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Buy or Rent? Part I: Higher Net Worth
Published on 11/08/07
by zot
I’ve been thinking a lot about buying a house. It’s a testament to the power of metaphors for life planning that it seems good in such a bad market. I’ve worked out a spreadsheet for calculating my net equity after buying versus renting a house and thought I would share it with you.
There are several sites out there discussing the imploding housing market. I particularly like Patrick.net, which has a blog and a housing crash page that posts updates to other articles. It also has a real estate “dating service”. Dr. Housing Bubble is another great site, and gives a lot of data and in-depth discussion. The “Real Homes of Genius” articles are both funny and sad.
With all the doom and gloom, there is a still a lot of enthusiasm locally about the idea of buying a house. Although a lot of people know that the market isn’t as good, they are still caught up in the dream of owning their own home and having it’s value skyrocket. The crazy adjustable-rate mortgages and other sub-prime lending is disappearing, so the large majority of people can’t afford to buy a house now anyway, but the dream is still there.
The spreadsheet allows you do designate all the necessary rates so that you can do as many projections as you want. These numbers are specially tailored to the Albuquerque housing market, since I was considering purchasing a house there. These are the important assumptions:
- Rent is $320/month
- Mortgage Rate is 6%, 30 years
- Cost of rent increases 3% per year
- Return on investment is 7%
- Cost of house is $200,000
Housing Appreciates 0%, Sell at 5 years
| Net Worth | |
|---|---|
| Buy | -$2,884 |
| Rent | $95,058 |
Housing Appreciates 5%, Sell at 5 years
| Net Worth | |
|---|---|
| Buy | $50,715 |
| Rent | $95,058 |
Housing Appreciates -5%, Sell at 5 years
| Net Worth | |
|---|---|
| Buy | -$46,770 |
| Rent | $95,058 |
Housing Appreciates 5%, Sell at 30 years
| Net Worth | |
|---|---|
| Buy | $838,457 |
| Rent | $1,619,834 |
In this scenario, buying a house rarely as profitable as investing. The results are strongly dependent on rates of appreciation, so different locations will have different returns. It could be that investing wouldn’t earn you 7% in the long term, or that housing will go up in your market by more than 5% a year. In fact, if your house appreciates at 8% per year, you will be better off buying a house (It seems obvious, since 8% is higher than 7%, but there are other costs associated with buying and selling a house).
It’s interesting to me that buying a house is so obviously a worse decision. I think most people buy houses because they want the metaphor, not because it’s a sound financial investment.
That’s not to say it’s a bad decision. Sometimes the immaterial things are more important than the finances. I know I still want to buy a house some day, despite these numbers. Having a family would really increase that desire, even if it meant taking a hit financially.
The spreadsheet lets you adjust property tax rates, expected growth rates of investment and housing, mortgage rates, length and rate of mortgage, when you sell, annual extra expenses, rent costs, the benefit of having a roommate, the rate you pay to a Realtor as a buyer and as a seller and…I think that’s it.
If you spot an error let me know, and if you find this sheet useful please consider donating. Thank you.
(Updated to reflect information from Jon Daley).
Buy vs Rent (openoffice)
Buy vs Rent (excel)
Values based decision in Buy Or Rent Part II: Non-Money Reasons.
-zot
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Comments on Buy or Rent? Part I: Higher Net Worth
8 Responses
Jon Daley
04/09/07
$320 for rent is pretty good. You can’t get that around here (Pittsburgh, PA, USA) though my comment here talks about why I think it was better for us to buy than to rent.
Scott
05/09/07
At least over here in Australia, a $200k apartment usually means $180-$200 per week rent, i.e. $770-$860/month assuming 30 day month. That would make the conclusion very different.
Then again the mortgage interest rate here is around 8.5%.
Also need to keep in mind about the tax. Sorry I am not familiar with the taxation law in the US, but in Australia every cent you made from your investment will be taxed (although capital gain gets 50% discount). However the capital gain of your primary residency is tax free.
Jon Daley
05/09/07
I played around with your spreadsheet today, and there are a couple errors on it.
The tax savings should not include the principal, but only the mortgage interest.
Your monthly cost should be reduced by the tax savings.
You need a field for a downpayment/closing costs, I sort of could get that by tacking on a buyer’s fee percentage, but it isn’t quite the same. My mortgage was less than the purchase price (and I think all mortgages are, I guess people get their closing costs rolled into a mortgage, but our fees were so low, we just wrote a check for a couple thousand at closing)
I can’t figure out how to get a positive growth in the rent category. Even if I sell it in 1 year, your spreadsheet has me making money.
zot
05/09/07
Jon: Thanks for your comments. I’ll have a look at the sheet and see what’s going on. It is a little too aggregated…needs to be broken out more.
Scott: Interesting, I don’t think I factored in tax costs on gains from selling the house.
You are both right that living in Albuquerque I have a very low rent. In bigger cities it be a lot more costly to rent.
edit: I’ve updated the spreadsheets. Whether or not you have gains in the first few years depends on how quickly your house is appreciating at. I had the rate at 8%, probably not realistic for many places in America right now. With a 4% appreciation rate you have a negative change in net worth for one year. Thanks again for pointing out the errors.
Jon Daley
06/09/07
A friend pointed me to this calculator.
They are trying to prove that mortgages are good, and you should ask them for a mortgage, but if you edit the assumptions to be better it looks alright. (Though I didn’t spend very much time on it – and since they didn’t provide their calculations, one can’t check to see if they are correct)
zot
07/09/07
Hi Jon,
I played with that calculator. It looks pretty similar, and if you adjust the parameters the results are close to what mine says. Gives me faith! Anyway, thanks for posting that link.
Cassandra
21/10/07
One thing that I’m not sure you factored in is PMI. In the market that I live, no bank will write a mortgage for under 20% down payment. In other markets, I’m sure that you can write a mortgage for under 20%, but you’ll get hit with PMI — which if your house either appreciates quickly enough or you pay down your principal, you can get it removed after a year. However, it’s still an expense to be calculated in.
zot
21/10/07
@Cassandra: I think you are right. If it’s under 20% there is the mortgage insurance. Thanks, I’ll have to update the spreadsheets.
-zot
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