This calculator will help you to compare the costs of renting to the costs of buying a property. Since there are all kinds of forces at work behind the scenes (interest, property taxes, tax savings, appreciation, opportunity costs, closing costs, selling costs, etc.), comparing the cost of renting to the cost of buying is a lot more complicated than just comparing the monthly mortgage payment to the monthly rent payment. This calculator attempts to forecast the net effects of all the hidden forces so you can make an informed decision.
Much like the stock market rises & falls due to changes in earnings and multiple expansion, the cost of owning vs renting changes across time & location, as real estate is local.
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Should You Purchase a House?
Owning a home is often called the American Dream, but are you really ready to buy a house? Purchasing a home is one of the biggest investments you will make in your lifetime, and when you make this purchase you want to purchase the right house at the right period of time in your life. There are a variety of different scenarios where renting makes more sense than buying, and other scenarios where buying will be the best decision for you and your family long term. It is important to consider a variety of different factors when you are toying with the idea of viewing homes and making an offer on one. Here is your straightforward guide on Buying vs. Renting so that you can make an informed and educated decision.
When Is the Time Right to Buy Versus Rent?
Buying a house makes quite a bit of sense for many individuals, but only when the time is right. The first subject you will need to study to determine if it best to buy or rent is timing. Individuals and families go through several different stages, and not every stage is the right time for an individual or a family to buy a residential property. Timing is everything when it comes to home ownership, and there are red flags to look out that will tell you that it is not your time to buy. Here are some of the factors that you should sit down and consider before you call a real estate agent, make an offer, or prequalify for a loan:
Your credit score is low
Lenders all around the nation are offering low interest home mortgage loans, but this does not mean that every borrower will receive low rates and fair terms. Everyone who is considering buying a home should run their credit report, compare their reports with all 3 credit bureaus, and fix errors before applying for any mortgage loans. If any of your reports show a score of 620 or less, you should press pause on your mission to buy a home until you can raise your credit score.
Virtually all lenders see FICO scores under 620 as risky, and if you do find a lender willing to extend a loan to you, you are more likely to be dumped in the hands of a predatory lender and will be paying higher rates over the life of the loan. Take time to look at your credit report in depth and look at more than just your score. If you have several late payments, it can disqualify you from getting approved for a loan. Make sure defaults, late payments, and other derogatory reports do not get in your way of qualifying for a good home mortgage loan with low rates and fair loan terms.
Do you have job security?
Are you working in the field of your dreams? Many times, the field that you work in will determine how stable your job is. When you are answering this question, you must be very honest with yourself. Doing research online and looking at the Bureau of Labor Statistics' predictions of growth in your field can help you see if there will be growth in the future.
If you are not sure how well your company is doing, you can use public financial records and other information on the Internet to your advantage to see if there will be layoffs or cutbacks in the near future. No one ever wants to lose their job or experience a pay cut, but experiencing this when you own a home can be much more difficult. You can be earning plenty of money and still not be in the position to buy a residential property, so make sure that you know you have job security first because unemployment compensation is not enough to cover the average mortgage.
Is relocation in the future?
There are a variety of different reasons in your life that you might relocate, and you cannot foresee or predict all of them. If there is a possibility that you would need to relocate for work, or you have been talking about accepting a position across the country, it is best to rent so that you are not bound to a property long term. If you sell a home when you need to relocate, you risk the chance of losing out in potential profits due to time restrictions. Be realistic about how long you plan on staying in the area, and only commit to buying a property if you really plan on staying for years.
Do you have money for the down payment?
Is the time right financially? You may be making enough to cover your mortgage, your housing expenses, and all of your other bills, but do you have money that you can use for a down payment. When the housing market bubble burst in 2007, one of the biggest reasons why this happened is because of the fact that lenders were not requiring down payments and they were approving borrowers who could not actually afford to own a home. To prevent this from happening in the future, lenders have gotten very strict about down payment requirements.
Ideally, borrowers should have 20% of the purchase price of the property to put down, but lenders will approve you with less. Make sure that you speak with a mortgage broker to find out how much of a down payment you would need to satisfy the lender's requirements. In the past, there were ways to apply for piggyback loans which would take a borrower's down payment from 3 percent to 10 percent, but piggyback loans are gone. When applying for a conventional loan, you will need between 5 and 20 percent down payment,, with 20 percent being best. If you can come up with the entire 20% down payment, you will not have to pay Private Mortgage Insurance (PMI) which keeps your mortgage payments down.
Will life events require more space?
