Strange that they buried the most important factor way down at the bottom of the 3rd page of "Advanced" options.
At its core, the whole rent vs buy economic decision boils down to comparing your expected returns investing in the housing market to your expected returns investing in the market in general. The rest of the factors in that calculator are just there to help you arrive at the conversion factor.
Since it's pretty much impossible to determine what the stock market and housing markets are going to do, it's probably best to base your home buying decision on something more rational. Such as "Do I want to own a house?"
For me, the answer to that question is quickly arrived at by asking a few of your homeowner friends what they did last weekend, and what they plan to do next weekend. The answer will invariably revolve around some form of maintenance on the house.
Like it or not, buying a house gives you a new full-time hobby. Lots of people like that hobby, and that's why they have houses. If gardening and cleaning gutters don't sound like fun to you, there are plenty of other ways to invest your money that are less hands-on.
Maintenance isn't so bad, and it doesn't require every hour of every weekend. But I've got a small apartment with a small patch of grass. It takes me 10 minutes to cut the grass and 20 to trim the hedges, once a month.
Like any hobby, you get out what you put into it. I spent 2 weekends gutting and renovating the kitchen, put ethernet and coax in every room, and wired my garden for electricity and music.
My last rental had 3 fireplaces, none of them worked because the owner, rather than paying someone to clean and maintain them decided to plug them up. Ethernet? forget about it. Cable in every room, not an option. The kitchen was nice and new, but designed to someone else's specification, not mine.
Nobody says you have to buy a big house. The amount of maitenance is directly proportional to how many plumbing fixtures, windows, appliances, lights, cabinets, etc you have.
If they had a rule of thumb, link between mortgage rate and investment return (eg. r-2 for savings accounts or r + 2 if you think you can beat the risk free rate consistently), would you be satisfied?
Increasing the rate of return gives you some interesting curves.
A simple way to quickly compare buying vs renting for entire areas is the "rent ratio", which is calculated by dividing an area's median house price by its annual rent. Obviously it just paints a geographical picture and each property should be evaluated individually before making any sort of specific buy vs. rent decision. We turned the rent ratios for the US into a heat map a few years ago (but keep it up to date): http://hotpads.com/search/rent-ratio-heat-maps
It's interesting to see just how sensitive the scale is to initial assumptions. But more important to me is the inefficiency created by the drag on movement - when you're renting, it's much easier to move, even when you've got furnishing and the whole lot etc. When you've bought, and you want to move, you may be at the mercy of the current state of the property market as to whether you make a loss or a gain, or even need to stay for a few years more.
I grew up in rented homes. Perhaps the most poignant thing is that the house I remember best (age 9 to 18 or so) has been renovated, sold etc. It's not somewhere I can ever go back to. But that may have been the case with a bought home anyhow.
I believe that it would necessarily be irrational to ever "need to stay for a few years more" because of the state of the housing market. (I do agree in general that you're more mobile as a renter, I just think think you've overstated it.)
An extreme example: You buy a house and then the value plummets to a fraction of what you paid. Why might you need to stay in that house? Other house prices presumably fell along with yours so you can still sell yours and buy a similar one. I think people find it painful to sell at a loss because it makes a loss on paper become explicit. If you don't sell then you can tell yourself that you're speculating -- you really think your house is worth more than it will currently fetch so it's imprudent to sell. But probably you're not smarter than the market in that regard. In other words, there's no harm in turning a loss on paper into an explicit loss.
Bottom line, if you want to move from house A to house B and the price difference (plus moving costs) is worth it, then do it, with no thought at all to the price you happened to have paid when you bought the first house.
Of course, moving costs when realtors are involved are huge so the original point partially stands. You're never stuck in the sense the parent implied, moving is just more expensive when you buy vs rent.
> Other house prices presumably fell along with yours so you can still sell yours and buy a similar one.
Not if the house lost more value than your down payment. If you're underwater (and a lot of people are), you need to either arrange a short sale or bring money to the close. Either way it's nowhere near as easy as you imply.
