How to Determine Whether to Rent or Buy a Home
Browse articles:
Auto Beauty Business Culture Dieting DIY Events Fashion Finance Food Freelancing Gardening Health Hobbies Home Internet Jobs Law Local Media Men's Health Mobile Nutrition Parenting Pets Pregnancy Products Psychology Real Estate Relationships Science Seniors Sports Technology Travel Wellness Women's Health
Browse companies:
Automotive Crafts, Hobbies & Gifts Department Stores Electronics & Wearables Fashion Food & Drink Health & Beauty Home & Garden Online Services & Software Sports & Outdoors Subscription Boxes Toys, Kids & Baby Travel & Events

How to Determine Whether to Rent or Buy a Home

How to determine whether you should buy a home or rent an apartment based on your income, rent vs home price ratios, and tax breaks.

When deciding on whether it makes financial sense to rent or buy many analysts use a rule of thumb where you divide the purchase price of a home by the annual rent of a similar property. Anything over a 15, and you should rent because it will cost you less over a period of time. If it is below 15 you may want to start looking for homes.

This buy-rent ratio is a rough estimate and there are many other factors to consider before making such a large decision. Some factors that vary by city and the individual are income, property taxes, and whether home values are likely to rise.

Trulia has an extensive list of pricing information that is broken down by state or city as well as trends in the real estate market. http://www.trulia.com/city/

What Can you Afford?

The first step in the decision-making process is to determine whether or not you can afford to purchase a home. Issues to consider include your ability to make a down payment, which is between 5% and 20% of the home’s purchase price, and pay closing costs which may be an additional 5%. These costs are likely to exceed substantially the initial payment and security deposit that would be required if you were renting instead of buying. But it does not end here.

Before moving into your new home, you’ll need to put some thought into how much it’s going to cost you to stay there after you take up residence. Many financial experts suggest that your monthly mortgage payment not exceed 28% of your gross monthly income and that your total monthly debt payments not exceed 36% of your gross monthly income. If you go beyond these limits, you may run into trouble because, in addition to paying the mortgage each month, you have to account for home maintenance and upkeep. Also consider furnishings, association fees, higher energy costs, and repairs just to name a few. Renting may be easier to plan for since there is a fixed-dollar cost for monthly expenditures and repairs are typically included in the rent. Taxes are included in your rent, but as a homeowner you are responsible for large annual or semi-annual bills for property and school taxes.

Pros and Cons to Buying a Home

There are several financial considerations you need to consider before buying a home. You may want to consult with a CPA or financial advisor to help you understand the pros and cons to buying a home.

Equity

Pros- Some of the money that you give to pay a mortgage goes directly toward building equity in your home whereas when you rent you will never see any of the money you pay. Home equity can serve as collateral for a loan, enabling you to convert the equity into cash.

Cons- Payments made during the first few years of a mortgage go primarily toward interest on the loan. You should have an amortization table printed out to see what the ration is to interest to principal payments are. If you move after living in a home for only a few years, you may have little or no equity in the property. And after the costs of selling the home, you could end up losing money.

Taxes

Pros- Unlike money spent on rent, the mortgage interest and property taxes you pay are both deductible on your federal income-tax return. If you sell your primary residence at a profit, much of your gain is likely to be exempt from federal taxes. If you take out a home-equity loan, some or all of the interest on the loan may be deductible on your federal income tax return.

Cons- The tax breaks on interest and property taxes apply only when the amount of your itemized deductions is greater than the standard deduction amount. So you and your spouse have a standard deduction of $9,700 and itemized deductions of $8,000. You are better off taking the standard deduction because it’s greater than the itemized amount and you receive no tax break on the mortgage interest you paid. Every dollar spent in interest adds to the amount above the purchase price of your home that you will need to make just to break even when you sell it. Owning a home means having to pay real-estate taxes every year. So even after your mortgage is paid off, you’ll still have to keep making payments to someone to keep your home.

Investment

Pros- Your primary residence is likely the single largest asset you will ever have. Over the long term there can be significant appreciation in the value. Many homeowners downsize their primary residence when they retire and use the profit from the home sale to supplement their income.

Cons- In general the data suggests that your home will appreciate over time, but there are no guarantees. There are always areas of the country where homes have lost value, and owners are unable to sell them at a price equal to or greater than the purchase price. A home purchase is considered a very long-term investment and was more suited to a time when people did not move frequently and the economy was growing at a faster pace. Neither fact may be true now.

Rating Cities – Rent or Buy

Las Vegas - Buy

Median home price: $65,100

Median annual rent: $10,200

Price-to-rent ratio: 6

Manhattan – Rent

Median home price: $1.31 million

Median annual rent: $42,370

Price-to-rent ratio: 31

Miami- Buy

Median home price: $140,200

Median annual rent: $22,460

Price-to-rent ratio: 6

Seattle- Rent

Median home price: $418,200

Median annual rent: $17,600

Price-to-rent ratio: 24

Arlington, TX- Buy

Median home price: $67,600

Median annual rent: $9,200

Price-to-rent ratio: 7

Kansas City, MO- Rent

Median home price: $213,900

Median annual rent: $10,300

Price-to-rent ratio: 21

Phoenix, AZ- Buy

Median home price: $75,500

Median annual rent: $9,400

Price-to-rent ratio: 8

San Francisco- Rent

Median home price: $763,400

Median annual rent: $37,200

Price-to-rent ratio: 21

Mesa, AZ – Buy

Median home price: $64,400

Median annual rent: $8,100

Price-to-rent ratio: 8

Memphis, TN- Rent

Median home price: $174,300

Median annual rent: $8,500

Price-to-rent ratio: 20

Jacksonville, FL- Buy

Median home price: $83,200

Median annual rent: $10,000

Price-to-rent ratio: 8

Los Angeles- Rent

Median home price: $489,700

Median annual rent: $24,900

Price-to-rent ratio: 20

 

Need an answer?
Get insightful answers from community-recommended
experts
in Real Estate on Knoji.
Would you recommend this author as an expert in Real Estate?
You have 0 recommendations remaining to grant today.
Comments (1)

Interesting and informative. Excellent presentation Daniel.

ARTICLE DETAILS
RELATED ARTICLES
RELATED CATEGORIES
ARTICLE KEYWORDS
RECENT SEARCHES ON KNOJI SHOPPING