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June 1, 2012 | No comments yetTags: buyer, buying, calculator, Financing Friday, mortgage, renting, taxes
Renting vs. buying is where it starts, so beginning today, I am starting a new series of posts on financing issues specifically addressed to buyers. Over the next few weeks, you can plan on seeing posts on all kinds of issues along those lines, so if there’s something in particular you want to see, be sure to let me know.
When you’re thinking about buying a home, the first thing you need to consider is renting vs. buying. Oh, sure this is the best market ever, and “everyone” is saying now is the time to buy, but what about you? Is buying in your best interests? Luckily, my potential buying friend, I can help you sort that out. We can play a “what-if” game with one of the financial calculators right here on this site.
How about — just for fun — we use the “Rent vs. Buy” calculator? (For future reference, you can find it, along with all the buyer-focused calculators on the Buyers > Calculators for buyers page.) To show you how it works, it would be helpful, for this first go-round of renting vs. buying analysis, if you’d enter the figures I tell you to enter. So let’s get started, with the following scenario:
- Purchase price $350,000
- Annual appreciation 3%
- Annual maintenance $2500
- Down payment 20%
- Interest rate 4% (really!)
- Term 30 years
- Tax rate .8% (don’t forget the decimal point)
- Insurance rate .5% (ditto)
- Tax bracket 28% (unfortunately, no decimal point here)
- State tax bracket 4.63%
- Rent $1,000
Then, hit the calculate button, and watch the renting vs. buying results appear magically on the screen.
Now let’s go through it, and see what we’ve got. Then I’ll tell you about some caveats before I turn you loose on it.
You’re already loose on it, aren’t you? I know it’s fun to push buttons, but let’s talk about what the numbers mean.
The first figure, right below the title ($260.11) is the net monthly cost of housing if you buy a home with the parameters we just entered in our renting vs. buying scenario. As long as that figure is less than what you’d pay per month in rent, it’s beneficial to own. If that figure is negative, then you’ll actually be getting paid to own that house. That doesn’t often happen, of course.
Going down the screen, you’ll see these numbers:
- Mortgage @4% for 30 years (what we entered) $280,000. This is the price minus the down payment (20% or $70,000).
- Total monthly payment, $1,715.93. This includes the principle and interest payments to the lender and also an amount they collect and hold for property taxes and insurance. That’s what PITI stands for. This the amount you will be writing a check for each month.
- Net cost of housing, $260.11. This is how much it actually costs you per month to own the house, after you take into account the effects of income tax deductions, appreciation, and maintenance. As long as this is less than rent, it is cheaper to own your home than rent it. This is the key figure in this whole analysis, and that’s why it’s highlighted at the top of the page.
- The monthly rent (for comparison) is just a repeat of the the figure we entered.
- Monthly cost of renting vs. owning is rent from above ($1,000), minus the true cost of owning ($260.11). This is the net effect of NOT buying the house. In other words, this is how much more it costs you every month to NOT own the house. Or, in still other words, this is how much money you are throwing away. Every month.
- Same as above, but times 12, so you can see the effects for a whole year.
- The last section — Effect of Leverage — shows where you’d stand at the end of seven years, assuming the increase in market value (appreciation) we entered (3%). You can see how much total equity you’d have, and where it came from: either from what you put down when you bought the house, what you get by paying down the loan (amortization), and what you get from market appreciation. Each portion is also shown as a percentage of the whole equity.
The two charts at the bottom of the page show figures for the next seven years. The left chart shows much rent you’ll pay each year, assuming our annual market appreciation estimate (3%) is correct. The right-hand chart shows how much, accumulated over those seven years, you’ve lost by renting instead of owning. It does not take into account any earnings you might get from investing the cumulative savings. You can see that, in this case, after those seven years, the figure is almost $92,000.
With just a bit of planning, that’s a college education without a student loan.
Let’s get back to the net cost of housing. It’s the whole point of doing this renting vs. buying analysis, so let’s make sure it’s clear.
Simply put, there are a lot of advantages to owning your own home. Many of them are intangible, and I touched on some of them in the post about giving yourself the gift of a home. Aside from that, though, there are real financial advantages to owning your home. Over the long run, the value of real estate goes up. When you own the real estate, that increase in value belongs to you, not your landlord. The interest you pay on your mortgage loan can generally be deducted from your income taxes. Rent is not deductible. The principal portion of the mortgage loan amount that you pay each month builds your equity, similar to a savings plan.
Go ahead and play around with the numbers. The figures we entered here were not necessarily random, but enter figures as you see fit, and use assumptions you are comfortable with. See what happens in your own renting vs. buying analysis. You might be pleasantly surprised.
So where did I get the numbers we used? According to the latest figures from the Denver MLS, $350,000 is just about the average home price in Highlands Ranch, and the average rent around here is now about $1000 a month. The appreciation figure is just about what is being estimated for the next several years. The percentage figures (taxes and insurance) are pretty reasonable, given the true rates. The state income tax rate is correct, and the federal income tax is probably a pretty good number, since that’s the tax rate in effect for the income needed to purchase a $350,000 home like this one. Your mileage might vary, of course, so feel free to enter whatever rates work for you.
A word about down payments, though. If you enter anything less than 20%, the monthly payment calculated will include an amount for Private Mortgage Insurance (PMI, if you’ve heard of it). That’s the subject of a whole ‘nother post, but just know that if you can’t make the payments match something you’ve calculated elsewhere, that’s probably why. By the way, if you click the “Download PDF” link at the top right of the results window, you’ll get a written report that goes into a bit more detail. Sometimes it helps to have them handy so you can compare different scenarios side-by-side.
Now, I know I talked about how much you might be “throwing away,” but maybe — even with all these positive numbers — your situation can’t be entered into a tidy little renting vs. buying analysis like this one. It’s true that a lot of stuff simply can’t be quantified, or maybe you think it can’t be. That’s when it’s time to take the next step, and start talking to someone in the field.
Someone like me.
So we can see where you are, where you want to go, and figure out a way to make it happen. Are you ready?
So what’s next? Take your pick.
Yeah. You should probably do at least one of those things right now.
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