Why it can be Cheaper to Buy a House than to Rent It

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Why it can be Cheaper to Buy a House than to Rent It
June 18, 2014

You have been renting a home for some time, and would like to consider purchasing it — or something similar — in your neighborhood. However, it is difficult to factor in all of the economic tradeoffs between renting and buying. You must consider all the costs associated with closing, and make assumptions on what will happen over time, such as how much your rent would rise versus how much a home might appreciate if you bought it. Understandably, all this complexity has prevented you from taking action.

You are in luck, however, because a February report from Trulia did the work for you. Their report concludes that, for most people, buying under current conditions is cheaper in the long run. Closing and other transaction costs are more than offset by tax write-offs and other savings in the longer term.

The Trulia report makes a series of relatively conservative assumptions to determine the cost-benefit analysis over a seven-year period – thus, you should assume that you will be staying in the home for at least seven years before this scenario is valid and that mortgage deductibility remains at status quo.

Among other assumptions are 2% annual inflation, a yearly 2.2% rise in both rents and home prices (although they are adjusted for areas that are known to follow other trends), and a 30-year fixed-rate mortgage at 4.5% with a 20% down payment (as compared to the current rate near 4.2%). The study also takes into account opportunity costs – the return you would receive had you spent your money elsewhere.

Under these conditions and assumptions, payments are predictably low enough that buying allows you to recover initial cost differences over time – but it is highly dependent on the interest rate and the presumed rise (and hopefully not fall) in home value. The study puts this in perspective through tipping points – the mortgage rate at which renting becomes cheaper than buying.

Nationally, the Trulia study concludes that buying is 38% cheaper than renting, down from 44% last year because of higher home prices and interest rates. In all 100 metro areas studied, buying was preferable – although there are some local markets where renting is nearly as economical.

Of the top ten areas where renting is almost equal to owning, six are in California – three in the Bay Area (San Jose, San Francisco and Oakland) and three in the L.A. area (Los Angeles, Orange County and Ventura County). However, the top spot is in Honolulu, where under the 2014 Trulia assumptions the interest rate tipping point is at 5.0%.

Meanwhile, the top ten areas where buying is an obvious advantage, due to depressed housing values, are scattered throughout the Midwest and South – areas such as Toledo, St. Louis, and Cleveland. Topping this list is Detroit, with the tipping point at a staggering 33.8%.

To analyze your situation, Trulia offers a Rent-vs.-Buy calculator that allows you to test your own scenarios based on any assumptions you make. The New York Times recently published a similar online interactive calculator online.

The Trulia guide is about buying or renting comparable properties, not upgrading – so keep this in the overall context of not buying more than you can afford. You can still use the calculators for rough comparison of an upgrade, but keep in mind that is not what they were designed for.

In the end, these calculations are only good as a starting guide, because actual changes on interest rates and home prices can easily swamp the assumptions in these studies. Use the calculators as relative comparisons if you like – but the real benefit of buying is the building of equity to get some return on your housing investment.

Your time is better-spent working on your individual situation with income, down-payment money and gauging home affordability than it is running endless rent-vs.-buy scenarios. Do not buy a home just because it seems to be a better deal – buy a home because you want to be a homeowner.

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