Often, owning a home is not always the investment that the real estate industry leads consumers to believe it is. For example, in 2014 Federal Home Loan Mortgage Corporation Freddie Mac said the value of an average home increased 3.6% a year compounded annually over the previous three decades. In contrast, the compounded annual return of the S&P 500 over that same period was 11.1% according to Morningstar investment and research.
Your home may grow in value or it may not. Furthermore, when you go to sell a home, you have to recover other expenses like the broker’s commissions (5 to 6%) and transfer taxes of 1% to 2% (depending on the location).
In today’s employment climate, relocation flexibility is important and sometimes essential to an employee’s ability to climb the economic ladder. Families may have growing concerns regarding job security coupled with a growing dependence on a two-family income. In these situations and others, renting may provide a much less costly option than buying. The cost of selling a home combined with the amount of time it takes to actually close the sale are serious impediments to relocation.
The rent vs buy decision is going to vary depending upon each individual and family’s circumstances. Below are some important financial considerations you should weigh before making your final decision.
House Price Declines
Hopefully, housing prices will never see as significant a decline in price as they did in the recent recession of 2007. Even a small decline in home prices can cause a significant financial impact on a family. History tells us that modest declines in home prices are fairly common. In fact, in 2014 the average price for a two, three, and four-bedroom home in the Philadelphia area declined 5.0%, 3.6%, and 7.3% respectively.
Rent vs Buy Cost Comparison
The cost of rent is often less than the cost to buy a home. Buying a home is not for everyone. When you rent an apartment, you are not obligated to pay, like homeowners are, property taxes, homeowners’ insurance, and the cost of maintenance. These three items cost the average homeowner 3% of the purchase price of a home, year after year. This is equivalent to $621.56 a month.
Additionally, even with a home mortgage interest deduction, a homeowner will still be required to pay a steep sum of interest. For instance, a mortgage amount of $198,400.00 requires a 20% down payment of $49,600.00, an interest rate of 4.667% (the interest rate published by PNC Bank as of July 21, 2014 for an 80% mortgage with zero points) results in an interest payment of $174,214.00 over the lifetime of the loan. Assuming the family was in the 25% tax bracket, the savings would have been $1,451.71 a year or $120.98 a month. The out-of-pocket interest would have cost $4,355.42 a year or $362.95 a month. You would save $43,553 over the life of the loan, and you would have paid out over $174,000.
Whereas an income-to-debt ratio can pile up for a family, monthly rental payments on paper are not considered a debt, but rather an expense.
Home Maintenance Costs
As stated before, the cost of maintenance of a home can be very significant.
When it comes to owning a home, upkeep is a regular activity. Cleaning the gutters, replacing your roof, replacing the HVAC system, fixing doors, lawn care, snow removal, and so on. Thousands of dollars can easily be spent replacing your air conditioning, carpeting, and landscaping, as well as appliances like a washer and dryer. You can’t write off the expense on your taxes, and while it is possible to recover the cost at the time of sale, rarely is the entire amount ever recovered.
Evaluating Mortgage Payments
Mortgage payments are very predictable under a fixed-rate mortgage. Under a variable mortgage, the rates can adjust yearly. Given current historically low-interest rates, it is very likely interest rates will rise in the near future. Between 2011 and 2014, interest rates changed 0.0032%. From 2008 to 2014, interest rates changed 1.33%, and interest rates changed 1.79% in the 2007 to 2014 time period. Add to this the fact that real estate taxes can change based on property assessments. If you owned a home in Philadelphia, you would have had an increase in your real estate taxes of approximately 19% compounded between 2010 and 2012, a period of just three years (10% in 2010, 4% in 2011, and 4% in 2012). This does not even take into account that under the City of Philadelphia’s AVI plan, many homeowners saw their annual real estate taxes increase as a result of reassessment.
Home Mortgage Interest Deduction
The home mortgage interest deduction has been around for a long time, but that doesn’t mean it will be here 5, 10, 15, or 20 years from now. A change in the mortgage deduction has been under discussion from the time of the Bush administration through the current Obama administration. In 2013, the Brookings Tax Policy Center advised Congress that “achieving a revenue-neutral tax reform that reduces marginal tax rates significantly would be difficult or impossible to achieve without cutting back the mortgage interest deduction or some other equally popular and wider used provisions.”
Buying or renting needs to be carefully evaluated by individuals and families. There is no general answer to the question of buy vs rent as the above discussion illustrates. Careful consideration based on specific individual family circumstances and finances is required. In many circumstances, renting may be the most affordable alternative.