Also, people don't usually sell their house and buy a similar one in the same place -- they either upgrade or downgrade, or move to a different neighborhood or city, and in either case, the prices are likely not to have moved in the same direction at the same pace. In my neighborhood, 1-BR coops have dropped in price more quickly than 2-BRs, for example.
If you owe more than the house is worth then theoretically you should default and walk away. I know that question has been debated endlessly and I don't understand all the practical implications like what it means for your credit rating, or even whether it should be considered ethical.
I concede that if defaulting is not an option then you may be stuck if you owe more than the value of the house and can't borrow more money. Good point.
Defaulting differs in different countries. You may be forced to liquidate other investments to make up the shortfall. Nonrecourse loans are not usual outside of California, AFAIK.
This is a huge factor. A large amount of the real estate boom and bust has been concentrated in a fairly small section of the US: CA, NV, FL and maybe AZ. If you want to move out of CA's central valley to a job in, say, Boston MA, you're going to be screwed: the fall in home values in the Central Valley is much much larger than the fall in home values in the Boston metro area. And that's not an isolated example: people don't generally leave on economically ruined area for another. They want to go to places that are not economically ruined, and such places tend to have more stable real estate markets where prices took much less of a cliff dive over the last few years.
Buying is as much a emotional decision as it is a financial one.
You have to take into account not only the how much you can afford and how much you want/would like your money to grow but what kind of lifestyle you desire. If the lifestyle that owning one's home affords is more important than the increased returns then perhaps you should buy. On the other hand if you are happy to rent for a decade or two you will likely end up richer.
I am currently of two minds, I love the idea of being able to do what I like to my own home. But at the same time real estate isn't necessarily the best investment, though where I am (Melbourne, Australia) we've had massive growth in housing prices (somewhere in the order of 20%+pa off the top of my head) though it is slowing down now.
Another piece of the lifestyle choice is control. While renting you are at the mercy of the landlord. I found this out last year when our landlord decided she wanted to move back into her house. Even though we had a lease, and the law is suppose to protect you, it doesn't stop them from making your life miserable - and that cost isn't worth any amount of money to me.
That's bleeding horrible, and I agree. I've had some pretty miserable landlords (though I still continue to rent, and will not buy a house (at least not in the city I'm living in)).
Banks are pretty happy to let you borrow against your house. They're not likely to do so as easily with other investments. Means you can try to have your cake and eat it too if you're clever . . and perhaps a bit lucky too.
If you are doing the startup thing, it may be worthwhile keeping your financial obligations/footprint to a minimum. You can always downsize a rental, but a mortgage is not so easy to exit.
Plus, that mortgage downpayment might be better invested in yourself and your venture?
There are factors besides the rent vs buy calcs worth considering esp for entrepeneurs.
Let's see. Housing is propped up by the policies of a government that is currently borrowing 43% of the largest budget in human history. Will it be able to continue doing either indefinitely?
If you think so, by all means buy a house.
But if you think everybody reaps what they sow, think twice.
FWIW: the dynamics of governments borrowing - particularly governments with control of their currency, and debts denominated in that currency - are in no way like personal borrowing.
If the country we are talking about was at or close to its richest point, and it is in a bad recession, I would expect its budget to be very large with a significant portion of borrowing. To do otherwise would be irresponsible.
No, I think its irresponsible, especially in light of all the nonsense being funded.
Stimulus does not create recovery, any more than the stimulus of a massive housing bubble and two ways prevented the current economic trouble.
In fact, government created this bubble and the inevitable with stimulus. A phony economy where building things that people would not ordinarily demand requires building an expensive infrastructure which becomes useless when the phony economy collapses.
We can either let the economy return to normal, building things people are willing to pay for. Or we can try to create another phony government-directed economy with another recession to follow.
Not living in the US, but also worried about my government giving away all my money: isn't real estate one of the safer options? All my money and other investments, the government can simply take away (taxes) or devalue. Even gold is not safe - history shows that the government will try to get it, too.
Now the government could of course also try to take my house, but I think the public outcry would be bigger than for other investments - so it seems even more of a last resort governments would choose than other forms of taxpayer exploitation. Am I wrong?
