Question: Should I Rent or Buy my Next Home?

The decision to rent or buy is common.

If all else is equal (i.e., location, distance from work, size of the home, etc.), then your decision comes down to a simple comparison of costs. Seems easy enough. But what are all the costs? In the following post I will go over (1) the costs associated with renting, (2) the costs associated with buying, and (3) a conclusion.

The Cost of Renting

The most obvious cost of renting is that your money is not recoverable. That is, you pay your monthly rent to the owner and the owner never gives it back to you. You can add up this cost by taking your monthly rent amount times the time period you will live there. For example:

$800 X 48 months (4 years) = $38,400.

Seems like a lot. But we’ll discover later why it might not be.

Maintenance is usually done by the landlord or property management company, saving you some money. But the biggest pro of renting is that you can pick up and leave with very few consequences. If you leave in the middle of a lease agreement period you will probably lose your deposits. Other than that, you are free as a gazelle grazing the green grass of Guyana (are there gazelles in Guyana?).

The Cost of Buying

Most people assume that by buying a house they are building equity through their monthly payments. Equity is just a fancy word for “worth,” or, for our purposes, “money I can get back.” Let’s figure out what the first year of equity would be under one scenario:

Mortgage payment: $800.56

Average Interest Rate (right now): 4.5%

Years on the mortgage: 30

Loan amount: $158,000.00

Since you can consider the interest paid as irretrievable money, only the amount going toward the “principle” of the loan can be considered equity. Remember that interest is calculated and paid first before being applied to principle each month.

After the first year the total equity under this scenario is $2,332.

After four years the equity will be be $10,671.

You paid out $800.56 X 48 months = $38,427. This means you paid $27,755 of interest. The interest is of particular concern during the first few years of a mortgage.

This all points out that simply buying a house doesn’t mean that all the money you would have paid in rent will go toward building equity. The interest is money lost, unless you can recover it when selling the house.

When you sell your house after four years (assuming you are able to sell it at all), you will need to pay back the remaining mortgage of $147,328.

If you can sell it for exactly that price, then you are just as well off renting as buying.

If you can sell the house for what you paid ($158,000) then you will have lost only $27,755 (the amount you paid in interest).

This means that you need to sell it for at least $185,755 just to break even (the original price of $158,000 plus $27,255). Selling at $185,755 in this case recovers the amount you paid in interest.

Just for your information, selling your house at $185,755 represents a 17.6% gain in value of the home. Use www.zillow.com to evaluate the price fluctuations of specific homes in your area.

Conclusion

If the total cost of renting is lower than the total cost of buying, then you should rent.

If the total cost of renting is higher than the total cost of buying, then you should buy.

The trouble is, the fundamental part of this discussion is knowing how much you’ll be able to sell your house for at the end of four years. That would take either Merlin’s Beard or a sophisticated knowledge of the real estate market in your area.

Of course, another option exists: renting out your purchased home after you move out. In this way you can start offsetting the interest you paid during the four years you lived there.

To calculate the interest that you would be paying on a mortgage, use an amortization calculator which can be found here.

Hope this all helps!