Are you planning on having a baby? Do you have children who will be leaving the nest in the near future? Will you be responsible for caring for your elderly parents when they cannot care for themselves? These are all timing factors you must keep in mind before you select a home. You need enough space, and adding space to a home can be very expensive. If your future is plagued with a lot of uncertainty, it may be best to hold off buying until you know how many rooms you will really need for children, guests, and elderly family members. If, on the other hand, you know how many rooms you will need and you can afford a home that will grow with your family, buying could be a good option.
Considering Purchase Price vs. Income and Rent vs. Purchase Price
If you have determined that the timing is right to buy a home, you need to move on and find out if your finances are right as well. Household income will pay a major role in whether or not you are actually ready to cover your mortgage payments and other household expenses. There are a variety of different ratios that you can use to determine if you are making enough money to become a homeowner, or if the rents are going to be more realistic for you in the short term.
The Front-end and Back-end Debt-to-Income Ratios
You can use the two different ratios that the lenders use to determine if your income is large enough to buy a home within a reasonable price range. Before you start applying for mortgage loans, you should take the time to understand how debt-to-income ratios help the lenders underwrite your loan application and determine if you can really afford to own a home and pay for your other bills as well.
The front-end ratio is a ratio calculated between mortgage payments and gross income, and most lenders only approve borrowers who will only use 28 percent or less of their gross monthly income towards mortgage payments. The back-end ratio is used to calculate the percentage of gross monthly income that will go towards covering all debt payments. Lenders generally only approve loans when the mortgage payments for the purchase price of the property and all other debt payments when 36 percent or less of the household's income goes towards the total debt.
Rental prices versus purchase price
If you have a high debt ratio, you may be able to qualify for a home mortgage loan. If you use a home mortgage calculator to calculate the mortgage payments based on a specific interest rate and a purchase price, and you determine that your front-end ratio is extremely high, you may want to look at the rental prices and how they compare to the purchase prices of properties. If you have a high front-end and back-end debt-to-income ratio, this means that in the eyes of the lender you cannot afford to feed yourself, pay your mortgage, and cover your other bills.
In some cases, the cost of rent for similar properties are much lower than the price that you would pay if you bought a home. In the real estate sector, comparing the purchase price and the rental price costs is referred to as a price-rent ratio formulation. To calculate the price-rent ratio, you should take the median purchase price of a property in your area and divide this median number to 12 times the median rental price. When you calculate this, you will have an annualized ratio. The smaller the number, the smaller the gap is between rental prices and purchase costs. When this gap is small, it may be more attractive to buy rather than rent. When the gap is larger, it means that in the short term it is much more affordable to rent.
Using Local Real Estate Market Conditions to Make Your Decision
After you have determined front-end and back-end debt-to-income ratios and price-rent ratios, you should then move on to considering the real estate market conditions in the area. If buying costs you less than renting, that does not mean it is in your best interests if the price trends in your area are going down. On the other hand, the wisest buyers will purchase homes when housing values are low and the trends show that the prices are on the verge of rising and gaining momentum. Assessing the trends in a suburban, rural, or metropolitan area that you would like to live in is key to making the best decision on buying or renting.
There are a variety of different pieces of data that you should look at the assess the local market conditions. Assessing the current conditions and which way the market will move is extremely important. If you use expert predictions of the real estate market, be aware of the fact that the predictions are not guaranteed. They are strictly to give you an idea of how the trends can play out in the future, and you should do your own homework and research the credibility of the "expert" before you make a decision based on one prediction.
Two numbers that are extremely important are the listed sales price of homes and the number of months homes have remained on the market. If you find that the sales prices of the homes in an area are going up and that the months a home has been on the market are going down, this is a sign that buyer demand is on the rise. When buyer demand goes up, this means that more buyers are finding financing, more buyers are confident that the market is on the rebound, and more sellers are accepting serious offers.
If the number of homes being listed on the market declines, the inventory is low and there are more buyers competing for a smaller number of homes. In these scenarios, the average purchase price of properties goes up and buyers cannot find the best bargains. If the trends show that inventory is going down and prices are going up, you should strike while you can still afford to buy. If the trends show that homeowners are currently losing equity but new developments in the area will make the area desirable in the future, you should buy while sellers are willing to take low offers and then bank from rises in equity when demand in the area is higher. As you can see, there are a variety of different marketing conditions to consider before you really commit to making such a long-term investment.
