Compare the unrecoverable costs
The mistake is to set a rent check against a mortgage payment. The honest comparison sets rent against the money an owner never gets back: mortgage interest, property tax, homeowner's insurance, maintenance, any association dues, and mortgage insurance if the down payment is under 20 percent. Property tax varies from roughly 0.3 percent of the home's value a year to more than 2 percent, depending on the state. Maintenance averages about 1 percent of the value a year, arriving in lumps such as a new roof. Add the return your down payment would have earned had you invested it. Only the principal portion of the payment is savings, and early on it is small. After five years of payments on a thirty-year loan at 7 percent, you have paid off about 6 percent of the balance.
The cost of getting in and out
Buying costs roughly 2 to 5 percent of the loan in closing costs. Selling costs more, commonly 6 to 8 percent of the price once commissions, transfer taxes, repairs and concessions are counted. Appreciation has to cover the round trip before you are ahead of a renter. That is why the break-even point usually falls around five years, and later when interest rates are high or local prices are steep next to local rents.
Three quick tests
- Divide the price of a home by a year's rent on a comparable one: a ratio under about 15 favors buying, and a ratio over 20 favors renting.
- Keep total housing cost under about 28 percent of gross income, and all debt payments under about 36 percent.
- Make sure three to six months of expenses remain in the bank after the down payment and closing costs.
A buyer who fails the third test is one furnace away from credit card debt.
What the math leaves out
The mortgage interest deduction helps only those who itemize, and most households now take the standard deduction. A renter comes out ahead only by investing the difference each month, and many renters spend it. Owning carries forced savings, a fixed payment under a fixed-rate loan, and the right to paint the walls. Renting carries mobility, a capped downside, and a landlord who pays for the water heater. A job that may move or a city you are unsure of argues for another year of renting.
Tip Run your own numbers in a rent-versus-buy calculator that asks for appreciation, investment return and years of stay. Then change the years from seven to three and watch the answer flip.
