Buy vs Rent Decision

If you have committed to buying a home because it will be your own place and you can do what you want with it, then you should read no further. There are some advantages to owning a home that can’t be quantified.

However, emotions aside, there are some other considerations that can help you determine the best choice from a financial perspective.

The U.S. government gives a great break on taxes for homeowners that make the buy vs. rent decision skewed more towards the buyer, and that is the income tax deduction for any mortgage interest. Especially if you are in the higher tax brackets, this deduction can reduce your interest payment by as much as a third.

One of the biggest guesses in determining whether you should buy or rent is how much the real estate market will rise in the period of time you will own the home. We all are aware that prices took a big hit in the 2006-2010 period, so determining a yearly appreciation rate is difficult. One way to get an idea of future increases is to see what happened in past periods. According to the U.S. Census data, median prices rose from $79,100 in 1990 to $119,600 in 2000, a 33% gain in a decade. But on average, you shouldn’t really expect more than a 3-5% price increase every year.

Another important factor in determining whether you should buy or rent, are the expenses you will incur when you own your own home. Some of those expenses are:

Home maintenance – homes need new air conditioning/heating, kitchen appliances, painting, roof repair/replacement, plumbing/electrical repair and more. Newer homes need less maintenance. Older homes need more. And don’t forget those normal routine maintenance (which can vary depending upon weather, geography and your interest and skill in doing some of that maintenance yourself), like air conditioning/heating, landscaping, pool maintenance, drain clogs, etc.) For a 10 year old 2000 square foot home, budget at least $2000 per year in maintenance.

Taxes and Insurance – Renters don’t need to handle these items, but it becomes a necessity for homeowners.

Homeowner’s association fees – if you live in an area that has a homeowner’s association, expect an additional monthly fee.

Costs to sell the home – When you sell your home, you’ll need to factor in real estate agent fees and closing fees. Contact me to get a better estimate, but it may be in the range of 6-8% of the home price.

If you want to calculate your own buy or rent decision, use our Buy vs. Rent Calculator. I’ve included an example given real-life Anthem AZ home purchase and rental prices.

I’ve used a 3000 square foot home with a pool, that can be rented for $1500 per month. I can purchase this size home for $250,000. I think I will sell the home in 5 years, and I’ll pay 7% of the home’s value in fees. I’m guessing that I got a good deal on the home and it may appreciate at a 4% rate every year. My loan is for $200,000 at a 5% interest rate for 30 years. My income tax rate is 26%, my annual taxes are $1600 and annual insurance is $1500. I guessed that rents will increase the same as home prices, at 4% per year. Should I rent or should I buy?

Using the values I’ve specified, I will be much better off buying rather than renting.
My home purchase benefit is $108,869 minus my original $50,000 down payment is $58,869. Pretty good for a 5 year home ownership stint! Of course my benefit will decrease markedly if my actual appreciation is less than 4%.

One factor not included in this calculator is the Opportunity Cost of your down payment. If you rented, how much would your down payment make if you invested elsewhere?

Once you’ve finished your analysis, you’ll want to keep it to see how you’ve fared when you sell your home. And if your projections were a bit too rosy, remember that a home purchase isn’t always about the money, but coming out ahead makes your next home buying decision a bit easier.

Next Article: How Much Can I Afford?