In the US, property owners generally have to pay property taxes. In places where tech folk congregate, such taxes can be quite significant. Most municipalities fund education primarily through property tax levies and given the long term trends in the costs of primary and secondary education, I expect that property taxes increases will outpace inflation over the next decade or two. There are two reasons: technological improvements haven't raised productivity in this part of the economy and aren't likely to in the near future. Secondly, it seems that some (many?) municipalities are engaged in a status arms race regarding education spending and since most people are not equipped to assess educational outcomes, decisions often turn on more easily measured proxies that have little effect on outcomes.
Now the government could of course also try to take my house, but I think the public outcry would be bigger than for other investments - so it seems even more of a last resort governments would choose than other forms of taxpayer exploitation. Am I wrong?
I don't think you're wrong so much as that you haven't assembled evidence to make a convincing case. You're speculating. But without evidence, I don't find your speculation to be persuasive. I don't see much difference between the government raising property taxes and raising income or capital gains taxes. There's no need to seize your home.
exactly. They can take your house more quickly than they are by raising your taxes. And when they do, the value of your house will decline rapidly, as it is no longer as good an investment.
I remember when Massachusetts reduced property taxes in the 80s, housing prices went up rapidly. It suddenly became a better investment, costing much less every year to maintain.
Interesting - on the few California properties I tried, it says it never makes sense to buy, no matter how long you live there.
This could actually be true in some areas. Prices are still really high relative to rent. The Houston prices I put in made sense to own after a 2-3 years.
I noticed the same. Who looks only at the figures? I certainly don't and I suspect that most people just partially factor them in.
For me, the biggest factor is that does the apartment or house feel like my home. If it does, then I will consider buying or renting, depending on whether it's on sale or to let.
This is a superb calculator, however it assumes a faster growth rate relative to inflation than is likely. Try it with a -1% appreciation rate (which is the historical average for residential real estate since ww2)
Another thing to check is condo or homeowner's association fees. The default value in the calculator is 0, but for many condos the fees are 1/4 or more of what you'd pay in rent on a comparable apartment, which makes a huge difference long-term.
Every place I've, rented the association fees were in addition to the rent. It might be included in the rent but listed as a seperate item, or it could be the renter that pays directly. In any case, association fees weren't included in the deposit. In my case rent was 1500, deposit was 3000, but the check every month was 1700.
Apartment buildings normally don't have HOA fees. I can't imagine why they would since no one there is a homeowner. If you are renting a condo then the owner may or may not include the fee in the rent. In my case this charge includes heat and water, 2 things that change frequently.
I bought a house. According to this calc i may or may not have been a good idea based on how the house appreciates (I got it at the bottom of the market).
But at the end of the day my house is like 4x bigger then my apartment. So worth it even if it does not end up being an over all savings or not.
I think I can make intuitive why the "rent is forever gone" argument is wrong. Another way to state that argument is "after I pay off the mortgage I own a house and live for free whereas if I'd rented the whole time then I'd own nothing and still have rent to pay".
Imagine yourself 30 years from now with a house you fully own, with no more payments to make. Now imagine your alternate renting self who, instead of steadily paying down the principal on the mortgage, has built up hundreds of thousands of dollars in equity in some other investment. You still have rent to pay each month but that's also about how much you're collecting in interest on your investments. So the renter now lives for free just like the home-buyer.
Another way to say all this is that if you ignore price bubbles, taxes, personal preferences, and leverage then renting and buying are roughly financially equivalent. Not that you should ignore those things, just don't fall for the myths that it's a no-brainer decision.
Another way to say all this is that if you ignore price bubbles, taxes, personal preferences, and leverage then renting and buying are roughly financially equivalent.
And that shouldn't be surprising. In a world where buying really is clearly superior to renting, there would be lots of arbitrage opportunities to buy houses and rent them profitably. That would increase both the demand for houses and the supply of rentals, which would make buying more expensive and renting cheaper until they reach a point of equivalence.
