Renting vs Buying: The Whole Story

The age old question: is it worth it to buy or should I continue renting?  Well, let’s look at a hypothetical:

Let’s say John currently rents a 2 bedroom place in San Diego for $1,500 per month.  He’s tired of paying someone else’s mortgage and wants to begin putting money into his own equity and is trying to figure out if it’s worth it.  First off, let’s look at the financial side of things.  In order to do that we need to begin with a couple of rules of thumb:

1.  First off, calculating a payment can be complex and I always recommend speaking with a lender, but an easy way to start is to think that for every percentage point of interest rate you have, your monthly payment is equal to $100 times that for every $100,000 you finance.  In other words, let’s say you’re financing $300,000 at 5%.  A basic payment (before HOA dues and property taxes) would be $1,500 per month (5% at $100,000 would be $500.  $500 times 3 is $1,500).  Note that this doesn’t include property taxes, which in San Diego County are about 1.25% of the purchase price or any HOA.  Also, without getting too technical, the monthly payment depends on the type of loan.  If you do a VA loan or an FHA loan your property taxes are built into your monthly payment in an impounds account (i.e. assuming a $300,000 purchase price with a VA loan, property taxes would be $3,750 annually at 1.25%, or an additional $312.50 per month built into the payment within an impounds account).

2.  John’s payment is heavily reliant on his down payment and financing because the qualifications are different.  If he puts 20% down and does a conventional loan a lender only needs to see his last year’s tax statement.  An FHA loan (with 3.5% down) would be the last two years and these days banks want to see an increase in income from oldest to most recent.  Again, everything we’re doing here is “rule-of-thumb” without a calculator and just to give you a basic understanding.  In order to know what you qualify for and what a payment would be, speak with a lender.

Ok, back to John.  John’s trying to figure out if it’s worth it to buy today or one year from today since the market is so wacky.  John’s biggest concern is that if he buys something today and then prices soften more, maybe he should’ve waited.  Maybe.  Think of this: if John is paying $1,500 per month, in order to save money for next year the market needs to drop by $18,000 ($1,500 rent per month times 12 months).  That may not mean much at the $400,000 and $500,000 level but if John likes his payment around $1,500 per month, he’s probably looking in the $250,000 – $300,000 house area.  An $18,000 drop would be a drop of 7.2% drop (at $250,000).

Another major benefit to home ownership is the tax break.  Owning a house and paying a mortgage gives you the opportunity to  write off all your mortgage interest and property taxes.  Consult a CPA to know exactly what you can write off.  With the money saved in taxes, a $1,700 payment really becomes at least a $1,500 payment.

Making the jump to buy a home is a big step.  It means you are making a commitment to pay on a house for (usually) the next 30 years.  It means that you are established enough to feel like this will be home for at least the next couple of years, or that you can rent it out.  It means you are willing to take on the challenges of home ownership (i.e. plumbing breaks, roof leaks, etc) without the help of a management company or a landlord to call.  But here’s the kicker, after all the tax benefits and assuming he can find something he likes in his price range, John can actually save money by buying right now as compared with waiting until next year.

There’s no question our market is in uncertain times.  But if John knows that he will be staying in the house for at least the next 5 years, market signs are very strong that purchasing right now is a smart decision.  Based on the numbers above, if John is looking in the $250,000 house range, the market would need to drop 10% in the next year for him to break even.  Any drop less than that means he’s actually making (or saving) money.

If you have questions about it, please feel free to contact me.