Over the last couple years, there has been much discussion on whether it’s smarter to rent or buy a home. For generations, owning a home was a sign of success, a trophy. That changed when the housing bubble burst in 2007, sparking the Recession. From that moment on, the façade of success and financial stability associated with owning a home was broken.
As of late, renters account for 37% of American households, the highest since the 60’s. Evidence suggests that renting is a popular trend amongst young people. 51% of American renters are under 30 years old. New Jersey alone has just over 1 million people living in apartments. In addition, more people are staying and raising families in apartments than ever before. Yet, one shouldn’t jump to conclusions. People still need to recognize the benefits of the two.
19th Century German Astrologer, Johannes Kepler once wrote, “Nature loves simplicity and unity.” The web developers at the New York Times attempt to appeal to these same loves, particularly simplicity. The Times website employs a complex, user friendly interface that essentially serves as a “rent/buy calculator.” In this article, I’m going to show you how to interpret it.
Before we start, let’s weigh all the pros and cons of both renting and buying. The pros for renting. Renting is more affordable. When you rent you’re not held responsible for any cleaning or maintenance duties. In addition, renting allows you to save up for other things. The cons. You don’t have much control over your living space. If you own a home, you can make any additions whenever and wherever you want. Also, your rent can go up every month. Furthermore, you also can’t build equity, which we will go over shortly.
With buying a home comes the freedom to make any additions you want. Owning a home and paying bills on time can help you establish good credit which can get you a sound interest rate. As implied before, home ownership gives you the opportunity to build equity. Equity is the amount of your home that you actually own. You can increase your equity by updating kitchens and bathrooms, decreasing debt, and increasing property prices.
The cons. When you own a home, as many of us know, you are a responsible for the maintenance and cleaning. Owning a home also makes it harder to just pick up and move whenever need be. Before you buy a home, it is important that you are financially viable or have “skin in the game.” To be financially stable, you have to at least be able to pay 20% for a down payment on your property.
Now onto the New York Times:
1) The Home Price
The sales price of your desired property will vary due to a plethora of factors, including but not limited to the surrounding area, crime rates, and even the cleanliness of your neighbors. As they say in real estate, “location, location, location.” For this category, suppose we use the average housing price of the area I grew up in, Essex County. Plug in $377,000 and 20% for the down payment.
2) How Long You Will Be Staying
It’s important to note that if you plan on staying for only a short time, renting is the better option. Renting will give you the freedom to move whenever need be. However, for our example, suppose you are looking to stay 10 years.
3) Mortgage Rate
The mortgage rate is defined as the rate of interest charged on a mortgage as determined by a lender. For our example, we’ll use an average mortgage rate of 3.7.
4) Length of Mortgage
This is the time in which you plan to pay off your mortgage. We’ll use a 30 year mortgage plan because they are the most popular. Remember, the longer the mortgage, the smaller the payments due.
5) Growth Rates and ROI
The home price growth rate is used to measure any increase in value in your home. Historically, home price growth rates have hovered around 3%. So let’s use that. In addition, rent growth rates measure the amount your rent increases annually. If put in layman’s terms, the longer you stay, the higher your rent becomes. Rent growth rates typically hover around the rate of inflation, for our example use 2.5%.
The “Return on Investment” or ROI is a performance measure used to evaluate the efficiency of an investment. For this, suppose our scenario resulted in a ROI of 4%. And finally, let’s give a ball park number of 2% to inflation rate.
6) New Jersey Taxes
Unfortunately, New Jersey has some of the highest property tax rates in the country. In 2015, it was discovered that 48% of state and local revenues came from property taxes alone. 48%! Property taxes in Essex County are among the highest in the state. For our example, enter 2.51%. Moving on, the other tax rate mentioned is the marginal tax. The marginal tax rate puts you into tax brackets based on every dollar of income you make. Let’s assume your successful career has put you in the 25% tax bracket.
7) For closing costs, keep the 4% for the cost of buying a home and the 6% for the cost of selling a home
8) For Maintenance fees, plug in 1% for maintenance, .46% for homeowners insurance, $350 for monthly utilities, Common fees – $0
9) The Security Deposit
A security deposit is the amount of money a renter pays to his or her landlord that can be used if the renter causes any damage to the property. The standard security deposit is typically one month.
10) Broker’s Fee
This is the fee charged by an agent to facilitate the transactions between buyers and sellers. To simplify our scenario, let’s say we don’t have any broker’s fees.
11) Renters Insurance
Renter’s Insurance covers you and your personal belongings should the worst happen. Accidents, burglaries, explosions, vandalism and fires are all covered under renters insurance. It is worthwhile to note that the average renter is 25% more likely to be burglarized than a homeowner. For this last slot, type 2.51%
After all this information is plugged in, it should yield an average renting cost of $1,700 per month for this particular piece of property. There will be a phrase that reads, “If you can rent a similar home for less than … (said price) … then renting is better.” In other words, if you can find a property similar to the home you’re considering and its renting cost is cheaper, then renting is more economical. On the other side of the coin, if a similar property cost more than the given price to rent, you should probably just buy it.
*Reminder that this inequality is relegated to our example and should not be used as a universal measure.
Deciding whether to rent or buy depends on a variety of factors: whether you’re single, married with children, how much money you have on hand, the area you want to live, your job security, your property of interest, the school system your children will grow up in, savings goals, as well as your willingness to take chances. These are all questions that should be answered before making any serious financial decision. With the math behind renting and buying constantly changing, it is most important to answer these questions first. After that, your course of action should be clear.