Buy vs. rent — #2 — the short term

September 11, 2006

In my first post on this topic, the “aha” insight was that, even with today’s wacky ratio between home prices and rents in the Bay Area, you’re likely to be better off in the long run — five years or so — buying than renting, even if you assume fairly modest property appreciation. This “killer” chart, based on how long you’ll be in the house and what you expect the housing market to do in that time, helps you figure out the tradeoff.

Now let’s play with some numbers and see where this graph came from.
Since we’re comparing renting and owning, it makes sense to start with a sample home and figure out what it would cost to rent and what it would cost to buy.
Let’s imagine your standard ranch-style 3-bedroom, 2-bath, 1400 square foot home, in good condition, in an average neighorhood in, say, Mountain View, for which you would expect to pay around $825,000. Renting the same home would set you back around $2400 per month.
Let’s assume you buy the home with 10% down and finance the rest with a 6% 30-year fixed loan. (Current interest rates are actually a bit higher, but that doesn’t materially change the answer.) Let’s assume property taxes are 1.25% per year, and that maintenance and insurance cost you around 0.5% per year each — figures very much in line with my own experience as a landlord. Though technically only mortgage payments — not taxes, maintenance, and insurance — get paid monthly, let’s smooth things out and pretend all of these are monthly expenses.
Punch these numbers into your calculator, and you’ll end up with just under $6000 per month in expenses — a hefty premium over the $2400 you would pay to rent. But…as we real estate professionals never tire of telling you…don’t forget the tax benefits of home ownership.
Uncle Sam, and his counterpart in Sacramento “Uncle Arnold”, often let you write off your local property taxes plus the interest portion of your mortgage payment. Assuming you’re in a 30% federal and 10% state marginal tax bracket — and in this area it’s hard not to be — that gives you a tax break of about $2000 per month. You end up with a net monthly cost of just under $4000, a lot better than $6000, but still uncomfortably higher than your $2400 rental bill.
Ouch! What if you go with an interest-only loan to reduce your monthly payments? Keep the other assumptions the same, but let’s change your mortgage into a five-year interest-only product at 5.25% (again, the real rates are higher, but this doesn’t materially change the answer). Now you end up with monthly expenses of only $2900 per month, closer to but still higher than your monthly rental expenses of $2400.

In the short run, you are indisputably better off renting than buying. In the long run, however, the opposite becomes true.
Stay tuned…

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Written by Kevin · Filed Under Buy vs. rent, For buyers, Mountain View, Real estate, Real estate data 

Comments

One Response to “Buy vs. rent — #2 — the short term”

  1. NEIGHBOROO BLOG » Blog Archive » Finding a Home - Part 2 on February 2nd, 2007 11:22 am

    [...] Buy vs. Rent Part 2 [...]

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