How-to Monday: Buying vs. renting
Associated Press photo
Is a housing downturn the best time to get your foot in the door?
If you follow the stock-market advice to buy when everyone's selling, today's conditions look pretty favorable. That's what the National Association of Realtors and the National Association of Home Builders keep saying.
But wait -- if you believe the forecasts of economists who expect significant price declines in the near future, you'd want to hold off 'til things get worse for sellers and better for you.
Oh, and if you're extremely nervous about buying in a neighborhood only to end up living near foreclosed or otherwise vacant homes, you might think it best to sit tight until prices, sales and the economy at large are again rising merrily.
Got all that?
Apologies if you were expecting a straight answer. There doesn't seem to be one, and there are enough opinions out there already -- you don't need mine. Instead, let me offer you a way to do your own forecasting.
If you saw my Sunday story, you know I ran numbers through a "rent vs. own" calculator to give everyone an idea of when you're better off renting and when you're better off buying, and under what circumstances. I encourage you all to do the same with numbers tailored to fit you and your expectations.
Pick a rent vs. own calculator. I used E-LOAN's, which you can find HERE, because it allows you to plug in all sorts of numbers. You've got plenty of choices, though, including one at Ginnie Mae and another on the Baltimore Sun site.
Decide which ways you're average. E-LOAN only asks you for a few figures and supplies the rest, but you can go in and change most everything to suit you. Here are the figures I used:
--Monthly rental payment of $1,030, the Baltimore metro area average, according to M/PF YieldStar, an apartment market research firm. (That's the overall average regardless of size, but it also happens to be very close to the average for a two-bedroom. The other size averages are as follows: $750 for an efficiency, $925 for a one-bedroom and $1,250 for a three-bedroom.)
--Annual rent increases of 3.5 percent. That's what M/PF YieldStar says is common in this area, though your results may vary. (The year-over-year increase is actually quite a bit less at the moment, the company says.)
--Home purchase price of $308,000, the average for units sold in November, according to Metropolitan Regional Information Systems. If you know where you want to live, you can see the averages for local jurisdictions HERE or for ZIP codes HERE.
--Down payment of 5 percent, or $15,400. Mortgage brokers who work with first-time buyers assure me that this is still typical in today's lending climate.
--Interest rate of 6 percent. That's just a hair above what Northstar Mortgage in Ellicott City was quoting a week ago, though of course it could go up or down in the coming months. Freddie Mac keeps national averages HERE.
--Number of years you plan to be in the home: I put in every year from 1 to 30 (yes, that did take a long while, especially since I kept refining my numbers and had to start all over again), but you don't have to go through all that. Pick a year, or pick several to compare and contrast.
--Home values increasing 0 percent for the first five years and 4 percent a year thereafter. Why? I didn't want to be as optimistic as the optimists or as pessimistic as the pessimists. Four percent is the annual average increase for the metro area between 1979 and 1999, according to the National Association of Realtors.
Unfortunately, I have yet to see a rent/own calculator that will let you plug in a varying appreciation rate. So for each of the first five years, I put in "0." After that, I needed an average annual percentage increase that took into account those five years of zilch. Here's the formula: increase=(1.04^(1 - 5/N))-1. "N" is the year, so it's 5/6 for Year Six, 5/7 for Year Seven, etc.
Excel will handle it for you quite nicely if you paste it, not including the word "increase," into a cell. (Either set the cell for percentage or multiply it by 100.) The "1.04" refers to the 4 percent rate, so feel free to change to suit your needs. Yeah, this is the wonkiest Wonk post yet, but you can do it. Breathe in, breathe out. (And thanks to Mr. Wonk for the math assist.)
--Closing costs of 2.4 percent to buy the home. That's what it would cost you to buy that $308,000 house in Baltimore County, not including anything you're prepaying, like property taxes, according to Northstar Mortgage's calculations. (It's actually 2.5 percent of the loan and 2.4 percent of the home value.) If you think you can get a government grant or a motivated seller to cover your costs, you can gleefully enter "0" here.
--Property taxes of 1.1 percent. This is about average for the Baltimore suburbs, says the Greater Baltimore Board of Realtors. The city's rate is a much higher 2.4 percent. Both figures include the state's share of property taxes. You can see the county-by-county breakdown HERE.
--Annual home maintenance of 1 percent. "Are you crazy?" you say. "I'm not spending $3,100 a year in maintenance!" Well, real estate companies and economists say you should budget for it. My condo fees alone, which cover things like landscaping, are more than half that.
--Cost of selling. I set this at zero because I wanted to know when, just living in your home, you're doing better financially than renting. If you want to include the not inconsiderable costs of selling, you might enter 6.25 percent to account for closing costs and Realtor fees. I ran that figure past several people in the industry, but keep in mind it can really vary. You can choose from agents charging a wide range of fees or go it on your own.
--Income tax rate of 25 percent. That's the marginal tax rate for a married couple earning $85,000, the average household income in the metro area. You can figure out your rate HERE (scroll down a bit). This is important because it determines the usefulness of your tax deduction for mortgage costs.
--Savings/investment rate of 0 percent. In other words, I assumed that the renter would take the $22,800 not needed for a down payment and closing costs and save it by sticking it under the mattress. This was my way of dealing with the fact that while some people would invest the heck out of that money, others would spend it. Moody's Economy.com suggests that 4 percent a year is reasonable to plug in for a risk-free investment.
--Monthly renter insurance of $30. This was E-LOAN's suggestion, and I stuck with it, since it doesn't give you the option of adjusting the homeowner insurance rate.
So: What are your numbers? I'd be interested to hear what you get as the crossover year -- the point at which owning makes more financial sense than renting.
By the way, this story grew out of a question from a Wonk reader. Thanks very much to her, and keep those ideas and questions coming, guys.