Benefits of Owning a Home vs. Renting
Low prices and record low interest rates have made buying a home more affordable than it’s ever been AND a bargain compared to renting. One may ask why would people rent instead of buy a home especially now? How much would they benefit if they buy instead of rent? See answers to these questions below:
Why People Rent a House?
· Uncertainty about the housing market and the economy in general.
· Uncertainty about their jobs and steady incomes (employed now, but could be unemployed tomorrow).
· Don’t want to commit to a long term contract.
· Don’t want to spend time & money for maintenance.
· Don’t have or don’t want to commit the money for the down payment, closing costs, etc.
· Low risk of obsolescence. It may be possible for lessee tenant to avoid some of the risks of obsolescence associated with ownership.
· Don’t qualify for the loan (e.g., low credit score, low income, too much debts, etc.).
· Lack of real estate knowledge.
· Bad experiences.
Why People Buy a Home?
· Control. The homeowner who lives in his/her home has, within the limits of the law, freedom to change/modify/remodel the home as he sees fit.
· Don’t want rules & restrictions imposed by landlords on properties they live in.
· Don’t want to waste their money on rents and get nothing back in return.
· They look at home ownership as an investment to build the equity by property appreciation and paying principal over time.
· Tax Savings. The owner of a property is entitled to the tax savings resulting from cost recovery rules and mortgage interest during the holding period and when the property is sold.
· With such low interest rates, monthly mortgage payments could be less than the monthly rent.
· Great feeling, pride of ownership and being in charge (priceless)
30-Year FRM (Fixed Rate Mortgage) Rates 1971 – 2010
30-Year FRM Rates 1971 - 2010:
Reproduced with the permission of Mortgage-X.com.
Historical performance of the National Average Contract Mortgage Rate
National Average Contract Mortgage Rate, 1963 - 2010
Reproduced with the permission of Mortgage-X.com
Economic Benefits of Owning a Home vs. Renting a House
Both values of the homes and rentals are dependent on many factors such as: location, condition, local housing market (supply & demand), size, age, number of stories, etc. In order to compare apple-to-apple, we looked at similar houses (same age, size, condition, etc.) that were sold and leased in last 6 months in a specific location (subdivision) in Collin county Texas.
Our findings, for that specific subdivision, are as follow: (See Table 4 for Comp. at the end of this report for detail information)
· Average Monthly Leased/Sq. Ft. was about $0.70
· Average Sold/ Sq. Ft. Price was about $85
With this information, a 2000-SqFt house could be purchased at $170,000 and could be leased at $1,400 per month.
The two methods of comparing leasing and owning costs are the Net Present Value (NPV) method and the internal rate of return (IRR) method. The NPV method compares the NPVs of the cash flows for each of the alternatives. The IRR method calculates the IRR on the difference between the owning and leasing cash flows. To calculate NPV and/or IIR you need to have a Real Estate Financial Calculator (e.g., HP 10bII) or have access and authorized to use the CCIM Financial Calculator Excel sheets.
Net Present Value Method
This method reduces each alternative to its periodic cash flows after tax. Applying the user’s appropriate after-tax discount rate, an NPV is calculated for each alternative.
Internal Rate of Return of the Differential Cash Flows Method
The IRR method subtracts the lease alternative’s periodic cash flows after tax from the own alternative’s periodic cash flows after tax and calculates an IRR of this differential. This IRR is after tax and is compared to the user’s appropriate after-tax discount rate
Savings on Owning vs. Renting calculation
Table 7, also visit the web page at http://www.texasfivestarrealty.com/Blogs/NPV_Calculation_Bahman_1Page.pdf to see an Excel spreadsheet, showing a step-by-step calculation of Net Present Values (NPVs) of owning and renting for a simple scenario with no tax savings for a set of default values. We used the special CCIM financial calculator Excel worksheet to derive the results.
Since not everybody has access nor is authorized to use the CCIM financial calculator Excel worksheet, I have developed a free user-friendly internet-based tool that calculates the cost of owning and leasing during a holding time and after, considering all possible costs and benefits related to owning and leasing. The results of this tool and the actual result from the CCIM financial calculator are very close (about +-0.05%). because the current 1% discount rate is very small.
You can try this tool at www.TexasFiveStarRealty.com/rent_vs_Own.asp
Based on a set of typical assumptions, please see the attached data sheet for a complete list of input data and assumptions. We found the following results:
Basic Assumption:(For a complete list of assumptions, please see Table 2 enclosed data sheet).
- Rent per Month is $1400. Expect Annual Rent Increase of 5%
- Purchase Price $170,000. Expect Annual Appreciation (Increase) of 3%
- Various costs of purchasing (e.g., closing costs, up front mortgage insurance, monthly mortgage insurance, property taxes, insurance, HOA, …), cost of maintenance, repairs, upgrades,up-keep, …, the eventual selling costs (e.g., commission, closing costs, upgrades, etc.. (see Table 2 input data sheet)
- No HOA fee per month
- Interest Rate 4.5% for 30 Years Term
- Hold for 5 Years
- Income Tax Bracket 28%
Table 1: Cost Saving: Owning vs. Renting
Down Payment %,
$ Saving Owning vs. Renting
With No Tax Saving
With Full Tax Saving
100%, $ 225,791
20%, $ 143,716
10%, $ 133,458
1) Please not that 0% down payment loans are NOT readily available to everybody. E.g., only USDA and VA loan offer 0% down payment and both are very restrictive programs meaning only very small part of the population would qualify.
2) Please note that depending on each individual’s tax situation, that individual may or may not be able to take advantage of all or some of the tax savings. Therefore, the total benefit of owning falls between the two numbers shown under “With No Tax Saving” (worst case) and “With Full Tax Saving” (best case) columns.
3) Please note that the comparison above is only an estimate based on the specific set of assumptions. See next page for complete list of assumptions.
4) You can change the data and assumptions based on your specific needs and come up with different savings by visiting http://www.texasfivestarrealty.com/Rent_vs_Own.asp
5) Please note that all these assumptions and calculations are for “owner occupants” (those who will live in the home) and not for investors. Investors have different sets of rules, restrictions, and benefits that are different from the “owner occupants”, e.g., investors can deduct and take advantage of depreciation and insurance payments, whereas “owner occupants” cannot.
Low prices and record low interest rates have made buying a home more affordable than it’s ever been AND a bargain compared to renting.
Based on the fact described in “Why People Buy a Home?” and financial benefits shown on Table 1, there are clear advantages to owning rather than renting.
Why should someone buy a home NOW more than ever (if possible)?
· In many locations in the nation, rents have increased more than 10% over the last 12 months. With fewer consumers able to make the leap into homeownership, rents could continue to climb higher.
Source: First Published: April 5, 2012: 9:59 AM ET
· Asking prices for homes declined 0.7% over the past 12 months through March.
(Source: Reports released Thursday April 3rd, 2012 by Real Estate Listing Site Trulia)
· In many Counties, i.e., Collin County Texas, the assessed value of the houses, Property Taxes, insurance, therefore total monthly payments have been reduced compare to the years before. Allowing more money in homeowner’s pockets.
Source: Collin County Appraisal District Statements for Year 2012.
For detail information and calculation to derive the above result, please see http://www.texasfivestarrealty.com/MyBlogs_Rent_vs_Own.asp.