Why we rent
March 5th, 2008 | Living
Since getting married, it seems like everyone is asking my wife and I when we’re going to settle down and buy a house. The idea is, we can’t settle down and start a family unless we take out a mortgage to buy a house. But with housing prices at nearly historic heights, and rapidly falling, buying a house can be a huge financial gamble. So why do we rent? Because, at least for now, renting is almost half the cost of buying a house. I’ll crunch the numbers on three example homes and show you how much money you can save by renting in today’s market.
The rules
Since no two homes are the same, I’m going to try my best to compare apples to apples in my examples. I will find a national homebuilder actively selling a floorplan in a development and compare it to the same floorplan available for rent in the same community. Financing will assume a fixed 30 year loan at 6% interest, with a 20% down payment to avoid private mortgage insurance (PMI). Property taxes will be based on the homes selling price and county millage rate. Insurance will be based on regional averages. Insurance rates are a rough estimate. Since homeowner association dues are hard to find, I will pretend that this is a perfect world and that there are no HOAs.
Example 1: 3 bed/2.5 bath townhome in Orlando, FL
Townhomes in the Provenance Townhomes community are offered at $195,990 for a nice 3/2.5 that is nearly 1900 square feet. That works out to a little over $100 a square foot, so it must be a great deal, right? Let’s crunch the numbers.
- 20% down payment: $39,198
- Annual property tax: $3,371
- Homeowners insurance: $900
- Total monthly cost (PITI): $1,296
Or, you can rent the same home for $999 a month. So, do you want to put down nearly $40,000 and then spend another $1,300 a month for 30 years, or would you prefer spending $1,000 a month for a lease?
Example 2: 5 bed/3 bath McMansion in Phoenix, AZ
A top-of-the-line 3571 square foot, 5 bedroom, 3 bathroom, 3 car garage home is offered at $303,900 in Phoenix. How much does that home cost to own?
- 20% down payment: $60,780
- Annual property tax: $12,159
- Homeowners insurance: $650
- Total monthly cost (PITI): $2,525
So you can either spend a little over $2,500 a month after putting more than $60,000 down, or you can rent the exact same home for $1,500 a month. It’s your call.
Example 3: 3 bed/2.5 bath townhome in Minneapolis/St. Paul, MN
For my last example, I tried to pick a home in a market that was less affected by the recent housing bubble. A nice, 3 bedroom, 2.5 bath townhome outside Minneapolis will run you $204,990. Does it make sense to buy now in a market that didn’t have a crazy a run-up in prices over the past few years?
- 20% down payment: $40,998
- Annual property tax: $6,026
- Homeowners insurance: $450
- Total monthly cost (PITI): $1,523
So if you can purchase the home with more than $40,000 down, you’re monthly payment works out to $1,523. So what’s the rent on the same floorplan? $1,595 a month. So if you have 20% down, you can own this home for less than the cost of rent.
The verdict
Even with a 20% downpayment, it still remains cheaper to rent than it does to buy a home in most markets. The Minneapolis example just goes to show that not all housing markets are unaffordable. So if you have an extra $40,000 to $60,000 for a respectable down payment, you might be able to purchase a home with monthly payments less than rent. However, in a lot of markets this isn’t the case. States like California, Arizona, Nevada, and Florida are still extremely pricey. In those states, the savings can be thousands of dollars a month. What would you do with all that extra money in your pocket?
But what about the equity you might be missing out on because you’re paying down a mortgage? After all, the rule of thumb is that renting is throwing your money away. With a house, you’re slowly paying down a mortgage, which results in equity in your home. The problem with that idea is that home prices in many markets are in a free fall. No matter how fast you can pay down your mortgage’s balance, the value of the home is falling faster.
And that’s why we rent.
Very interesting. I like your examples. It really shows how far prices need to come down, which is depressing for me.
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We bought a new house in August 2005. Our neighbors down the street just sold their home for less than what we paid for it. Looking back, I wish we had rented. We can’t afford to sell our house now if we had to.
Awesome Seb - thanks for those calculations. I really did find this interesting as me and my fiancee are looking to buy a house within the next year. But just as the stock market fluctuates, housing markets do as well - you never know what could happen - and they could turn up again just as quick as they turned down. Aren’t you effectively trying to “time” the market?
Thanks for the comments, everyone. I’m not sure if I’m trying to time the market or not, since I wasn’t looking to buy when prices started to fall. I’ve become a lot more concious of housing though now that I might be buying in the near future… Which is probably why I post so much about it.
My wife and I are in the same situation right now. We want to buy a house, but financially it just doesn’t make sense. We’re waiting until prices down further before we make the plunge.
