There are a plethora of online tools that attempt to provide financial analysis to answer the Buy versus Rent question for consumers. The problem with the majority of these is that they present their findings in financial isolation without attributing a value to the indirect benefits of home ownership. These include, long term stability, pride of ownership, the ability to make upgrades to your home and an improved credit profile as a homeowner. Potential Employers may also view home ownership as an indication of financial responsibility and maturity.
Most Buy versus Rent calculators tend to focus on cash flow, not on true investment results. Many present the concept of lost opportunity cost in relationship to your down payment and buyer paid closing costs so let’s have a closer look at that.
Let’s assume that we are looking at a home for $500,000 and the total down payment and buyer paid closing costs are $80,000. In this example let’s assume that we keep renting and invest the $80,000 in a diversified portfolio of Stocks, Bonds and Mutual Funds with an annual return of 8%, the historical average. In five years our $80,000 would be worth about $118,000 for a gain of $38,000.
Now here is the first magic of a Mortgage, when we invest the same $80,000 in a home we are controlling a $500,000 asset. Even though the historical annual increase in home values is only 3% – 5% we will earn that return on the $500,000 not just the $80,000 acquisition cost. In the same 5 year period, even at the low end of the historical range of 3% our $500,000 home would now be worth about $580,000. This represents a 15% annual return on the $80,000 invested to acquire our home and $42,000 more than the rent and invest example above.
You might be thinking, but I still have to keep investing in my home through my monthly payments and other costs of ownership. First of all you have to live somewhere, right? So in reality, your only additional investment is the difference between what you would pay in rent for a similar property and your total cost of ownership in your home. Let’s assume that a similar property could be rented for $2,500 per month, but your mortgage payment, property taxes and insurance are $2,750 per month. How can we evaluate the financial benefit of the additional $250 per month? This is done through the second magic of a Mortgage, Tax Savings. 100% of your Mortgage Interest and Property Taxes are deductible. There is no tax benefit for renting other than your ability to take your standard deduction of $6,200 per person. Let’s further assume that there are two people involved in this Buy versus Rent analysis so the total standard deduction as renters would be $12,400 and this couple is in a 25% marginal tax bracket.
In the purchase scenario, during the first 5 years in this example, the combination of deductible Mortgage Interest and Property Taxes would average $2100 per month of the $2,750 in total monthly costs. This would generate an annual itemized income tax deduction of $25,200. This greater income tax deduction will save $3,200 in tax or $267 per month, more than compensating for the additional monthly cost of $250 to Buy versus Rent!
Now here is the real kicker! In the first 5 years as a home owner you are paying yourself over $500 per month, this is the portion of your monthly payment that is paying down your loan balance and increasing the equity in your home! Your current rent payments are doing that for your landlord!
In this scenario, making a decision to Buy vs Rent is a no brainer. If you would like us to help you answer the Buy versus Rent question in your specific scenario please click here or call us @ 877.633.9137.