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Rent or Buy?

The cliché says that there has never been a better time to buy.  The hard data in the housing affordability index confirms that.  The affordability index, which takes into account median income, median home price, and mortgage rates, has been bouncing around in the 180 to 200 range since the beginning of this year – the highest reading since the index was first used in 1971.

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Yet, you still encounter consumers hesitant about taking advantage of possibly the greatest home buying opportunity of a lifetime. Should they buy now or not?

Let’s consider the situation in which a family earns $60,000, which is about the national average.  They are renting at $1000 per month.  They are considering buying a home that requires them to take out a mortgage of $170,000, which would be fairly close to the current national median home price.

At the current rate of 4.8 percent on a 30-year fixed rate mortgage, the monthly mortgage payment would be …(drum roll) … $891 per month.  That’s not all.  A measurable portion of the monthly mortgage payment is actually goes towards principal reduction on the loan balance.  For example, in the first year about $215 of the mortgage is for the principal payment, which in essence is a forced-disciplined savings imposed on the home buyer.  The remainder $676 ($891 minus $215) is the pure interest payment to the bank.  So the $676 monthly mortgage interest payment looks a lot sweeter than the $1000 in rent that was being shoveled out the door.  With each passing year, the principal portion gets larger while the interest portion declines because of a steadily falling loan balance.

That’s still not all.  A fixed rate mortgage means the monthly payment is fixed and will not rise for the term of the mortgage.  In this example, a person theoretically could be paying $891 in mortgage in the year 2041.  What would be the cost of living at that time? Food price? Gasoline price?  Also rent?

If rent was to rise by 3 percent a year, starting with the base $1000, the monthly rent will be $1344 in 10 years, $1806 in 20 years, and $2427 in 30 years.  If rent was to rise by 5 percent, then it goes to $1628 in 10 years, $2526 in 20 years, and $4321 in 30 years.  If monetary policy were to get of control, with too much money printing and inflation rose by 10 percent per year, then the rent becomes $2593 in 10 years, $6727 in 20 years, and $17,444 per month in 30 years.  Many economists are expecting 3% to 5% annual rent growth over the next two years based on recent falling trends in apartment vacancy rates.

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When rents rise, there is also a tendency for home prices to rise.  Fundamentally, rent and home price would rise roughly in lock step – provided that home values do not contain bubbles and are back in line with their historical relationship to rents.  The chart below shows the rent (based on rental rent component of the consumer price index) and NAR median home price trend with the index set at 100 in 1980.  Well, today, home price and rent ratio are pretty much back to historically justifiable levels.  So it is reasonable to presume that any rent increase will also at some point lead to equal gains in home values.

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If home values were to rise 5 percent (under rent growth assumption of the same) then the home value would rise to $178,500, translating into a gain of $8,500 in housing equity in the first year.  Subsequent cumulative gains over several years would be sizable, if the yearly 5 percent increases could be sustained.  Nationally the annual average home price increases have been at around 4 to 6 percent each year.  Even if by some strange event home value was not to increase one cent over  the next 30 years, the home would be owned free-and-clear by the 30th year.  (Or much sooner if the family makes additional principal payments)

One always has to mindful that all real estate is local.  One cannot simply pick up a home from Detroit and plop it down in San Francisco to get a fast price appreciation. Therefore local conditions, figures, rent growth projections, and analysis will significantly vary.

Moreover, homeownership cost entails not only mortgage, but the additional costs in terms of property taxes, insurance, and money needed for maintenance and remodeling, though there are cost savings such as the mortgage interest deduction and property tax deduction for tax purposes that were not considered.

What is most important from my perspective is whether the family likes the home they are about to purchase and whether the family is willing to stay well within their budget.  If these two criteria are met, then now may indeed be a good time to consider buying.

Lawrence Yun, PhD., Chief Economist and Senior Vice President

Lawrence Yun is Chief Economist and Senior Vice President of Research at NAR. He directs research activity for the association and regularly provides commentary on real estate market trends for its 1 million REALTOR® members.

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Comments
  1. I could not agree more…this is the time to buy. Historically it the issues have remained the same…it is all about staying within your budget, looking at your family and their needs in the family unit and community.

  2. John hamrick

    This is pure spin. The truth is that in a lot of cases you are much better off letting someone else bear the burden of home ownership. It remains an individual financial decision, there is no global “right answer”. One can just as easily spin the alternate strategy, especially those who purchased in 2005 and have been financially devastated.

  3. Ken

    I agree with the principal and interest payments being $891. Curiously, there is no mention of taxes, hazard insurance, or mortgage insurance. Perhaps Mr. Yun could enlighten us as to where in the US there is no property tax. I’d be curious to learn what banks are not requiring hazard insurance as a condition of the loan. Since the article doesn’t mention down-payment, I’d love to know what bank is offering 100% financing at 4.8% with zero mortgage insurance.