In fact, landlord profits are probably a very small part of the equation: on par with the cost of collecting your rent and arranging (not paying for) maintenance. We can check this by seeing how much property management companies charge. Casual web searching indicates it can range from 3% to 15% of rent. But that includes the cost of finding new tenants — the equivalent of which home-buyers pay in spades in realtor commissions (directly or indirectly). I think it's safe to say that at most a few percent or so of your rent is wasted in the sense of being profit for your landlord.
(Which is what you'd expect in a competitive market, as someone above pointed out.)
The strategic picture is this: if renting were so much better than buying fewer people would buy, and nobody would be dumb enough to buy and then rent the place. But obviously buying is better than renting because a lot of people choose to go and spend their money buying extra homes beyond the one they need and renting it.
I don't need to refer to google searches for my information, I have seen the landlord perspective 1st hand. I'm not surprised that most landlords see very little in the way of month to month cashflow profit. The renter pays in but you have to pay out a lot of other expenses (as mentioned).
But at the end you own the house and the renter doesn't. Basically if you have enough money to front for the down payment the house costs you little or nothing after that except time/hassle of dealing with your tenant. It probably doesn't actually put more money in your pocket each month, but neither would a bunch of stocks if you were reinvesting the returns.
So why tie yourself up in a single house instead of a bunch of stocks?
Leverage.If I have 40k and get a mortgage on a 200k and make a small return, at some point that is better than getting 40k of stocks and making hypothetically a bigger return.
Plus there are other intangiables. I can buy a shitty little house and spend a few weeks working on it and turn sweat equity into real equity, no matter how much you look at your stocks you haven't increased their value.
Of course there are negatives, the tenant can trash the place, you can go without tenants for a while, but overall it makes sense for a lot of people who have some free cash and a bit of extra time and want to have a side business.
if renting were so much better than buying fewer people would buy, and nobody would be dumb enough to buy and then rent the place.
Correct, which means that renting isn't clearly superior to buying either. (Except during insane housing bubbles). Again exactly what we should expect.
But obviously buying is better than renting because a lot of people choose to go and spend their money buying extra homes beyond the one they need and renting it.
And obviously growing your own food is better than buying it because lots of people grow extra food and sell it. The point is that the profits you can earn in either case aren't so great that it's foolish not to do it.
> Imagine yourself 30 years from now with a house you fully own, with no more payments to make. Now imagine your alternate renting self who, instead of steadily paying down the principal on the mortgage, has built up hundreds of thousands of dollars in equity in some other investment. You still have rent to pay each month but that's also about how much you're collecting in interest on your investments. So the renter now lives for free just like the home-buyer.
Actually, the renter is better off from a purely financial point of view. Even if the house is owned free and clear, property taxes and maintenance will still need to be paid. The renter's rent covers all that.
I don't get this commonly made argument. I'm either paying rent or a mortgage. It seems to rely on an assumed rich renter, who has enough money to rent an apartment AND invest money on top of it.
Say the home-buyer can just barely afford the mortgage payments and their renting alter ego can just barely afford rent. Then necessarily the renter is getting a much nicer place. Holding the niceness of the place constant, the renter will indeed have extra money to invest just like the home-buyer is gradually building equity (investing) in the house.
Rent ratios are actually often such that the above is even more extreme: buying a house cost more per month even if you pay only the interest on your mortgage (which is equivalent to renting: building no equity in the actual house).
These buy vs rent calculators assume that any savings made from paying rent instead of mortgage is paid directly into an investment account. I.e. you sock away the full theoretical mortgage amount less rent paid into a managed fund or some such.
The reality that I've seen is that people never actually do that, or at least not to the full degree, and treat the difference as extra disposable interest. And so the money gets frittered away and the calculations are wrong.
You can't do that with a mortgage: you have to pay it, and so therefore people have an enforced savings/investment discipline. And also the incentive to sock as much money into their house as quickly as possible, to pay down the debt.
So the money side is generally better, and you generally get a better house, when buying. But it's a bit of a commitment which some people will avoid on principle.
Well said, but that doesn't make the calculator wrong.
