Rent Vs. Buy

Rent Vs. Buy
by: James Lange, CPA, Attorney

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When making crucial financial decisions, comparing alternatives is beneficial. We have developed software which makes such comparisons easy.

This page will concentrate on one of these decisions that you, or someone you know, must make regarding renting vs. buying. Although the attached example below concentrates on the question of renting vs. buying a house, we could also help you analyze a "lease vs. buy" decision for cars, business assets, second homes, and more.

Please note that my goal is not to talk you out of buying a house. My goal is to have you realize that purchasing a house is not usually as good an investment as most people think. If you like, I would be happy to change any of the assumptions and run a customized worksheet to help analyze your particular options.

List of Assumptions

Please start with the List of Assumptions below and note any changes that you want to make. Many of the costs are presented as a percentage of the purchase price or rental cost. Although support exists for every assumption made, the assumptions will vary for different real-life situations.

The most difficult assumption is determining what is equivalent value for renting and buying. I have assumed $1,000 in rent and have used $100,000 as the cost of a home.

Of course, in many situations, comparable rentals are simply not available. In addition, I have not attempted to quantify the satisfaction or the hassle of home ownership.

Home Renting Information
Monthly Rental Amount $1,000
Monthly Utilities $350
Annual Rent Increase 2.5%
Annual Repair, Maintenance & Insurance 1.0%

Home Purchasing Information

Purchase Price $100,000
Down Payment $10,000
Annual Increase in Value 3.0%
Annual Repair, Maintenance & Insurance 3.5%
Monthly Utilities $350
Closing Costs 3.0%
Selling Costs 10.0%
Land % of Fair Market Value 15.0%
Building % of Fair Market Value 85.0%
County Tax (mills) 36.5
City Land Tax(mills) 184.5
City Building Tax(mills) 32.0
School Land Tax(mills) 59.7
School Building Tax(mills) 59.7
Mortgage Interest 8.25%
Term of Mortgage (Years) 30

Common Information

Tax Rate 28.0%
Annual Inflation 3.0%
Annual After Tax Return on Investment 4.0%

Rent vs. Buy Worksheet

Renter Costs

Please start from the left and move to the right. R&M&I is repairs, maintenance, and insurance. The investment column is cumulative and is calculated by taking the down payment and the closing costs and investing them at a 4% rate of return. The yearly cost is the total rent, utilities, repairs, maintenance, and insurance.

 

Year Rent Utilities R&M&I Investment Yearly Costs
1 12,000 4,200 120 13,520 16,320
2 12,300 4,326 123 14,061 16,749
3 12,608 4,456 126 14,623 17,189
4 12,923 4,589 129 15,208 17,641
5 13,246 4,727 132 15,816 18,105
6 13,577 4,869 136 16,449 18,582
7 13,916 5,015 139 17,107 19,071
8 14,264 5,165 143 17,791 19,572
9 14,621 5,320 146 18,503 20,087
10 14,986 5,480 150 19,243 20,616
11 15,361 5,644 154 20,013 21,159
12 15,745 5,814 157 20,813 21,716
13 16,139 5,988 161 21,646 22,288
14 16,542 6,168 165 22,512 22,875
15 16,956 6,353 170 23,412 23,478
16 17,380 6,543 174 24,349 24,097
17 17,814 6,740 178 25,323 24,732
18 18,259 6,942 183 26,336 25,384
19 18,716 7,150 187 27,389 26,053
20 19,184 7,365 192 28,485 26,740
21 19,663 7,586 197 29,624 27,446
22 20,155 7,813 202 30,809 28,170
23 20,659 8,048 207 32,041 28,913
24 21,175 8,289 212 33,323 29,676
25 21,705 8,538 217 34,656 30,459
26 22,247 8,794 222 36,042 31,264
27 22,804 9,058 228 37,484 32,089
28 23,374 9,329 234 38,983 32,937
29 23,958 9,609 240 40,542 33,807
30 24,557 9,898 246 42,164 34,700
Total 526,832 199,817 5,268 42,164 731,918

 

Owner Costs

These costs include a calculation of your mortgage payment, including the amount allocated to principal and interest. It also shows the payment amount and the balance of the mortgage over time. Also listed are the real estate taxes, repairs, maintenance, insurance, and utility costs.

To provide a meaningful analysis, however, I included appreciation on the house. In addition, I calculated the tax savings which results from having the ability to deduct real-estate taxes and interest. Please note that if you do not itemize your deductions, then the tax savings could be exaggerated. If, on the other hand, you are in the 39% bracket, then I have understated your tax savings by assuming a 28% tax rate.

The yearly costs consist of the mortgage payment plus the real estate taxes, repairs, and utilities, less the tax savings.

