Where Buying a Home is a No-Brainer
Cost of Buying vs. Renting (%), 2013
Cost of Buying vs. Renting (%), 2012
Farmington Hills, MI
|8||Kansas City, MO-KS|
Note: Negative numbers indicate that buying costs less than renting. For example, buying a home in Detroit is 70% cheaper than renting in 2013. Truliaâ€™s rent vs. buy calculation assumes a 3.5% 30-year fixed-rate mortgage, 20% down, itemizing tax deductions at the 25% bracket, and 7 years in the home.
In the largest metros, the rent-versus-buy decision depends largely on location. Within the New York metro area, buying is just 6% cheaper than renting in Manhattan, but 53% cheaper in suburban Westchester County. This, however, is an extreme example. The differences within most metros arenâ€™t quite so stark. In theÂ Los AngelesÂ metro area, buying is 22% cheaper than renting in the Pasadena / San Gabriel Valley area (telephone area code 626), while buying is 36% cheaper than renting in the San Fernando Valley (area code 818). The difference between the 626 and the 818 is a lot smaller than the difference between Manhattan and Westchester.
Hereâ€™s How Renting Could Be the Better Deal
Three factors have a real impact on the rent-versus-buy math: mortgage rates, tax deductions, and how long you stay in your home. Change any of these factors, and buying a home wonâ€™t look quite as inexpensive relative toÂ renting. Using our baseline assumptions of getting a 3.5% mortgage rate, deducting at the 25% bracket, and staying in your home for 7 years, buying is 44% cheaper than renting nationally. Hereâ€™s the â€œbutâ€:
- Lower mortgage ratesÂ lower the cost of owning. While buying is 44% cheaper than renting with a 3.5% mortgage, buying would be 39% cheaper than renting at 4.5% and only 33% cheaper at 5.5%. Higher rates mean a higher cost of owning, but prices today are low enough relative to rents that buying would beat renting even if mortgage rates rose two full points.
- Itemizing deductionsÂ lowers the cost of owning. Mortgage interest and property tax payments are typically deductible. If you itemize deductions (at the 25% tax bracket) regardless of whether you own or rent, buying is 44% cheaper. Without itemizing (read: youâ€™re just taking the standard deduction), buying is still 35% cheaper than renting. This means that even if tax deductions were eliminated entirely â€“ donâ€™t worry, no one in Washington is seriously proposing anythingÂ thatÂ drastic â€“ the rent-versus-buy decision probably wouldnâ€™t change that much. Though it would probably encourage people to buy smaller or cheaper homes.
- Staying put longerÂ lowers the relative cost of owning. The combined cost of buying and then selling a home can easily total more than 10% of the homeâ€™s value. Staying put longer means, in effect, spreading those costs over more years. Buying is 44% cheaper than renting if you stay put for 7 years, 37% for 5 years, and 20% for 3 years.
In other words, depending on your circumstances, buying could be a bad deal. Suppose you stay put for only 3 years AND donâ€™t itemize your deductions (lots of homeowners with mortgages donâ€™t itemize, by the way). Even with a 3.5% mortgage, buying would be only 9% cheaper than renting nationally. And in many markets, buying would be MORE expensive thanÂ rentingÂ if you stay put for 3 short years and donâ€™t itemize: buying would be 2% more expensive than renting inBoston, 9% more inÂ Los Angeles, 26% more inÂ New York, and 45% more inÂ San Francisco. Clearly, buying is not for everyone â€” especially if you live in a more expensive housing market.
Remember, also, that owning carries a lot more risk than renting. Some of the factors affecting the cost of ownership involve a lot of uncertainty.
- One uncertainty: you might plan to stay in your new home for a long time, but unexpected family or employment circumstances could make it necessary to move sooner and incur those closing costs after just a few years.
- A second uncertainty: unforeseen maintenance or renovation problems could push the annual care and upkeep costs much higher than 1% of the homeâ€™s value, which is what we included in our model.
- And, of course â€“ as if this needs to be said after the last few years â€“ thereâ€™s no guarantee that home prices will rise. Weâ€™ve used a conservative estimate of a little over 2% home price appreciation per year, varying a bit by metro â€“ which is just slightly above the rate of inflation weâ€™ve included. But actual appreciation could be much higher or lower than that. Price declines are always a risk, and not just inÂ Las VegasÂ andÂ Detroit. Even metros that didnâ€™t see huge price declines during the most recent housing crisis have sustained price declines in the past. For instance, prices fell by more than 20% in much of Texas and Oklahoma in the late 1980â€™s, and by 10-20% across much of New England and upstate New York in the early 1990â€™s, according to FHFA.
Buying Probably Wonâ€™t be This Cheap Relative to RentingÂ NextYear
How will the rent-versus-buy math change over the next year? Two factors matter most: (1) whether prices or rents are rising faster, and (2) whatâ€™s happening to mortgage rates. Looking forward, the gap should narrow more sharply because both factors should work together to raise the cost of buying relative to renting.
First, home prices are likely to keep rising faster than rents. The continued economic recovery will make people more able and interested to buy a home, boosting the demand for housing whileinventory remains tight, fueling price increases. At the same time, the increase inÂ multi-unit-building constructionÂ should add more supply, especially to the rental market, which will keep rent gains modest.
Second, mortgage rates are likely to rise in the next year as the economy improves, even though they fell in the past year. The consensus among macroeconomic forecasters is for 10-year Treasury bonds â€“which 30-year fixed-rate mortgages track pretty closely â€“ to rise 6 or 7 tenths of a point over the next year. This translates roughly into a 7-9% higher monthly payment for a given mortgage.
Together, prices outpacingÂ rentsÂ and higherÂ mortgage ratesÂ will make buying less affordable next year relative to renting than it is now. By this time next year, the cost of buying could even exceed the cost of renting in some of the priciest metros. The rent-versus-buy decision depends on so many factors, both economic and personal, and next year the math could look very different.
Courtesy of: Jade Kolko