Buying vs Renting: 3 Numbers To Know

Certified Mortgage Advisor
NMLS 1701021
Published 
July 28, 2020

Why rent or buy?

Today we're talking about the age-old question of buying versus renting. So first we'll talk about the mindset of buying versus renting. First of all, you shouldn't even be considering buying a home unless you're actually ready to buy.

What does ready to buy mean?

The first thing that I would want you to have is to make sure that you don't have any high interest. If you have credit card debt, you want to try and get that paid off before you purchase a home.

"Dave Ramsey"

The reason why is because, as Dave Ramsey says, if you purchase a home and you're not in a good financial position, buying a home is not going to be a blessing to you. It's going to be a curse. It's going to make existing financial problems worse when you purchase a home. Try to get rid of the discretionary debt that you have. So take off those high-interest credit cards, personal loans, maybe car loans.

Always have an emergency buffer

Then you need to make sure that you have an emergency buffer set up. A couple of months of expenses saved up in case of an emergency because when you go from renting to buying you now take on the ownership of not only the home but the problems that come with it. So if your water heater decides to go out or you need to replace a fridge, or you need paint then that comes out of your pocket.

Be financially ready

You have to take on all these other monetary costs. So if you're not financially ready, don't consider purchasing a home.

You have your own pace

A quick side note, just on the emotional impact of this is you're probably seeing maybe people in your age range who are purchasing homes. And it can feel like if you're still renting or if you're not in a place where you think you need to be, you can feel like you're being left behind and you get this fear of missing. And just know that it's okay to feel that, and people are always on different timelines than we are. The best thing that we can do is not compare ourselves to other people, but see, what can we do to understand where we're at, create a plan for where we want to go, and be happy with that journey along the way.

What people is not always true

Also, a quick side note is you want to be very careful of the people who are going to try to sell you into buying. I'm using all of these outages has that even a word editor's using all these like old sings, like people say, when you're renting, you're throwing money away, or when you're renting, you're just paying your landlord's mortgage.

While some of that may be based on truth, that's not always entirely true when we're looking at the long-term impact of purchasing a home.

Be careful and understand

We have to be really careful of is understanding the motive behind the person who's telling you to purchase. So for instance, you might be talking with a realtor and they're pressuring you to buy a home because they're saying buying a home creates wealth, and all this stuff renting is throwing away money. The same thing with a mortgage lender, I'm a mortgage broker, I make money when people purchase and refinance homes. So it would be advantageous for me to tell you, you need to buy, but honestly, it might be good for you to rent again.

Weigh your situation, don't just dive into conclusion

You want to make sure you're in a good financial position first, then explore, purchasing a home. There's no point in trying to purchase if your finances aren't where they need right now.

Don't let peers pressure "pressure" you

So just be careful of the motives of people and also understand that your family members probably don't have great financial advice. So when it comes to Thanksgiving and people around the table saying, Hey, why don't you purchase a home? That's gonna help you build wealth and all that stuff. If you're not ready to purchase, don't worry about it.

Renting as a jumpstart

So a quick summary of what we're going to cover is if you are looking at housing in the short term. So let's say in the next three to five years, then renting might be something that you consider really strongly, especially if you're closer to that two to three-year mark, if you anticipate moving around two to three years, renting is going to be your better option.

Purchasing as an option

Purchasing is almost always better long-term so three-plus years. Purchasing is going to be a great suggestion for you. So renting short-term purchasing long term.

The reason why is because when you purchase and when you sell a home, you have costs involved in there and you want to make sure you don't. If you're going to keep moving around, you don't have to pay the cost by, then the cost of sale and the cost of buying the cost to sell over and over again, we're renting doesn't have any of those acquisition or sales cost.

3 Numbers and a calculator

So let's go and dive into the three numbers you need to consider when you are considering buying versus renting. So here is our handy-dandy buy versus rent comparison. Now this is a tool that we use internally in our company, and it's not available publicly, unfortunately, because it's super powerful, but I can walk you through and show you these numbers that you need to consider.

A walk through

So first, what I'm going to do is insert in the zip code that we are in, so Dayton, Ohio for example. Then let's run a scenario for a $250,000 purchase price. We're just going to make up some numbers in here, and the whole goal really is to just get a picture of what's going on with all of these numbers.

Renting scenario

So first let's set up our renting scenario. So what we're comparing is trying to find a comparable $250,000 home versus renting. Now, this is comparable rent and Montgomery county, Ohio. Let's say,  they were paying $1500. We have renter's insurance and then we can see the average rent increase in Montgomery county. That's being factored in here as well. Something that we need to consider.