    Without these real-world considerations, I can’t accept this analysis as fair and reasonable. Sorry.

  4. This is great information that can be used to help renters see it is a great time to buy. I have used these same kind of reasoning with a client who started out wanting to rent, but when I showed what he could purchase for that same amount they became a buyer. Just put in an offer on a townhouse for that client.

  5. Kevin

    Is this a joke? How do you explain to the millions of people who saw their home values drop by 25% or more in the last few years that owning makes sense. I agree that if you plan to stay in this home for the next 20 years or so and you are comfortable with housing values dropping further as banks start to release foreclosed properties into the market; then I say go for it.

    Although, if it was me, I’d rent my house and own my life!

  6. Dan Matthews

    John H. – i’ll bear the cost of ownership for you, so can pay for my mortgage in rent!…love it!

  7. True, he does not take into account the cost of mortgage insurance, taxes and insurance. However, he has a very compelling argument for buying. Obviously, renters are necessary to sustain the system. In my market, with today’s interest rates, even with very low rental rates, it is better to buy a home under 200k. But once you get to 4 bedrooms or more it reverses to a situation where it makes more sense to rent. There are many factors that a savvy consumer will take into account such as; amortization, depreciation, tax benefits, etc. What is important is to examine the facts and give sound advice without the influence of a paycheck.

  8. Mike K

    One thing Mr. Yun does not mention is the possibility of a long drawn out decline in real estate prices. Historically, in mulitple countries including the US, after a major recession/depression, home prices have at times declined year after year. In some cases, this decline has lasted approximately 20 years or so. With this in mind, even if rents do increase 3% per year, one would still have to take into account whether or not renting or buying is the right thing to do when the possibility of buying a house today may result in its value being less in 15 years than it is today. Factoring in true historical data such as a long decline in real estate values drastically changes the equation for many people.

    What’s more, Mr. Yun’s analysis assumes renters will do so for ever. I personally will not be buying a house for several more years to give the market more time to decline some. In the short term, it’s not likely to cause any real long-term harm by renting. Especially considering the fact that during the first few years of home ownership, the principal balance isn’t reduced all that much. Buying today, on the other hand, is quite likely to resulting in having a home valued at what’s owed in two years or so. In other words, even though you’d be paying down the amount owed, as real estate prices continue to fall, in two years, the value of the home will still be close to what is owed on the home. In this scenario, the only real benefit is that owning a home is good for your credit score.

  9. kria

    Thank you for the article. This is the best time to buy. Interest rates are really low. Population is expected to increase not decrease. If you plan to live in the home for more than a year or two you will come out ahead. Most people do live in a home for more than that. Yes this article does not talk about taxes and insurance. But even if you are renting you pay that via the rent. My clients that have been renting are paying less now that they bought a home. They also get the interest deduction.

    I think if you have a long term strategy meaning I am going to own my home in X amount of time, then you can. The money is cheap now and houses are cheap. You can pay it off faster by paying a little extra towards principle every month. That is what I did. I am almost there too. I will have my 30 year mortgage paid off in 3.5 years from now. I started paying on my home 10 years ago. I also did not use my house as an ATM

  10. I have to agree with Ken – this seems to be based on highly theoretical models that aren’t closely related to the real world of tax and insurance. John is right – this is spin. There is no global right answer – you know the old metaphor for there being no correct weather report for the US.

    At a macro level though, I would say that affordability is low and this can inform your micro level – very localized – decision to buy or rent. And then the personal level is your own financial stability and situation.

  11. This is a great truth about renting vs. buying. It explais well. This is the best time to buy. Past History supports that too. Low housing price + low interest rate = more affordibility. (same thing for investors too) or vacation home.

  12. If you’re going to move in a few years rent is not wasted money. You have a roof over head and a place to call home. However, if you would like to stay in the same home for many years, buy and pay off the mtg then live rent free! With proper money management and buying a home within your pricerange you could pay off your mortgage faster than you think. We recently bought a home and we’re on track to have the home paid off in 10 years. I really like the idea of owning my home free and clear and living “rent free”! Especially since I know that rent will be a lot more in the future than my 4% interest rate.

  13. Bill T

    Mike K, please share with I’s a country who’s economy is equal to ours where the housing prices fell for 20 years?! That is the craziest comment I have ever heard.

    For someone who practices Real Estate on a day to day basis, I would say that now is the time to buy. In my local market, new construction is taking off, and inventory levels are balancing out. Houses are selling over appraised values due to high demand and therefore driving prices up again.

    That is all!