I thought this post was really interesting as my fiance and I have been looking more and more at the cost of houses. We are not ready to buy yet but it really seems that renting would be a better option for us.
Of course that means we would not be able to personalize the home like we would want to…but then we also have the freedom of all the hassles that come with home buying.
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Thanks Seb for posting this. I’m in a similar situation (minus the wife of course), in fact one of my financial goals for this year was to buy a house but the more I thought about it and the more I researched I decided to go against the conventional wisdom that owning a house means finacail stability. Personally at some point in the future I plan to buy a house but for now I feel confident in waiting until I’m ready to take on the responsibility - beyond financial - of owning a home.
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Renting can be cheaper, but there are upsides to both renting and owning. To each his own — we love our house!
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Great post. It’s important for everyone in the personal finance blogging realm to remember that one size fits all advice doesn’t work, which is why I like this post so much. It gave a great counter example to something that is generally assumed to be true.
For me, owning is cheaper and I like that a portion of each payment is essentially coming back to me in the form of growing equity. The recent declines in the real estate market do require everyone to rethink their situation. Even if you come to the same conclusion about whether to rent our buy, changing rules mean that you at least have to take the time to make sure that you still agree with your initial decision.
Anyway, thanks for presenting the other side in a clear, unbiased, and factual way!
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Oftentimes renting can be a “cheaper” way to get into nicer place that you otherwise couldn’t afford. It is possible though, to buy something adequate and have it still be affordable. If you look at buying a BMW or a large SUV versus leasing one, you could run similar numbers. But a used honda accord could do just fine, and it’s something that would be affordable to buy. I know cars aren’t the same as a house, but it’s an interesting parallel
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Nice post.
A question. As the total payments (PITI) include the principal component on the mortgage payments, the straight cash flow comparisons will not be completely accurate (even if you get to more or less the same conclusions).
The next stage in the evaluation of rent or buy decision making is comparing what the investments you will make with the extra cash flow will be worth compared to the equity built up the home. Both of these are much harder things the estimate.
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could u consider the benefits of tax when owning a home?
Great post, I definitely agree with you that the old blind “better to buy than rent” isn’t always true. However, I’m not sure you’re totally comparing apples to apples.
With your PITI, remember that part of that is the PRINCIPAL (as trainee investor suggests). Its not really fair to compare principal payments against rent, as you can either build equity and get that money back when you sell, or get an interest only mortgage and avoid that part of the payment (or get a HELOC and withdraw the principal portion each month / as needed). For the Orlando example, the first month the principal portion of the payment is $211.15 (and this goes up each month as you pay down the mortgage).
That means for an extra $90 / month (in theory - there would be other costs, like maintenance, if you were the homeowner), you’re getting the full benefit of any appreciation (and risking any drops in value), getting a tax deduction (in the US anyway) kk mentions, gain the ability to do whatever you want to the place without getting the landlords permission (and get tied down to the area - its much easier for renters to move than home owners) and avoiding any potential rent increases (property taxes and insurance may go up, but this will certainly be less than rent increases, as these expenses are part of your rent - landlords pass them along to tenants). You also have to factor in the opportunity cost of the down payment.
Definitely an interesting comparison, and as there will probably be a different conclusion in each market.
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@traineeinvestor - The difference in money saved from renting vs. buying is up to the individual, but even with the tanking stock market, you will likely see better returns (at the moment) by investing the extra money in stocks vs. a depreciating house.
@kk - The tax benefits of owning a home (tax deductible interest) vary with each purchase. Over time, the amount of money you can save with taxes diminishes, as you pay less toward interest on your mortgage note and more toward the principle. The first 5-10 years of paying a mortgage will of course come in handy come tax time, but you realistically won’t reap those benefits every month when you have to pay your mortgage.
In the end, each market and everyone’s situation is never the same. For us, at least for now, it makes greater financial sense to rent a house than purchase one. In the meantime, the money we are saving from the difference is going toward investments and a sizable down payment for when we do make our purchase.
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As someone who is trying to save for a downpayment, I feel better reading this article. I’m not missing the great prices that every one is telling me about.
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Yeah! My husband and I graduate in May and people are asking us the same questions. I honestly don’t care about owning a house- or even being “tied” to a geographical area for a long time. I want to have the flexibility of loading up all our possessions in a U-Haul and fallowing opportunity. We have made lots of other choices to keep this dream alive, like not buying furniture except our bed (we have a $10 goodwill couch, and will probably buy another $10 couch once we move). The only other thing we will take with us when we move is our new washing machine that we got a as a wedding present (and I LOVE). Yeah for freedom! Boo for expensive housing!
