There are a number of factors to consider when trying to decide between renting vs. buying a house. In this article we’ll lay out some of the most important factors to consider.
Renting:
- + Flexibility
- + Maintenance usually done by owner (landlord)
- + Usually Cheaper
- – No equity (you retain no value from your payments)
- – No upside potential (you don’t benefit from price appreciation)
- – Rent generally increases over time
Buying:
- + Build equity (a portion of your mortgage payment goes to your home equity)
- + Upside potential
- + Potential income tax deduction
- – Flexibility
- – Maintenance
- – Property Taxes
- – Property Insurance usually required
Doing the math to figure out whether buying is a good financial decision for you depends on a number of factors. We’ll walk through an example and provide you the tools to help you make this decision for yourself.
At a high level, the longer you plan to stay in a home, the more likely it is that buying makes sense for you. Doing the math will require us to know a few things:
- Your down payment %
- The interest rate and amount of your monthly mortgage payment that goes to equity
- The local property tax rate
- Your current income tax situation
- Expected property insurance cost
- Expected maintenance cost
- Expected housing price appreciation
Down Payment %
Your down payment % will have a significant impact on the length of time you need to stay in a home for it to make financial sense. If you aren’t able to put 20% down up front, you will have to pay for PMI insurance. This protects the lender (i.e. a bank / mortgage lender) from losses should you stop making your monthly payments. This is an added cost for you with no associated benefit.
With a median sale price of ~$240k in Charlotte, many first time buyers will need to pay for PMI. There are a number of calculators online (like this one) that can help you calculate your expected PMI payment. Using the median sale price and assuming you can put 10% down, you may pay ~$50 per month for PMI.
Interest Rate
Your interest rate will determine your monthly payment and how much of your payment will go to interest. Using the same tool from earlier, you can find how much of your payment will go to equity. For a $240k house with 10% down, your monthly payment would be $923 (of this, $481 of your first payment goes to interest, $392 goes to equity, and $50 goes to PMI).
Over time, the portion of your payment that goes towards equity will increase. You can use something called an amortization schedule to determine how much of each of your future payments goes to equity. This is important because, while you total payment is $923 per month, you can expect to get the equity portion of your payment back should you sell your house in the future (assuming you are able to sell it for the same price you purchased it for).
Property Taxes
You will pay property taxes for any property you own. In Charlotte, you can expect to pay ~1.3 cents per dollar. This important to take into consideration when purchasing a home because, while you may be able to deduct a portion of this from your taxes, it is a recurring annual payment that you will need to make that you would not be responsible for if you are renting (your landlord would make these payments)
For our $240k house, this would come out to a little over $3k per year or $250 per month.
Your Income Tax Situation
Your primary cost of purchasing a home is the cost of your PMI insurance, the portion of your monthly payment that is devoted to interest (you will get the equity portion of your payment back should you sell some day in the future), and your annual property taxes. Depending on your tax position and the price of your home, you may be able to deduct a portion of these costs from your annual income taxes.
There are some online calculators that will help you figure this out. Using our example house, in year 1 you would pay:
- ~$3k in property taxes
- ~$600 in PMI payments
- $5.7k in interest
In this instance, the total amount paid is less than the standard deduction you likely take when filing your income taxes, so there would be no tax benefit.
Calculating your tax benefit is complex and depends on your total annual income, filing status (single, married, etc.), and whether you have any other deductions that could be itemized. It’s best to rely on an online calculator or your tax advisor to calculate this, if you feel it is an important part of your home purchase decision.
Property Insurance
Everyone should get property insurance and ,if you are getting a mortgage, you will be required to. There are many factors that impact the price of property insurance (the price and location of your house, your credit score, etc.); the average price is the Charlotte area is ~$1,000, but can vary significantly based on these factors.
Maintenance Costs
Once you own your home, you will be responsible for any maintenance costs; from unclogging drains to replacing the roof, the days of the building maintenance man are over. Maintenance costs depend on what you do yourself (if you have a lawn, are you going to pay someone to mow it?), but a common rule of thumb is ~1% of the home purchase price. A study done by Zillow and Thumbtack found the average maintenance cost for the Charlotte area was ~$2,900. Based on these, we’ll assume an average cost between $2,400 and $2,900 for our “average” home.
Price Appreciation
Our newsletter provides some additional detail on historic price appreciation for specific areas, housing types, etc. There are a lot of factors that determine how much price appreciation to expect (the economy being a huge factor); post-2008, we saw 0 price appreciation in the Charlotte area (many areas across the country saw prices decrease), recently housing prices have increase > 6% YoY (and some areas of the city have seen significantly higher appreciation).
If we average the annual appreciation over the past 30 years, it’s ~4% per year, so we will assume our house appreciates at this rate.
In Summary
Assuming we put 10% down on our $240k house, we would owe $216k on the house. While the $24k down goes to your equity (so it isn’t really a “cost” although your money is tied up), you will also need to pay some closing costs up front (you can read more about closing costs in our other article here).
Year 1 cost of owning a home:
- + 12 mortgage payments $11,076 ($5,700 goes to equity)
- + Property Tax $3,000
- + Insurance $1,000
- + Maintenance Costs $2,650
- – 4% price appreciation $9,600
- Total Cash Out = $17,726
- Equity Increase = $15,300
Assuming 4% price appreciation, your cash output is largely offset by improvement in your home equity, making your net “cost” of living there <$3k per year. If you assume no appreciation in the house price, then the net “cost” increases to ~$12k, so appreciation in the hosing price plays a large role in determining the economic cost of living in your home.
Compare this to the average Charlotte rent of ~$1,300 (annually $15,600) and you can see that purchasing a home requires MORE cash be paid out per year (in this instance ~$2k more), but that the benefit is in the equity of your home.
How long you plan to stay in your home plays a significant role in determining whether purchasing a home is the right decision. You will often need to pay a real estate agent to sell your home and between realtor fees and closing costs, you can eliminate any financial benefit of purchasing a home. A general rule of thumb is that you will roughly break even, if you decide to sell your house within 1 1/2 – 2 years. If you are planning to stay in your home for the long term though, you can reap significant benefits.
Total 5 year cost of owning a home:
- + 60 mortgage payments $55,384 ($25,100 goes to equity)
- + Property Tax payments ~$15,000 (may increase with appreciation)
- + Insurance payments $5,000
- + Maintenance Costs $13,250
- – 4% price appreciation $52,000
- Total Cash Out = $88,634
- Equity Increase = $77,100
If you sell your home after 5 years, you will have spent ~$89,000 in cash (ignoring your down payment) vs. $78,000 renting, so the total cash cost of purchasing a home is ~$11k higher. While homeownership may “cost” more you are building equity along the way. When you sell your home, you will get ~$55k in equity back (after accounting for $20k – $25k in selling costs) giving you a net cost of $34,000. While the cash cost of home ownership is higher, the total net cost is ~$44k lower.