Owning a home is one of the biggest dreams for many people. However, making that dream come true is not always an easy task, and it requires a lot of hard work and effort. Searching for a community that we love, a location that is convenient to work, and a place that fits our budget can be a tough process. Though owning a home is a big dream that everyone loves to have, it’s not always the best option for all. Sometimes, it is more fiscally prudent to rent a home instead of buying one. Usually, in rent vs. buy calculations, there is a certain point in time that they will “break even”, i.e. the point in time where it becomes cheaper to buy than to rent. Buying a home requires a much larger upfront cost compared to renting, which usually only requires a couple months of rent to start. If someone cannot picture herself living in the same home long enough to hit this break-even point, she is better off renting because she will end up spending more on buying a home than she would with renting. Perhaps this person wants to move to another city soon, they are in a long distance relationship, or their job requires them to relocate often. In other words, renting or buying is very situation dependent; it depends on many variables. There are many things to think about before coming to a correct decision.
For people who are not ready to settle down in one place yet, this is a no brainer, renting is the best option for them. Instead of buying and selling a home every time they move, they can stay flexible by renting. Untethered to their location, they can move to a new place any time they want. Moreover, they do not have to worry about the maintenance, repair or any issues that happens to the property. Another good thing about renting is tenants never have to worry about the property tax or mortgage interest. All they have to do is pay their rent and let the property owner take care of all the other things.On the other hand, homeowners have their own benefits in owning a home. Owning the property gives them the flexibility to do anything they want to the home from making holes on the walls to hang their picture frames up, changing the color of the doors or even the floor to their liking, to something bigger like upgrading their home HVAC system. Every mortgage payment builds more equity in the home. At the end of the year, they can itemize and deduct the amount that they paid for property tax and mortgage interest, and after they pay off the mortgage loan, they own an appreciating asset that holds its value. If they ever want to exchange their home for another, they can sell it, take the equity back out and use it to buy another home. All they have to do is look for another home and get an agent to help sell their current one.
Whether the decision is to buy or rent, it should be made based on each individual’s situation and the factors applied to their own unique case. We will be examining only the important financial factors and scenarios to see if a person should buy or rent a home in the following sections.
Buying or renting a home is a question that is always dependent on each individual and his or her circumstances. The decision making can be quite tough sometimes since it does not only depend on the money; it also depends on the location, type of jobs, staying length, living style, etc. However, to make it easier to give everyone a general idea of the benefits and cost of owning vs. renting, we will only focus on the fiscal numbers, and we make the following assumptions and choices in our Excel model. Let’s assume that a lady named Mary is about to move into Pennsylvania area, and needs to find a place to live. Mary is looking to rent or buy a move-in ready home and plans to stay there for 5 years max. She has been fiscally responsible her entire life, hence she is in a good financial position to buy or rent, which ever benefits her best. She has enough savings to cover the 20% down payment. She has a stable job and maintains a good credit rating that allows her to obtain a home loan. This analysis mainly focuses on similar clients; therefore, it might not be applicable to other clients who are in different financial positions and situations.
Mary wants to check out 3 areas in Pennsylvania that she likes: Philadelphia, West Chester, and Wayne. She does not like apartment or condo style homes, she prefers to buy or rent a home that has 2-4 bedrooms.
There are several different kinds of mortgage interest rates according to mortgagenewsdaily.com. Mary prefers a 30-year home loan with a fixed rate of 4.63% for any possible home purchase.
As stated by Zillow, closing costs are the extra costs that home buyers pay at purchase time to get the property transferred from seller to buyer. They include application fees, appraisal fees, credit report, taxes & mortgage insurance, home inspection, title search, title insurance, origination fee, and other miscellaneous fees. The rate of closing costs can vary from 2% -5% of the home’s purchase price. The model uses an estimated 3% of home price throughout the analysis to calculate the closing costs.
In addition to these purchasing costs, once the home sells 5 years later, Mary has to pay another fee to the real estate selling agent. This type of fee is usually paid by the sellers to realtors to help sell the houses. It’s about 6% of the selling price of the property (Evans, 2017).
Homeowner insurance rates vary from place to place. It is affected by many different elements such as location, condition, age of home, etc. According to Zillow.com, home owners pay an average of $35 per $100,000 of the home price to insure their home. Mary uses this rate to calculate the homeowner’s insurance in the model.
Home maintenance is another issue homeowners have to put up with that renters do not. Annual maintenance expenses depend on many factors. Location, weather, the age of the home are just a few among others. As stated by Pant from The Balance, “One popular rule of thumb says that one percent of the purchase price of your home should be set aside each year for ongoing maintenance.” Mary will use this 1% cost in her model.
For property tax, Mary will use the tax numbers provided by website (Zillow and Realtor) for the homes in the data model.
As for home appreciation/depreciation, this analysis does not model any home appreciation or depreciation in the calculations. Because home prices are highly location dependent and can be unpredictable, it’s hard to predict if either appreciation or depreciation would occur and at what rate. Mary decides not to take appreciation or depreciation into consideration for the model.
On the other hand, there are considerably fewer costs associated with renting. Mary will pay a fix amount of monthly rent throughout the time she stays there. She will also pay for renter’s insurance of $180 per year or $15 per month which she found from effectivecoverage.com.
