When making crucial financial decisions, comparing alternatives is beneficial. We have developed software which makes such comparisons easy.
This page will concentrate on one of these decisions that you, or someone you know, must make regarding renting vs. buying. Although the attached example below concentrates on the question of renting vs. buying a house, we could also help you analyze a “lease vs. buy” decision for cars, business assets, second homes, and more.
Please note that my goal is not to talk you out of buying a house. My goal is to have you realize that purchasing a house is not usually as good an investment as most people think. If you like, I would be happy to change any of the assumptions and run a customized worksheet to help analyze your particular options.
List of Assumptions
Please start with the List of Assumptions below and note any changes that you want to make. Many of the costs are presented as a percentage of the purchase price or rental cost. Although support exists for every assumption made, the assumptions will vary for different real-life situations.
The most difficult assumption is determining what is equivalent value for renting and buying. I have assumed $1,000 in rent and have used $100,000 as the cost of a home.
Of course, in many situations, comparable rentals are simply not available. In addition, I have not attempted to quantify the satisfaction or the hassle of home ownership.
|Home Renting Information|
|Monthly Rental Amount||$1,000|
|Annual Rent Increase||2.50%|
|Annual Repair, Maintenance & Insurance||1.00%|
|Home Purchasing Information|
|Annual Increase in Value||3.00%|
|Annual Repair, Maintenance & Insurance||3.50%|
|Land % of Fair Market Value||15.00%|
|Building % of Fair Market Value||85.00%|
|County Tax (mills)||36.5|
|City Land Tax(mills)||184.5|
|City Building Tax(mills)||32|
|School Land Tax(mills)||59.7|
|School Building Tax(mills)||59.7|
|Term of Mortgage (Years)||30|
|Annual After Tax Return on Investment||4.00%|
Rent vs. Buy Worksheet
Please start from the left and move to the right. R&M&I is repairs, maintenance, and insurance. The investment column is cumulative and is calculated by taking the down payment and the closing costs and investing them at a 4% rate of return. The yearly cost is the total rent, utilities, repairs, maintenance, and insurance.
These costs include a calculation of your mortgage payment, including the amount allocated to principal and interest. It also shows the payment amount and the balance of the mortgage over time. Also listed are the real estate taxes, repairs, maintenance, insurance, and utility costs.
To provide a meaningful analysis, however, I included appreciation on the house. In addition, I calculated the tax savings which results from having the ability to deduct real-estate taxes and interest. Please note that if you do not itemize your deductions, then the tax savings could be exaggerated. If, on the other hand, you are in the 39% bracket, then I have understated your tax savings by assuming a 28% tax rate.
The yearly costs consist of the mortgage payment plus the real estate taxes, repairs, and utilities, less the tax savings.
|Year||Interest||Principal||Payment||Balance||RE Tax||R&M&I||Utilities||FMV||Tax Savings||Yearly Cost|
Rent vs. Buy Comparison Table
Please start at the top and work from left to right. The first two columns come from the worksheet. The third column is the difference, or the amount of renter or owner savings per year.
The fourth column assumes that the renter puts his annual savings into a separate account that yields 4% after taxes. The fifth column shows the cumulative effect of investing the down payment and closing costs. The last column is a total of the previous two.
Below the table, find an analysis of what would happen if you sold the house at the end of 1, 5, 10, 15, and 30 years. I have assumed that you would be able to sell the house with normal costs and normal appreciation over the same periods.
This analysis becomes particularly important if there is a reasonable chance that you will want to sell your house before the mortgage is completely paid. In almost all cases, the earlier you sell the house, the better off you would have been had you rented. I have heard realtors say that their rule of thumb was that you had to live in a house for three to five years before you would break even. This analysis tends to show that, depending on the comparable rental, the “breakeven” point is five years.
Tax Deferred Savings and Rent vs. Buy
There remains one other crucial financial option to consider. Take the money that you save every month by not having a down payment and the lower cost of renting and invest it into a retirement account such as a 401(k), 403(b), 401(a), Keogh, SEP, or other deductible qualified plan. (Please note that this does not mean investing in a life insurance policy which is marketed as a tax-deferred investment!) Then, you could get a current tax deduction and accumulate wealth on a tax-deferred basis. I also have developed a program that runs those numbers. In fact, we could even integrate the two templates and complete that analysis if desired.
Special for Business Owners
Business owners often ask me about investments. For confident owners who believe in their business or service, I usually advise them to invest in their business. Small business owners should be able to get a 20% to 30% or higher return by investing in their business. (This may sound too high to you, but that is a different question for a different day.)
Assume that you have a business or service which would benefit from additional investment. Also assume that you could afford to live in a house but choose to rent instead. With all the money you saved by renting, you opted to invest in your business. Depending on the exact rental and price of the house that you purchased, you would almost undoubtedly be better off had you rented rather than purchased.
Rent vs. Buy Comparison Table
Rent vs. Buy Comparison Table & Graph
|Year||Yearly-Renter Costs||Yearly-OwnerCosts||Renter/ (Owner) Savings||Renter/ (Owner)Savings Investment||Down Payment and ClosingCost Investment||Total Rent/(Buy) Cash Savings|
|Sale of Home after||1 Year||5 Years||10 Years||15 Years||30 Years|
|Less Mortgage Balance||89,241||85,526||78,876||68,992||0|
|Less Selling Costs||10,000||11,255||13,048||15,126||23,566|
|Less Total Rent/(Buy) Cash Savings||13,732||15,891||16,588||14,653||(9,913)|
|Better to Buy or (Rent)||(12,974)||(121)||16,645||52,488||222,004|
Everyone used to think that real estate was a wonderful investment, in part, because we used to earn significantly higher rates of appreciation on real estate. Now, unless you make an exceptionally good deal or unless the economy changes drastically, real estate is having a hard time keeping up with inflation. In many areas, real estate is losing value to inflation.
Another factor is that with Pittsburgh and local municipalities looking for more revenue, the assessments on real estate have increased dramatically.
If you would like me to run numbers for your particular situation, I would be glad to do so. I can also use this program to help you analyze other decisions such as:
Car – lease vs. purchase
Asset acquisitions – lease vs. purchase
Existing house – upgrade, stay, or even rent
Owning rental property, break even analysis
A host of others
Finally, we have put the finishing touches on a program that provides accurate cash projections to help you choose from a variety of options.
If you would like me to help you make an important financial decision, please feel free to call.
Certified Public Accountant