Year Interest Principal Payment Balance RE Tax R&M&I Utilities FMV Tax Savings Yearly Cost
1 7,425 759 8,184 89,241 3,777 3,500 4,200 100,000 3,137 16,524
2 7,362 821 8,184 88,420 3,890 3,605 4,326 103,000 3,151 16,854
3 7,295 889 8,184 87,531 4,007 3,713 4,456 106,090 3,164 17,195
4 7,221 962 8,184 86,568 4,127 3,825 4,589 109,273 3,178 17,547
5 7,142 1,042 8,184 85,526 4,251 3,939 4,727 112,551 3,190 17,911
6 7,056 1,128 8,184 84,398 4,378 4,057 4,869 115,927 3,202 18,287
7 6,963 1,221 8,184 83,178 4,510 4,179 5,015 119,405 3,212 18,675
8 6,862 1,322 8,184 81,856 4,645 4,305 5,165 122,987 3,222 19,077
9 6,753 1,431 8,184 80,425 4,784 4,434 5,320 126,677 3,231 19,492
10 6,635 1,549 8,184 78,876 4,928 4,567 5,480 130,477 3,238 19,921
11 6,507 1,676 8,184 77,200 5,076 4,704 5,644 134,392 3,243 20,364
12 6,369 1,815 8,184 75,385 5,228 4,845 5,814 138,423 3,247 20,823
13 6,219 1,964 8,184 73,421 5,385 4,990 5,988 142,576 3,249 21,298
14 6,057 2,127 8,184 71,294 5,546 5,140 6,168 146,853 3,249 21,789
15 5,882 2,302 8,184 68,992 5,713 5,294 6,353 151,259 3,246 22,297
16 5,692 2,492 8,184 66,500 5,884 5,453 6,543 155,797 3,241 22,823
17 5,486 2,698 8,184 63,803 6,061 5,616 6,740 160,471 3,233 23,368
18 5,264 2,920 8,184 60,883 6,243 5,785 6,942 165,285 3,222 23,932
19 5,023 3,161 8,184 57,722 6,430 5,959 7,150 170,243 3,207 24,516
20 4,762 3,422 8,184 54,300 6,623 6,137 7,365 175,351 3,188 25,121
21 4,480 3,704 8,184 50,596 6,821 6,321 7,586 180,611 3,164 25,748
22 4,174 4,010 8,184 46,586 7,026 6,511 7,813 186,029 3,136 26,398
23 3,843 4,340 8,184 42,246 7,237 6,706 8,048 191,610 3,102 27,072
24 3,485 4,698 8,184 37,547 7,454 6,908 8,289 197,359 3,063 27,771
25 3,098 5,086 8,184 32,461 7,678 7,115 8,538 203,279 3,017 28,497
26 2,678 5,506 8,184 26,956 7,908 7,328 8,794 209,378 2,964 29,250
27 2,224 5,960 8,184 20,996 8,145 7,548 9,058 215,659 2,903 30,031
28 1,732 6,452 8,184 14,544 8,390 7,775 9,329 222,129 2,834 30,843
29 1,200 6,984 8,184 7,560 8,641 8,008 9,609 228,793 2,756 31,687
30 624 7,560 8,184 0 8,900 8,248 9,898 235,657 2,667 32,563
Total 155,513 90,000 245,513 0 179,686 166,514 199,817 235,657 93,856 697,675

 

Rent vs. Buy Comparison Table

Please start at the top and work from left to right. The first two columns come from the worksheet. The third column is the difference, or the amount of renter or owner savings per year.

The fourth column assumes that the renter puts his annual savings into a separate account that yields 4% after taxes. The fifth column shows the cumulative effect of investing the down payment and closing costs. The last column is a total of the previous two.

Below the table, find an analysis of what would happen if you sold the house at the end of 1, 5, 10, 15, and 30 years. I have assumed that you would be able to sell the house with normal costs and normal appreciation over the same periods.

Early Sales

This analysis becomes particularly important if there is a reasonable chance that you will want to sell your house before the mortgage is completely paid. In almost all cases, the earlier you sell the house, the better off you would have been had you rented. I have heard realtors say that their rule of thumb was that you had to live in a house for three to five years before you would break even. This analysis tends to show that, depending on the comparable rental, the "breakeven" point is five years.

Tax Deferred Savings and Rent vs. Buy

There remains one other crucial financial option to consider. Take the money that you save every month by not having a down payment and the lower cost of renting and invest it into a retirement account such as a 401(k), 403(b), 401(a), Keogh, SEP, or other deductible qualified plan. (Please note that this does not mean investing in a life insurance policy which is marketed as a tax-deferred investment!) Then, you could get a current tax deduction and accumulate wealth on a tax-deferred basis. I also have developed a program that runs those numbers. In fact, we could even integrate the two templates and complete that analysis if desired.

Special for Business Owners

Business owners often ask me about investments. For confident owners who believe in their business or service, I usually advise them to invest in their business. Small business owners should be able to get a 20% to 30% or higher return by investing in their business. (This may sound too high to you, but that is a different question for a different day.)

Assume that you have a business or service which would benefit from additional investment. Also assume that you could afford to live in a house but choose to rent instead. With all the money you saved by renting, you opted to invest in your business. Depending on the exact rental and price of the house that you purchased, you would almost undoubtedly be better off had you rented rather than purchased.

