose a mortgage over renting because they refuse to live below/within their means for a few years… never realizing how much it actually costs them in the long run.

What Do You Think?

I encourage you to visit Bankrate.com and try out their amortization calculator with prices from your area.  If you rent, take note of the difference between your current rent amount and a mortgage payment.  How much personal equity could you build in a year?  If you already own a home, try the pre-payment calculator to see if you can pay that bugger off early.

Do you believe people could ever be completely free from mortgages?  If not, why?

Categories // Debt, Mortgages, Savings Tags // Housing, Mortgages, rent

Powerful Advantages of Renting a Home Before Buying

06.19.2009 by Guest Author //

Powerful Advantages of Renting a Home Before BuyingThis is a guest post by Kevin Mercadante at OutOfYourRut.com.

It’s almost hard to go a day without hearing how lousy the housing market is but if you’re looking to buy you may be able to find an unexpected advantage in all the bad news.

Though not many people do it intentionally, renting a house before buying would provide a number of incredible benefits if you’re willing to do some digging in the market. It’s kind of like test driving a car before you buy—same principal. I’m not talking about a lease purchase, or rent-to-own arrangement either, but a traditional rent-to-rent-and-maybe-buy-at-a-later-date kind of deal.

Think of it as a “Try Before You Buy” philosophy to buying a home.

Lease Purchase

Lease purchases are generally formal arrangements which spell out the terms of final sale in the agreement, and typically require a non-refundable deposit which will be credited toward the eventual down payment. The written agreement is actually a contract of sale with a temporary lease provision included. As neat and tidy as this seems, there are a couple of major negatives in there from the tenant/buyer angle.

First, if you fail to complete the sale, you’ll forfeit your deposit, and that deposit can be considerably more than a typical rental deposit. Second, you are locked into the agreed upon sale price. That would be an advantage if house prices were rising, but at the present time they’re going the other way. Imagine this scenario: you’re locked into a contract at a price of X when the market value suddenly falls to X minus 10% by the agreed-upon sale date. Now you’re faced with a choice of either paying too much for the house or losing your upfront money for failing to do so. Heads you lose, tails you lose.

Rent-to-Rent (Then Own)

On a straight rental arrangement you preserve all of your options, which can be a huge advantage, especially in the current market. Some of the benefits include:

  • Negotiate a lower sale price. Not only will you get the lower future price if values continue to drop, but it is also likely your landlord will not have to pay a real estate commission & therefore will be more flexible in negotiating final price! It’s no secret that many homes are offered for rent in the hopes of securing tenants who might become a buyer, thus eliminating the need for an agent. You may also be able to gain a price advantage by the fact that you’re a buyer in hand, freeing your landlord from the responsibility of marketing the house or performing routine maintenance upon your departure.
  • No moving or moving costs – you’re already there. One of the great financial stresses involved in buying a house is that you’re besieged by costs from every angle—down payment, closing costs, escrows, inspections, new furniture. True, you will have already paid for the cost of the move when you first moved into the house, but one major expense is removed since you aren’t paying it at the same time as all the other costs. It’s spacing out your expenses, which can be a blessing at the closing table. Plus the stress of a major financial transaction is reduced by eliminating the need to combine it with a complete uprooting of your life.
  • No guess work on repairs, condition and flaws. As an existing occupant, you’ll know the real condition of the house as well as any issues that may not come up on a home inspection or appraisal, or that a real estate agent may fail to disclose. For example, an inspection conducted in the summer won’t disclose that a house is drafty in the wintertime. There are flaws and other serious issues that are only visible to a person living in the house.
  • No guess work on the neighbors, the neighborhood or the school system. In the real world, you can fall in love with a house, but find the neighbors or even the entire neighborhood to be intolerable. This is especially true now that so many homes are located in homeowners association controlled neighborhoods (HOA’s). Some HOA’s are overzealous in their enforcement of certain provisions and in others the provisions themselves are close to ridiculous. A friend of mine and her husband recently sold a house in an HOA neighborhood that prohibited overnight parking—in their driveway!  This isn’t something a seller or real estate agent would be particularly fond of telling you prior to closing, but as an existing occupant, you’d already know about it and whether or not you’d be willing to accept it.

Here is an excellent example of one couple who chose to Rent Vs. Buy and how they are putting the savings aside for a down payment on their future home!  They are being very choosy and waiting until they can get exactly what they want!  I think this is a very wise choice, especially considering today’s housing market.

Finding Acceptable Rentals

The good news in this market is that many of the houses that are offered for sale are also potential rentals. In many markets around the country, expected market times to sell a house are running close to year, and often more. A tenant may not be a seller’s perfect prospect, but eventually circumstances may force him to consider it. In short, view any property as a potential rental.

In most areas the number of homes marketed as rentals is small compared to the number that are for sale, so you can expand the number of rental prospects by investigating those listed for sale. Properties listed for sale by owner (FSBO’s) can be an obvious source, but houses listed by real estate agents can be investigated as well. In fact, consider making a rental offer on any house that you would consider as a suitable home for you and your family.

If the property is a FSBO, you can contact the owner directly with an offer to rent. Most will likely turn down your offer up front; that’s fine, leave them your name & phone number in case they consider the option in the future and move on to the next property. It is a good idea to target a specific neighborhood of your liking and employ this strategy.

It gets more complicated with a realtor listed property, but it’s still doable. Typically, when a seller lists his home with an agency, he is not allowed to accept offers outside the agent’s knowledge. But that exclusivity may not extend to rentals, as the seller has signed an agreement to sell, not rent, the home (check the laws in your state). However listings can and do expire without ever producing a sale (more so lately) and a seller is free to do what ever he chooses once it does. Same plan here, approach the owner, not the agent, with an offer to rent, leaving your name and phone number. You will most likely need to knock on the door to speak directly with the owner as all contact information on yard signs and marketing material will be directed toward the agent. In the likely event the owner isn’t home, leave a note on the door apprising him or her of your offer.

Tying it all Together

This will be a bit of a numbers game, and will be more effective if you can make offers on houses that have been on the market for six months or more, but approach enough sellers, and you may get a surprising number of parties interested in your offer, enough at least to provide a decent choice of homes.

It probably will be better if you don’t suggest any intention to purchase the home at some point in the future, leaving that proposal to the sellers. Whoever asks for the sale first is in the weaker position. No seller ever wants to rent his home as this will rarely solve all of his problems. But rest assured that even if he agrees to a rental, he will do so with the hope that you will be the eventual buyer. It is unlikely the seller will want to put it back on the market especially after being unable to sell on the first go round. You will be his first best choice as buyer by default.

If you find a home you like and the owner is willing to accept your rental offer, you can move in, “test drive” the house, the neighborhood (and the neighbors), as well as the school system.

What do you do if it all checks out? Wait for the owner to offer to sell the house to you; that will most likely happen sometime before your initial lease expires. When it does, you can move forward with 100% confidence that the home you’re buying is the right one for you. And you won’t even need to pack up your furniture!

Categories // Counsel, General, Investing, Spending Tags // buy, home, rent, save

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