It'd be cool if there were some form of financial instrument for the weak-willed individuals you describe (which as you say probably represent 90% of the population), that acted exactly like a mortgage but simply left your money in a pile you could access later.
Sorta like an IRA that you could force yourself to commit to, with nasty letters arriving in red envelopes if you skipped a payment.
There's something like that (though on a different timescale) called Christmas Club accounts. You can deposit money but you can't take it out until December. I understand it was quite popular in the 70s. The idea is to force yourself to save enough for holiday shopping.
I'm totally fascinated by commitment devices like that. I've been compiling a list of them here: http://padm.us/akrasia
The "getting a mortgage to force yourself to save" was actually the first example I thought of, from when this topic came up a year ago.
You're ignoring mortgage interest and costs associated with actually owning a home that you don't encounter when renting. Those are also gone forever and given that most of your early mortgage payments will be primarily interest ones when you sell early even for the exact same amount as you bought you lose out on that money.
As are property tax, neighborhood dues, garbage fees, and a half dozen other little fees associated with home ownership that, comically, add up to about the rent on a nice apartment in most cases.
One common technique for lowering the cost of a mortgage is to make one additional payment per year and/or each month. This lowers the principal and makes subsequent interest payments lower.
Although, not everyone can afford that it would be nice if this calculator would allow you to factor that in. I suppose you can fake it by altering the interest rate an appropriate amount but I'm not sure it follows the same curve.
I don't believe this is really a factor. Paying down the principal faster saves you the 5% (or whatever your mortgage rate is) interest on the amount of your pre-payment. It's tantamount to investing that money at a risk-free 5%. That might be the smartest thing to do with your savings but it doesn't change the calculus fundamentally.
Buying a house with a suitcase full of cash or getting a zero-amortization (infinity-year, ie, interest-only) mortgage or anything in between is all roughly financially equivalent if you have alternative investments available.
Actually the longer the mortgage term the bigger total tax deduction you get, so in that sense the more you pre-pay the costlier it is.
I don't have a mortgage so I don't personally do this, but I can tell you it's a popular practice.
> but it doesn't change the calculus fundamentally.
It does change the calculation that this tool is showing. If you use the tool and assume you make 3% interest on savings, but then make periodic payments on your 6% interest loan, there is no way to model that with this tool.
OK, so lets say this is a bad idea and you should instead not have any savings in that case, and make all of your savings into payments on your mortgage interest. You're saying we could model that by assuming you are making periodic risk-free 5% (or whatever) investment instead.
> Actually the longer the mortgage term the bigger total tax deduction you get, so in that sense the more you pre-pay the costlier it is.
I get what you're saying but a tax deduction can never completely offset the interest payment right? Also, it depends on the difference between capital gains tax and the credit you would get on your tax rate for the interest.
> OK, so lets say this is a bad idea and you should instead
> not have any savings in that case, and make all of your
> savings into payments on your mortgage interest. You're
> saying we could model that by assuming you are making
> periodic risk-free 5% (or whatever) investment instead.
Exactly.
> I get what you're saying but a tax deduction can never
> completely offset the interest payment right?
Agreed, but I just meant that the more mortgage interest you pay the more you save on taxes, not that the interest is totally offset or anything.
Concepts like compound interest and tax calculation based on a known rate are based on straight mathematics, not politics. The only thing different between now and then is the starting figures you enter in the calcuator.
At its core, the whole rent vs buy economic decision boils down to comparing your expected returns investing in the housing market to your expected returns investing in the market in general. The rest of the factors in that calculator are just there to help you arrive at the conversion factor.
Since it's pretty much impossible to determine what the stock market and housing markets are going to do, it's probably best to base your home buying decision on something more rational. Such as "Do I want to own a house?"
For me, the answer to that question is quickly arrived at by asking a few of your homeowner friends what they did last weekend, and what they plan to do next weekend. The answer will invariably revolve around some form of maintenance on the house.
Like it or not, buying a house gives you a new full-time hobby. Lots of people like that hobby, and that's why they have houses. If gardening and cleaning gutters don't sound like fun to you, there are plenty of other ways to invest your money that are less hands-on.