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I generally agree with you with regards to the reason why you chose to rent as we would have done the same thing when we got married.
I WISH that were the case here in the DC metro area. Our mortgage is the same as you rent we paid last year which made it a better deal for us in the long run.
I am considering renting out our home while we go back to renting a two bedroom where we used to live to save money and because I MISS VA a lot! LOL! But hubby isnt hearing it..
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You must take taxes into account to make a realistic comparison. They take a huge chunk of the difference away. The renter is giving money to the feds that the buyer is “leveraging” into his investment.
For a simple and very approximate example, lets look at Phoenix again, and assume you’re in the 25% tax bracket (reasonable for that house). This means your property tax results in a 12k deduction which returns $3k in your pocket. The interest on your loan in the first several years is about 14k which results in 3.5k back in your pocket, and the principal (3k) goes “into” the house each year and is returned when you sell (assuming the price does not drop drastically… we’ll come back to that). So dividing 7.5k by 12 gives about $625 a month to subtract from the cost of buying, because that is money you would otherwise be giving to feds from your income.
Now we have a monthly outlay of closer to $1900 a month, or which $250 is still “yours”, going into the house as principal reduction, which you can subtract too if you want to take he long view. Now the numbers start to look more reasonable. (They really have to, otherwise landlords wouldn’t be in the game!).
For most of the past, owning a home more than 5 years has been a money maker for almost everybody. We are probably in a 2-3 year period where that won’t be the case.
Don’t ignore taxes in any part of your financial life, they make a big difference!
Finally if your state has income taxes, the numbers above get even closer to the renting figure.
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As mentioned many times above, consider tax reduction, opportunity costs of the downpayment and any difference between the cost of the mortgage or rent in the calculations. Also remember that assuming the mortgage you selected is fixed rate, that PI payment will remain constant, whereas over the 30 years that rental payment will increase, probably at a near inflationary rate to offset the extra property taxes, increased maintenance (as the home ages) and such that the landlord has to handle. Of course the same increases in property taxes and maintenance will also occur for the homeowner - probably not a wash though. Plenty of areas where assumptions can come in and of course depending how objectively you work with them, you could say renting or buying are cheaper.
Its not as simple as comparing gross mortgage payment with gross rental payment. Its something everyone should run the numbers for with their chosen purchase and see which ends up coming out cheaper (also include a risk/chance factor as to how those assumption may impact things in the future).
I purchased a condo in the Seattle metro area last summer, and right now I feel like it is the worst decision I’ve ever made. So I think you are wise to weigh buying and renting. The tax benefits on your income tax aren’t going to help when your property goes down in value by $13,000 in six months and you have a psycho neighbor who threatens to burn down the building.
Oh, to be renting again….
[…] Why We Rent Another compelling case for renting. I think it highly depends on what area of the country you live in. (@ pinching copper) […]
Doesn’t this analysis kind of miss the point, though?
Sure, buying a house might cost a bit more than renting, but all that money goes into you owning that house. That monthly cost is basically being invested, and if you chose your house wisely, then it’s being invested well.
If you’re renting, you may be saving some money each month, but you’re not getting anything in return.
I mean, take the first example- if you don’t move from that location for the 30 years it takes to pay off the loan, then renting will have saved you $100,000, but you’d still have spent almost $360,000 for the privilege of sleeping under someone else’s roof. Sure, you saved a lot of money, but you don’t have anything to show for that $360,000. It’s gone.
If you had bought, you would have spent a lot more money- more than $450,000- but that money is still in your portfolio. You own that house- it’s yours, it can be your child’s, and as you enter retirement, your living expenses will now be lower than the person who is renting.
I’m only 22- I rent, because that’s what makes sense. And I’m not saying it always makes more sense to buy, because there are certainly times when renting is the better choice. But, if you simply compare monthly costs and leave out the fact that the home-buyer is investing that money in something she will own, while the renter is simple giving it to someone else, you undermine the entire comparison.
The “tax benefits” of home ownership suck. That’s why only half of all owners itemize. The standard deduction is bigger.
You left out the cost of house and yard maintenance and repairs for homeowners. If the roof leaks and the furnace dies in January, a renter calls the landlord.
Houses will stop going down someday, maybe in 2 or 3 years. In Connecticut, home prices sank for 10 years in many towns after 1988. I vowed not to get caught upside down in a mortgage again.
I have owned three houses, but am renting now. It’s a great feeling.
[…] Why We Rent Another compelling case for renting. I think it highly depends on what area of the country you live in. (@ pinching copper) […]