Many people say ”’Don’t rent, it’s a huge waste of money!”
I want to run the actual numbers for an area to analyze if that’s true.
How to Analyze
The concept of analyzing buying vs. renting comes down to the idea of recoverable vs. non-recoverable costs.
All costs, regardless of whether you are buying or renting, can be put into these two categories.
For example, if you pay property taxes, these costs are “non-recoverable” as they are not something you would eventually get back. Paying down your mortgage (specifically the equity part) is a “recoverable” cost, as you can eventually get it back when you sell.
Now, for this analysis, let’s say you want to buy a house for 5 years and then sell it. Should you rent or buy?
Finding a House
I found a home in the Chicago suburbs for $375,000 (3 beds, 1.5 baths). I’m using this as an example, and you can run a similar calculation for your own area.
In the area, I also found a house for rent for $2,600/month, also with 3 beds and 1.5 baths.
Running the Numbers
When renting, your only unrecoverable cost is the rent. There is no other benefit you receive in exchange for rent payments.
Five years of renting would cost $168,989 with a 4% rent growth per year.
But it looks much different for buying…
Your recoverable costs are the down payment and the principal monthly payments. That’s the cost you can ultimately recover when selling.
The non-recoverable costs are interest payments, property tax, homeowner’s insurance, maintenance, HOA (if any), closing costs, and PMI.
Then, you will subtract the tax benefits (mortgage interest and property tax) to analyze the real numbers.
Let’s say you put a 20% down payment to buy the house. Currently, rates are high. After checking some sources, I see a 6.5% average rate for a 30-year fixed mortgage with no points.
Here’s what 5 years of buying would look like:
After five years, you will spend $94,167 in recoverable costs and $146,320 in non-recoverable costs, for a total of $240,487.
If the home appreciates at 4% per year, it will be worth approximately $456,000.
When it’s sold, you will pay off the mortgage balance of $280,800 and a 6% selling cost of $27,360. You will walk away with $147,840 tax-free due to the capital gains exclusion.
The net total cost of homeownership will be $102,300 ($240,487 – $147,840).
The total expense of renting is $168,989 (compared to $240,487 total for buying, or $14,300 less per year). However, we are spending more money every month on a house than we would on rent. Assuming you have the discipline, you should invest that $14,300 while renting into the stock market.
With an 8% yearly growth, you’d have $83,892. The net total cost of renting would be $85,097 ($168,989 – $83,892).
All in all, renting is cheaper by $17,200 ($102,300 – $85,097) over five years, or $3,440 per year.
However, there are a lot of assumptions built into this analysis, and it would look completely different for your real estate market. In addition, we only held the house for five years. The longer you hold, the better off homeownership becomes.
TLDR:
1. Numbers are extremely locality-dependent. Use my example as a basis.
2. The longer you stay in a house, the better the numbers get for buying.
3. What is the housing market pricing? The more expensive a house is compared to rent, the worse the numbers look for buying (e.g., a $1.5M home for $4,500 rent).
4. What are the interest rates? This calculation was run with a 6.5% rate, but cheaper mortgages will proportionally improve the numbers.
5. What are your goals? If you have children in good schools, buying provides non-financial peace of mind. Not everything is about math and numbers.
6. Would you actually invest while renting, or waste that money instead? Discipline is key here.
The main takeaway is that renting is not always a waste of money. You really have to analyze it on a case-by-case basis, analyzing your local market, life circumstances, and goals.
Any thoughts/questions? Feel free to reply back.
See you next Saturday.
MC, CPA