How to Prepare for Buying if Now Is Not the Time
If you have discovered that you are not financially ready to buy a home, do not be discouraged. It is not too late to get your finances in order and to start saving to become a homeowner. You should never just rush into buying a home because your dream is to be a homeowner. In fact, rushing into buying can hurt you financially and lead to devastation when you have no other option but to foreclose on the property. You should never have to take out lines of credit or apply for credit cards to live off of because you cannot cover your bills. Here are some very valuable tips on preparing yourself financially for buying a home:
Run Your Credit Well in Advance
You should not wait until the month before you plan on looking at residential homes to run your credit. Even worse, do not let lenders run your credit until you know exactly what has been reported under you social security number. There could be delinquencies you did not know about, and errors that will not look favorably on you as a borrower, and knowing what is on your report in advance will help you avoid damaging your reputation for creditworthiness.
You should run your credit report at least 6 months in advance so that you can work on improving your FICO score and paying down your debts. By doing this, you can work on lowering your debt-to-income ratio as you raise your score. This will help you qualify for the best mortgage interest rates. Some may recommend running credit reports a year in advance so that you have plenty of time to fix errors with bureaus. If you are close to your balance on your credit cards, leave ample time to pay down your debt so that the lenders are more likely to approve your loan applications.
Stop Borrowing Money
When you are committed to buying a home, you should stop borrowing money the minute that you start saving for a home. There is no denying the fact that the home is going to be the largest single debt you have on your credit report, and lenders must assess risk to avoid lending to the wrong borrower. To assess risk, lenders have very strict underwriting guidelines and requirements, and looking like a good risk is pertinent. When you have as little access to credit as possible, lenders will look at you as less of a borrowing risk.
Avoid applying for any new credit cards, do not take out a new auto loan, avoid taking out open-ended lines of credit from furniture stores, and say no to the temptation to take that 0% financing same as cash offer at the electronics store. When you stop borrowing money, you are less of a risk to lenders. By being less of a risk, you can qualify to buy a home with an average income instead of having to raise your salary just to live the American Dream.
Calculating the Expense of Owning a Home
Do you really know how much it costs to own a home? When you rent a home, you have a fixed monthly rental rate that you are obligated to pay until the rental term ends. You may have utilities, cable, internet, and renter's insurance, but the majority of the cost is known upfront. Calculating the expense of owning a home is not as obvious, and you should be familiar with all of the costs of owning a home so that you can prepare. The amount of house you can afford in the future is based on how much you have saved, how much you make, and your other financial obligations. If you are trying to get on the right path financially, here are some of the expenses that you must cover when you buy a home:
- Property taxes
- Private mortgage insurance
- House maintenance
- Homeowners association fees
- Mortgage payments
It is in your best interest to get preapproved for a mortgage loan well before you want to buy so that you can see the price range you can currently afford. If this price range is not sufficient, you can easily identify what you need to change so that you can qualify for a larger loan and more of a home. Make sure that you take the time to research lenders before you apply for preapprovals. By doing this, you will have peace of mind in knowing that a reputable lender with fair terms and conditions has qualified you.
Saving for your downpayment
If you put anything less than 20% down on a home that you purchase you will be required to pay PMI, or Private Mortgage Insurance, until the loan balance is 80% or less of the property's appraised value. Private mortgage insurance can be very expensive, and this is money that does not go into the equity of the home that you purchase. A downpayment is almost always a requirement, but the higher your downpayment the better. If you currently do not have a downpayment saved to purchase a home, it is important to start saving as you rent. Here are some tips on saving for a downpayment to purchase a home:
Create a monthly budget that allows you to put money away for the downpayment. Look at your monthly income, your expenses, and see what you can cut back. If you take notes of what you spend for an entire month, you can identify where you are spending unnecessarily and where you can save.
- Look for bills that can be reduced. If you have premium channels, get rid of them. If you have special phone features, eliminate them. Try to reduce auto insurance and renters insurance premiums.
- Look for a night job where you can earn extra money strictly to be put away for saving. You may be pressed for time, but if you save all of the earnings you will save for a downpayment quickly.
- Set a realistic goal, know the time frame, and put a specified amount of money from your paycheck into a separate savings that is for your downpayment.
- Ask family for help if you are not too proud. Many times, parents and grandparents are happy to help with a downpayment if they can afford to do so. If your family knows you are saving, they may be more open to giving you the gift of cash for Christmas and birthdays so that the cash can be added to your downpayment fund.
How Much Home is Considered Affordable?