Besides the monthly rent and renters insurance, Mary will also have to put down a security deposit that is equal to 1 month’s rent at the time she signs the lease. However, this amount with be returned in full to her once the lease is over, and under a condition that she does not damage the house during the staying time. Therefore, this amount shall be excluded from the calculation, assuming Mary is a perfect tenant.
In all cases whether buying or renting a house, Mary will have to pay the same cost for utilities. Therefore, utilities will be excluded from the data model calculations.
To efficiently compare the costs of buying vs. renting a home between houses, Mary builds an Excel model to help calculate total cost of ownership/renting. There are 3 variable factors that must be provided based on the information that are given about each home; they are the purchase price, property tax, and monthly rent. Other factors will be derived from these 3 variables, and the percentages will stay fixed throughout the examination.
After plugging in the known starting factors, this model will calculate total costs over the length of stay (5 years) for both rent and buy scenarios. This is the total cost to live in the property during this time. As a comparison point, this Excel model will also give us a break-even point in years by applying the Excel function, Goal seeks. That is, assuming the buyer/renter stays in the property, this is the amount in years where buying and renting costs equalize (if ever).
Price = P (Given)
Down Payment 20% = P * 20%
Loan 80% = P * 80%
Loan Term = 30 years
Length of Stay = 5 years
1 Time Closing Cost 3% = P * 3%
Real Estate Agent Fees 6% = P * 6%
Homeowner’s Insurance = (P * 35)/100,000)*12
Annual Maintenance 1% = P * 1%
Property Taxes = Given
Payment/year = -PMT (rate, total number of periods, loan amount)
Mortgage Interest 4.63% = Loan * 4.63%
Principal Amount = Payment – Mortgage Interest
New Bal. = Beg. Bal. – Principal Amount
Total Interest Paid of 5 years = -CUMIPMT(rate, total number period, loan, start_period 1,end_period 5, paid at the beginning 0)
Total cost of 1st years = Closing cost + Real Estate Agent Fees + Homeowner’s Insurance +Annual Maintenance+ Property Taxes+ Mortgage Interest
Total Cost of 2nd and later = Homeowner’s Insurance +Annual Maintenance+ Property Taxes+ Mortgage Interest
Rent = Given
Total cost of Rent per year = (rent per month *12) + (renter insurance per month* 12)
Difference between Buying and Renting = Total Costs of Buying for 5 Years – Total Cost of Renting for 5 Years
Break Even Year is the number of years it takes for buying and renting costs to equalize. It is conducted by using Goal Seek:
Set Cell = Difference between Buying and Renting
To Value = 0
By Changing Cell = Length of Stay
Scenario 1- Home in Wayne
In the first scenario, Mary finds a nice house in Wayne. It comes with a purchase price of $750,000. Property taxes are $7,835 per year. It can be also rented for $3800 a month. After entering the numbers into the Excel Model, Mary finds that after 5 years, if she buys the house, she would have to pay $65,260 more compare to renting the same house. If she rents instead, she can save $65,260 and invest it somewhere else. She also determines a break-even point of 7.406 years by using Goal Seek. This indicates that if she buys the house, she has to live in it for at least 7 and half years before it renting becomes more expensive. Otherwise, it is better for Mary to just rent the house for 5 years and save herself $65,260.
Scenario 2- Home in Philadelphia
In the second scenario, Mary looks at a house in Philadelphia. The seller is asking for $142,000. Property taxes are $1,018 per year. It can be also rented for $1,200 a month. After plugging the numbers into the Excel Model, Mary determines that it will be much better for her to buy this house instead of renting it. It will take only 3.28 years for the cost of buying and renting to be equal. She will save $19,533 after 5 years if she chooses to buy this property.
Scenario 3- Home in West Chester
In this last scenario, the house comes with a price tag of $253,213 and yearly property taxes of $2,957. The house is located in West Chester. It can be also rented for $1,750 a month. After letting the Excel Model work on the calculations, Mary finds that after 5 years, renting the house would cost a little more than buying it. With the benefit of saving $5,028 and a break-even year of 4.65 years, Mary is a little better off buying rather than renting the house. With a break-even point of 4.65 years, the cost of buying and renting equalizes a couple of months before the 5 year mark, but if Mary decides to stay in the home for the full 5 years, she will save $5,028 by buying.
So, is buying is always the best solution? Not necessarily. After examining these scenarios, we found 3 vastly different outcomes. For the Wayne home, it is clearly better to rent, as buying will cost Mary an additional $65000 over 5 years. In Philadelphia, where homes can be found much cheaper, buying a home can outweigh renting by a long shot. Lastly, for the West Chester home, renting and buying comes out evenly. Every property is different and must be examined separately.
Once we settle on a property to look at, the buy vs. rent question can be boiled down to strict numbers, and an answer found. However, calculations never tell the whole story. At the end of the day, the choice highly dependent on the home seeker, and what is important to him/her. The Excel model takes a look at money and makes it the sole determining factor, which isn’t always the case. The model doesn’t capture the intangibles like flexibility, time and effort needed to maintain the property, the effort needed to buy and sell a property and all the other tasks that homeowners need to be responsible for. The home seeker might not be ready to undertake all the extra challenges of owning a home and might be willing to pay a premium to forgo these. At the very least, this Excel model will serve as a framework to help the home seekers determine the fiscal advantages of buying vs. renting, and then they can consider all other intangibles and come to a solution that fits them best.