Rent vs Buy? Six Rules to Help You Figure It Out
“You’re paying $1,500 in rent? You’re crazy – that’s a mortgage payment!”
You’ve heard that, right? It implies, of course, that you’d be smarter to buy a house because . . . because . . . well, just because, that’s why. And millions of people, using that exact rationale bought up every structure with windows and a front door during the housing boom of the mid-2000’s, and now that banks are lending again, guess what? Borrowers are coming back for more.
Let’s get one thing straight up front. Rent DOES NOT equal a mortgage payment. Your rent typically includes all of the basic expenses of maintaining a house or apartment. A mortgage payment includes nothing more than paying the lender back the money it loaned you to make your purchase, plus interest. All those other expenses, they’re on you.
Ah, but, the American Dream, buying a house. Painting it whatever color you’d like, mowing your own grass, planting your own flowers and bushes. Buying whatever dog you like and not having to worry about a landlord deciding you’re not a great tenant. Sell it later and make a fistful of money. What could go wrong with that idea?
Not so fast. This is big money you’re talking about. And possibly your biggest investment, so why not take a few minutes and think it through? The pain of having seen the value of real estate drop 10% – 50% or more, depending on where you lived was not a bad dream, it was the reality of many factors coming together – some of which were totally under the control of those anxious homeowners who couldn’t wait to sign on the dotted line. You still control those, so consider them.
1. How much are you really paying for the house? Let’s say it carries a price tag of $400,000.00. If you have $400,000.00 in your piggy bank, then it costs you only what you could have earned with those funds had you used them for something else (minus the cost of renting or other living arrangements). If you’ll be borrowing, say 80%, or $320,000 at maybe 4.5% for 30 years, you’ll be repaying the loan, plus another $230,000 in interest (at $1,500 per month total payment). If your marginal tax rate is 20%, then Uncle Sam will pay $46,000 of that $230,000 for you, so the total price tag will be: $80,000 (your down payment) + $320,000 (principal borrowed) + $184,000 ($230,00 interest minus $46,000 tax break) or a total of $584,000. (Just for grins, if you were curious, let me mention that if the interest rate goes to 5.0%, the total payment jumps to over $680,000.)
Now you say, I can’t rent the same house I want to buy for $1,500 a month, so I want to buy. Read on.
2. Are you breaking the basic rule of investing? The cardinal rule of investing is “spreading the risk” because you never know what’s going to happen to one segment of the market. We could talk about what that means for a many pages, but one thing we know is this: if most of your money is going into your house and not being used for other investments (something defined as spend now, get a return from it later), you may be putting too many of your eggs in one basket . . . and if the value of your house goes down for whatever reason, you may have lost much of your savings.
Do you need to be saving for kids’ college? Your college? Retirement? Starting a new business? You can’t count on your ownership equity rising so fast that you can take out a second mortgage to finance those things.
3. What will the future bring? If you thought the value of your house was going to go up when you sold it, you’d feel a little better buying it, right? Would you feel as good if you thought about what you’ll have to pay for the next new living quarters? If you just keep buying, what are you really gaining? Conversely, if you thought the value of your house was going to go down, you’d feel a little uncomfortable buying it, right? But again, if you just keep buying less expensive houses, what are you really losing? Big point here being you can’t really count on what the value will be when you sell (hoping and counting on are not the same thing). Why? Things change over time. Jobs, families, needs. Etc. When you want or have to sell you will take the best price you can get . . . and if you have already bought another house, you’ll most likely take less so you don’t own two of them. . . or if you get a great offer right off the bat, then, with a little less negotiating power, you’ll scramble to buy something else and perhaps settle or overpay for not your favorite next house.
4. How about those other expenses that you thought you could estimate easily? New roof? (A barrel tile roof in Florida – those pretty red clay tiles that last forever – can cost tens of thousands of dollars. Yes, they last for decades. Maybe longer than you.) Digging up the yard to replace the septic tank? Probably $5,000+. Ripping up the walls to replace a major plumbing break? (How’s your insurance?) Replacing the central air or heat? Termites? And what about “cosmetics,” the little word that sounds optional and cheap, but isn’t. New countertops? $3,000 easy for formica. Cabinets? More. Flooring? Redoing the bathroom? . . . You get the point. You say the house comes with a warranty and anyway the inspector will have highlighted all of those probabilities before purchase and you will figure them in to the cost of the house? And you’re handy, you may do the work yourself. Really? Read the fine print of the inspection’s contract, and pay close attention to the exclusions. And check your free-time calendar.
5. Taxes, insurance, home owners’ association fees. Property taxes have a nasty habit of going up when the real estate market improves, so when you budget for them, add an escalator. Insurance is somewhat competitive and premiums vary widely depending upon the breath of your coverage (floods anyone?) and the size of your deductible. A typical annual premium minimum is probably $3.50 per $1,000 of value of your home. BIG caveat – consider carefully getting the type of insurance that will actually let you replace your house if burns down. And don’t forget to make sure you’re covered if a tornado or hurricane comes to town. Practically every area of the country now is a prime target for fire, flood, tornado or hurricane. Don’t assume that just because the bank insists you’re covered, the insurance is enough – remember, it only is protecting its mortgage loan. You’re protecting the entire home and its contents.
And a few remarks on HOA fees . . . while the monthly or quarterly charges may be easy to estimate, are the folks who run the association watching to make sure upkeep is proper? Those extra assessments for a new roof necessary when leaks haven’t been repaired properly or parking lot cracks aren’t filled are usually on top of your monthly payment.
6. And the best question of all – What’s really wrong with renting? It used to be thought of as the temporary living arrangement between finishing your education and moving into a “permanent housing” with a partner and maybe kids. And that attitude often made landlords regard tenants as temporary folks. Not so much anymore. Why not? Main reason – people have noticed that the real estate market has ups, and it has downs, and if you need to sell your house during a down, it can be very painful. Second reason – we’re all much more
mobile now and the flexibility of renting fits into that need. Might your employer move you from Chicago to LA? Might your employer go out of business or eliminate your job – and now you have to find your new employment where you can?
Landlords are reacting to the new reality – meaning that more and better rental living is available. Whole communities of rental houses are being built. Apartment communities are routinely including dog parks, tenants’ gardens, car wash areas, kids’ playgrounds. That’s another way of them saying “don’t leave us!”
If you were getting out your calculator and paper and pen, you’re in luck. The New York Times has done some of your work for you and can help you easily zero in on the exact numbers to solve your “rent vs buy” question. The newspaper published a handy-dandy rent vs. buy interactive evaluation tool that takes into account the points made here, and more. Take a look!
And, if you’ll permit me to say a few more words, if you’re looking to rent in the Sarasota-Manatee area, whether it’s for an annual, monthly or vacation rental, take a look at www.SRQrents.com – the area’s easiest to search site with hundreds of rentals for you!