Home affordability differs from region to region. If you want to calculate how much home you can afford, you need to consider not only location, but also lender qualifications. You need to keep the fact that the lender that underwrites your loan will generally sell your loan to a company who services the loan for the life of the loan, otherwise known as the amortization period. There are plenty of home loan programs designed to make housing much more affordable in areas where first-time buyers find affording a house to be difficult. If you want to calculate the rough estimate of the price of an affordable house based on your income, you can use affordable housing calculators and enter your information to get a general idea. The information you will need to enter into the calculator includes:
- Annual rate
- Amortization period
- Annual taxes and insurance
- Annual maintenance
Typically speaking, an expert financial planner will define an affordable house as one with monthly payments that are less than a quarter of of your after-tax monthly income. This figure may vary based on the interest rate you are charged and the loan period that you choose. It is best to deal with a mortgage broker or a loan processor directly to get exact figures when you are trying to determine affordability.
Determining the Incentives for Buying a Home
There are obvious short-term advantages to renting a home, but you also need to know the short-term and long-term incentives for taking the leap and buying a property. When you file your taxes as a renter, you can claim the renter's credit as the head of household, but this credit is not even close to the tax incentives you receive for owning a home. There is no denying that renting is cheaper in the first few years, because the cost of buying a home initially is high. But this added cost will balance out, and most experts say that, on average, buying a home is cheaper after 6 years. This is primarily because of the fact that you receive annual incentives. Here are some of the advantages and incentives that you must keep in mind when you are trying to determine whether renting or buying is the best long-term choice:
Government Incentives in the Form of Down Payment Assistance
In some areas, there are incentives in the form of down payment assistance available to first-time home buyers. The Federal Housing Administration and state governments have special programs that keep closing costs low and require buyers to pay small down payments so that the average American can buy a home who may not have qualified otherwise.
Tax Incentives for Owning a Home
Did you know that you can qualify for tax credits if you own a home? As an eligible tax payer, you can take advantage of a tax credit for buying a home and reduce your tax obligations for the year you purchase your home. You may be able to write off the down payment and other home buying costs, which will entitle you to a large refund. In addition to this, you will enjoy the luxury of writing off the interest payments that you make throughout the year every year on your taxes. Some home improved and even a portion of your mortgage payments can be written off if you do business in your home. The tax incentive for owning a home adds up over the years, and the refund that you receive can go in your savings or towards maintaining your home.
Earning Equity in the Property
When you are renting a home, unless you have a special lease to own contract, you are paying the landlord's mortgage in exchange for having a roof over your head. None of the money you pay towards a rental home will be available to you later down the line. You are simply paying into the property owner's equity so that you do not have to deal with the pitfalls of owning property.
If you purchase a residential home, every time you pay principal and interest payments towards your mortgage loan, you are earning a small amount of equity. This equity builds over time, and you have the right to tap into this equity if you ever need to. Most of time, it is best not to touch your home's equity, but if you have an investment opportunity that will earn you money, equity is great thing to have available. You can also use this equity during times of financial hardship by refinancing your home, but this should always be a last resort.
Enjoying Capital Gains without Having to Worry about Rising Rents
When property values rise, property owners enjoy capital gains. In a perfect world, property owners would sit back and watch the price of their property rise as they pay down the mortgage. This is not always what happens, but if you buy at the right time, the value of the home you buy will go up dramatically over time. If you buy a home at $200,000 and the value rises to $250,000 over a period of 3 years, you are enjoying capital gains of $50,000 over a span of just 3 years. If you were to sell the property at its new value, you would be pocketing the gains and using this for a new investment.
While there is no risk in losing money when values decline if you choose to rent, if you do not take on the risk you will also never reap the benefits of earning capital gains over time. You also need to recognize the fact that rental rates do rise over time. As property values rise, landlords have the right to raise rents to follow the housing market trends.
If you survey rental prices over a span of 5 years, you will see that rates do rise if values are rising, and you can avoid falling victim to rising rental rates if you decide to be a buyer instead of a long-term renter. This is a factor that many people overlook entirely when assessing the risk on both sides. If you apply for a fixed loan and you buy a property, you have peace of mind in knowing your monthly payments will always remain fixed, unless you qualify for a lower interest loan where your payments can go down.
Do What you Want to Your Home
If you rent a home for a long period of time, it may feel like your home but ultimately your landlord owns it. If you feel like adding a pool, adding a bedroom, changing the flooring, or updating the property, you must first get approval from the property owner. Even after you get approval, all of the modifications that you make are benefiting the landlord and not yourself. The additions are adding value to the property and making the property more appealing to other renters in a competitive market.
If you own a home, you can make the modifications that you want to make, and these upgrades will benefit you and no one else. If you improve curb appeal, not only will your home look nicer, it may have a higher appraised value. If you add a pool, not only can you entertain and throw pool parties, you can increase comparable values and make your home more valuable than others in your neighborhood. The improvement you pay for will pay for itself in the long run if you ever want to sell the home. If you do not want to sell the home, the improvements you make make the value of your home grow so that the property in the neighborhood goes for more.