 

Rent vs. Buy Comparison Table

Rent vs. Buy Comparison Table & Graph

 

Year Yearly-Renter Costs Yearly-Owner
Costs
Renter/ (Owner) Savings Renter/ (Owner)
Savings Investment
Down Payment and ClosingCost Investment Total Rent/(Buy) Cash Savings
1 16,320 16,524 204 212 13,520 13,732
2 16,749 16,854 105 330 14,061 14,391
3 17,189 17,195 6 349 14,623 14,973
4 17,641 17,547 (94) 266 15,208 15,474
5 18,105 17,911 (194) 74 15,816 15,891
6 18,582 18,287 (295) (229) 16,449 16,220
7 19,071 18,675 (395) (649) 17,107 16,458
8 19,572 19,077 (495) (1,190) 17,791 16,601
9 20,087 19,492 (596) (1,858) 18,503 16,646
10 20,616 19,921 (695) (2,655) 19,243 16,588
11 21,159 20,364 (795) (3,588) 20,013 16,425
12 21,716 20,823 (893) (4,660) 20,813 16,154
13 22,288 21,298 (990) (5,876) 21,646 15,770
14 22,875 21,789 (1,086) (7,241) 22,512 15,271
15 23,478 22,297 (1,181) (8,759) 23,412 14,653
16 24,097 22,823 (1,274) (10,434) 24,349 13,915
17 24,732 23,368 (1,364) (12,270) 25,323 13,052
18 25,384 23,932 (1,452) (14,272) 26,336 12,064
19 26,053 24,516 (1,538) (16,442) 27,389 10,947
20 26,740 25,121 (1,620) (18,784) 28,485 9,701
21 27,446 25,748 (1,698) (21,301) 29,624 8,323
22 28,170 26,398 (1,772) (23,995) 30,809 6,813
23 28,913 27,072 (1,841) (26,870) 32,041 5,171
24 29,676 27,771 (1,905) (29,926) 33,323 3,397
25 30,459 28,497 (1,963) (33,164) 34,656 1,492
26 31,264 29,250 (2,014) (36,585) 36,042 (543)
27 32,089 30,031 (2,058) (40,188) 37,484 (2,705)
28 32,937 30,843 (2,094) (43,973) 38,983 (4,990)
29 33,807 31,687 (2,120) (47,937) 40,542 (7,395)
30 34,700 32,563 (2,137) (52,077) 42,164 (9,913)
Total 731,918 697,675 (34,243)

 

 

Sale of Home after 1 Year 5 Years 10 Years 15 Years 30 Years
Selling Price 100,000 112,551 130,477 151,259 235,657
Less Mortgage Balance 89,241 85,526 78,876 68,992 0
Less Selling Costs 10,000 11,255 13,048 15,126 23,566
Net Proceeds 759 15,770 38,553 67,141 212,091
Less Total Rent/(Buy) Cash Savings 13,732 15,891 16,588 14,653 (9,913)
Better to Buy or (Rent) (12,974) (121) 16,645 52,488 222,004

What's Changed

Everyone used to think that real estate was a wonderful investment, in part, because we used to earn significantly higher rates of appreciation on real estate. Now, unless you make an exceptionally good deal or unless the economy changes drastically, real estate is having a hard time keeping up with inflation. In many areas, real estate is losing value to inflation.

Another factor is that with Pittsburgh and local municipalities looking for more revenue, the assessments on real estate have increased dramatically.

If you would like me to run numbers for your particular situation, I would be glad to do so. I can also use this program to help you analyze other decisions such as:

Car - lease vs. purchase
Asset acquisitions - lease vs. purchase
Existing house - upgrade, stay, or even rent
Owning rental property, break even analysis
A host of others

Finally, we have put the finishing touches on a program that provides accurate cash projections to help you choose from a variety of options.

If you would like me to help you make an important financial decision, please feel free to call.

Best regards,

James Lange,
Certified Public Accountant
Attorney-at-Law

 

 

James Lange, CPA

Jim is a nationally-recognized tax, retirement and estate planning CPA with a thriving registered investment advisory practice in Pittsburgh, Pennsylvania.  He is the President and Founder of The Roth IRA Institute™ and the bestselling author of Retire Secure! Pay Taxes Later (first and second editions) and The Roth Revolution: Pay Taxes Once and Never Again.  He offers well-researched, time-tested recommendations focusing on the unique needs of individuals with appreciable assets in their IRAs and 401(k) plans.  His plans include tax-savvy advice, and intricate beneficiary designations for IRAs and other retirement plans.  Jim's advice and recommendations have received national attention from syndicated columnist Jane Bryant Quinn, his recommendations frequently appear in The Wall Street Journal, and his articles have been published in Financial Planning, Kiplinger's Retirement Reports and The Tax Adviser (AICPA).  Both of Jim’s books have been acclaimed by over 60 industry experts including Charles Schwab, Roger Ibbotson, Natalie Choate, Ed Slott, and Bob Keebler.

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