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Rent or Buy a House?


To buy, or not to buy.
That is the question. Should you continue to rent? Or should you
buy your first home? This can be a challenging decision. But it need not be. In the next
few minutes we’ll show you simple way to determine exactly when to make the move to home ownership.
Let’s start with a quick comparison of the advantages of both options. Renting has two
primary advantages: mobility and simplified financial obligations.
Buying a home has different advantages. Each mortgage payment builds equity in your house;
House payments remain essentially fixed, even as other prices rise; Your tax bill will likely
be lower; and your home improvements build upon your investment.
But when is it best to switch from renting to buying your first home? From a financial
point of view, it essentially comes down to two factors:
The minimum number of years you plan to own the house, and the size of your down payment.
We’ll illustrate this with a spreadsheet we created in Google Drive.
(You can get your own copy of the spreadsheet by clicking on the link listed in the description
section below and copy it into your own Google Drive.)
The cells with no shading contain the all information we need for our calculations.
The default values are typical of those for buying a starter home with a cost of $100,000.
A summary of the analysis is best illustrated by two graphs. The first graph shows the projected
expenses for both renting and homeownership over the coming years. The curves show that
the projected accumulated expenses for house ownership start out higher, but eventually
drop below the rental expenses at some point in the future.
There are several reasons for this. First, as soon as you buy a house, you incur the
future cost of selling it. Even though this expense won’t be paid until the house is sold,
we count it as an expense right up front. It’s this expense that makes homeownership
initially cost more than renting. In most cases, accumulated renting expenses
will eventually exceed the costs of owning a home. This is because less money is spent
on mortgage loan interest as you build home equity. On the other hand, rental costs generally
continue to rise at the rate of inflation. By looking at this graph, it’s clear that
you will need to hold onto your house for at least a few years to break even. So if
there is a high likelihood of you moving soon, it’s better to continue renting and save for
a larger down payment. This brings us to the second primary factor–your
down payment. A higher down payment means a smaller mortgage, which lowers your interest
payments, thereby lowering your overall house expenses.
Further, if your down payment is less than 20% of the house price, your loan will likely
require the additional expense of private mortgage insurance (or PMI) as part of your
monthly house payment. Now that we know the two primary factors impacting
your decision, let’s look at the second graph in the spreadsheet. One axis represents the
amount of your down payment. The other, is the minimum amount of time you plan to own
your home. If your situation puts you within the shaded region, it’s better to continue
renting. But if you determine that your situation puts you outside of the shaded region, it’s
time to consider buying a home. For example, this graph shows if you put 20% down, you
should plan to own the house for at least 2.5 years.
You may have noticed that throughout our analysis, we have assumed that the values in our spreadsheet
remain the same over time. But in the world of real estate, nothing remains the same.
Inflation, mortgage rates, and home prices vary significantly over time.
So is the whole analysis hopeless and just a matter of luck? Fortunately not. A homeowner
has one significant hedge against all these variables. That hedge is “time.” According
to the famous Case-Shiller index, given enough time, housing prices will on average track
inflation. Therefore, in most cases, you can avoid a loss due to short-term depressed housing
prices by simply holding onto your home longer. As you have seen, the rent or buy decision
doesn’t need to be overly complicated. By focusing on two important factors, you can
start charting your course to home ownership. If you liked video and want to continue to
learn more about various aspects of home buying, please subscribe to the home buyer channel.
If your business involves home buying or financing, we encourage you to embed this video into
your website. Use the comment section to let us know what
you think of this video and what other types of home buying topics you would like to see
in the future.

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