So we have that set up next. We're going to compare it, a potential property. So we have the purchase price along with the effective tax. We have homeowners insurance is probably going to be a little bit higher. I'm going to say a hundred. We have a property tax increase, estimate repairs, cost added in here, and a cost to sell what people don't realize all the time is that if you're selling, you do have costs that you have to pay. Normally it's 6% it's cover the realtor's commission and possibly more.

If you're looking at paying the buyer's closing costs. So we'll put in six. Now we're going to set up the loan that we would potentially have on this new. So we could say maybe we're putting 5% down on a 30-year conventional loan at 3.5%. This all looks pretty standard. So basically what we're saying is, Hey, we want to compare renting $1,500 per month versus purchasing a $250,000 house with 5% down.

Now we can look here. Let's say we want to look at a span of 10 years of appreciation. I'm going to pick it for art. We can see historical appreciation versus forecasted. Let's stick with historical since it's lower. It's going to give us a safer bet here.

Cashflow

So now let's first talk about the cash flow difference. This is number one that you need to look at. Cashflow is the direct comparison of rent costs versus your monthly. Homeownership cost this is where people usually stop. They only look at this one number and see the difference there. But we can see, in our example here, printing is cheaper, right?

We said we were only paying $1,500 a month in rent and for our renter's insurance, we're only paying 1533 per year. Buying we said while we're actually being closer to 1858. And that this scenario might be a little bit different depending on where you're at. So what we can see here is this difference between the two and over a period of time.

Constant mortgage while rent increases

We can see the mortgage payment that we pay each month on the home is constant, but rent continues to increase over a period of 10 years. So we can see that over 10 years, we actually lost. 13,000, almost $14,000 just in cashflow. But if we're only looking at the cash flow, if we're only looking at the monthly difference between homeownership costs and renting, then we don't get the full picture of buying versus renting.

Appreciation Game

The next number we have to look at is appreciation game. So appreciation is when the value of your home increases. So we're going to go off of historical averages. The market is going to more kind of trend like this going up and down but over a long period of time, We can see it normally trends upward in a period of about 2.78%.

So starting home value at 250,000 in 10 years, that would put us at about 328,951. Now included in there. You have to consider there's inflation that goes into that as well. 300,000 now might not be as powerful in the future. So that's something that they consider, but appreciation gain would give us almost $79,000 worth of gain over renting.

So that's number two, we have the cash flow, which we actually lost money on. Then we have an appreciation, which we came to a considerable amount on, and then we have amortization.

Amortization gain

Amortization is a big thing that people forget because if we're just looking at cash flow, all we're looking at is the difference between the mortgage and the rent. But amortization gain shows us that actually, when we pay on a mortgage, some of that goes towards interest and some of it goes towards the principal and the principal is the equity that you now have in the property. When you go to sell it, that's the money that you now have access to that you get as a check when you sell your home. So over 10 years, we would have paid almost $54,000 into the equity of our home.

Cost to sell

So now, if we also factor in the cost of selling real estate commission, we're going to say 6%. So that's the $19,700 on this, a new price up here. So we can see based on 328,951 future values after 10 years.

Net gain by buying a home

So now let's look at the net gain buying. We can see the net gain over 10 years is $93,849, and this is a net worth gain. So this isn't necessarily money in your pocket game. This is net worth. So you're almost increasing your net worth by a hundred thousand dollars over 10 years by purchasing in this scenario compared to renting.

So as an example here, we're considering how much should we pay in closing costs, what's our appreciation gain, What's our cash flow difference, which we lost money or amortization gain, and then our cost to sell.

So if we sold the home in year 10, our net gain by purchasing this house is $93,849. Something interesting is we can take a look at year one. Year one gives us quite a bit of a negative. We're looking at a loss of $12,800. We're operating at a loss. So if you purchase a home, only lived in it for one year. You're not going to do too well. You lost $12,800. Same thing, year two, you're paying those upfront costs and you lost money in year two, but your three is where things start to turn around. Now we have a positive gain of 4,000, and obviously, this continues to grow the longer and longer it goes.

Two things we need to consider

So it really comes down to what's your timeframe look like? I think you can boil down this decision into two things.

Are you financially ready?

You can look at math and numbers. All-day long, but the first thing you need to consider is are you financially ready to purchase a home? Have you taken down most of our discretionary? Do you have savings set up? Do you understand how your budget is working? Do you know where your money is going? If yes, great.

Timeframe

Then let's look at your timeframe. If you're planning on being in the home for only three years, maybe renting might be the better solution. If you're looking at being in the home for longer than three years of staying, then purchasing might be a better solution.

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