Knowing the Risks Associated with Buying a Home
Buying a home, even when you are financially prepared, can be a risky venture. While the risk pays off more often than not, you need to accept and acknowledge the fact that buying is definitely more risky than renting. If you are not ready to take on the risks associated with buying a home, you may want to continue to rent homes until the risks are not as scary to you. Keep in mind that even conservative individuals can buy homes and feel comfortable buying. Here are some of the risks you should be aware of:
Buying a Home with Defects
A home must pass a home inspection before you can close on a loan, but sometime the minor and major defects are overlooked. There is nothing worse than buying a home and discovering the home needs a new foundation or roof just months later. You need to be aware of the fact that you are responsible for maintenance and the expensive repairs as soon as you receive the keys. As a renter, the landlord is required by law to make the repairs for you so that the home is safe and livable. In this sense, buying a home is a big risk.
Limited Lifestyle Flexibility
If your lifestyle changes, you need more space, or you need to relocate, there is not much flexibility when you buy. You can add a room if the code permits this change, but the cost will be high. You cannot pick up your home and move it to a new community or a new state to change jobs or shorten your commute. If you need flexibility for relocating or life events, you should continue to rent.
Lenders Want their Money Even if You Lose Your Job
Your lender and your landlord will both want the money they are owed if you are disabled or you lose your job. It is much more difficult to cover a mortgage payment when you do not have a job than it is to cover a rent payment. If you break your lease, it may affect you, but failing to fulfill your obligations on a mortgage can damage your credit for years and lead to foreclosure and bankruptcy. If you are renting, you only need to fulfill the rest of your lease, which is a period of a few months, but your mortgage can be a 30 year obligation. If you do not have a stable job, renting is much more practical.
The Risk of Catastrophic Loss and the Cost to Recoup
You buy home insurance as a homeowner and you buy renter's insurance as a tenant. While insurance is designed to help you in times of loss, insurance does not always cover everything. If you own a property and an earthquake strikes, you must find a way to cover your high Earthquake deductible or to pay for all of the repairs if you do not have a specialty earthquake insurance plan. As a tenant, the property owner must allow you to leave your lease if a property is damaged and the landlord cannot fix it. You are not liable for the repairs, unless you were negligent for the damage yourself.
As a property owner, you must be resourceful and find ways to pay for damage that is not paid for by your insurance portfolio. Building a good insurance portfolio is a start to reducing risk, but there will always be scenarios where the insurance company will not pay for all of the damages. Be sure you have money set aside to pay for repairs, and always have a game plan to mitigate damage in the event of a catastrophic loss.
Owning a House Can be Stressful
If you are easily stressed, you will find that owning a home tends to place more stress on you than being a tenant. You will find that you have more financial obligations, and that fulfilling the obligations can be more difficult. If you are not ready for the stress associated with being a homeowner, you may want to continue renting until you can find a coping mechanism. Debt is something that will not go away for a long time. Unless you know you will hit the lottery or you can cover your mortgage without any difficulty in the future, there will always be some stress.
There is much more to buying a home than just finding your dream home. Before you start tempting yourself to buy, sit down with your spouse or other half and think about all of the most important factors. There are beautiful rental homes and there are beautiful new constructions and resale properties. No matter how nice a home looks, you need to be sure that you are financially ready, emotionally ready, and that your liefstyle is ready for this big leap that you will be making. Home ownership has a lot of advantages, but there are risks you cannot ignore. If you find that you are not ready, set a goal and prepare for the buying process in the future. Buying is not for everyone, and not everyone benefits from renting either. Jot down the pros and the cons, and make the best decision for your own unique situation.
Key Tips & Advice
Things to consider when buying a home:
- While the 30-year mortgage is the most popular term in the United States, a 15-year term builds equity much quicker;
- Home buyers in the US move on average of once every 5 to 7 years;
- Early mortgage payments apply primarily to interest rather than the principal;
- Using a shorter loan term, paying extra & making bi-weekly payments can better help offset any transaction-based expenses.
Do Home Prices Always Go Up?
In the United States real estate prices have went up about 6-fold since 1970.
Our monetary policy is biased toward inflation. If you back out general inflation, outside of during market bubbles, real estate typically performs roughly inline with general inflation. Rather than looking at raw prices, better metrics to use for analyzing real estate prices are:
- Home price vs median income.
- Purchase price vs rent.