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Home > Investing > It’s Really True: Buying A Home Now Is A Great Idea

It’s Really True: Buying A Home Now Is A Great Idea

I’ve previously written that I rent. I live in a small town with public transit, restaurants and services just a few blocks away. If I were to buy, I would want to get the same lifestyle.

When I wrote that article, mortgage rates were about 4.5%. I remember about 10 years ago I was looking to buy a home and at the time a 7% interest rate was available (and that was a good rate). With rates now around 3.5% and home prices down from previous higher prices from 5 years ago, does it make sense to give this another look?

I won’t waste your time: yes, you can absolutely crush renting now by buying instead. Read on for the numbers and reasoning.

The Traditional Case For Buying

 

The traditional case for buying a home in a ‘normal’ market (a market without The Fed manipulating interest rates or mortgages with its securities purchases) is that a fairly constant mortgage payment over the years that pays down principal against an ever increasing rent bill will eventually lead you to a better financial position. The math works, and it works quite well even if your mortgage payments are significantly higher than rent.

Here’s an example of a typical comparison from before the financial crisis. Let’s compare a 2 bedroom apartment that rents for $2,000/month to a 4 bedroom home that costs $500,000 at a monthly payment of $3,800. The costs of the home are pretty significant (I’m using New Jersey/New York prices) as you see here below (for all the charts and calculations I’m using Trulia’s website). With property taxes of $1,000/month in addition to the mortgage, this home has a much bigger money payment.

I will use the numbers from 5-10 years ago: a 7 percent mortgage rate with a money market account yielding 5%. The money market account yield is used as the return on savings (which you would earn on your down payment if you didn’t buy the home).

In the chart below, these are the inputs to Trulia’s rent versus buy calculator.

Before I show you the result, note the difference in initial monthly payments:

Rent: $2,000/month

Buy: $3,800/month

The house costs a lot more from a cash flow point of view (almost double!).

When you run this calculation, you get the following result.

So, over a 30 year period, buying a more expensive bigger home pays off. The primary reason is that you get the own the home at the end and enjoy all the appreciation and tax savings along the way.

Buying A Home Today

 

Today, we face much different circumstances that are favorable to the home buyer. Home prices are lower than 5 years ago (in many places but not all) and mortgage interest rates are near record lows. Mortgage rates are around 3.5% for a 30 year fixed loan. Low mortgage rates come at a price, such that you can’t get 5% in a money market fund. However, you can still get around 3%/year buying 30 year Treasury bonds, so I will use that rate as the return on savings.

Let’s calculate the rent comparison to a home using more up to date financial amounts. I will use a home that costs $400,000 (instead of $500,000) and I will use a home that has better costs so that it’s property taxes are $5,800 instead of $12,000. Here’s a link to the home I selected on Trulia.

Here’s the result from this calculation.

 

Wow, it isn’t even close. There’s a 650K difference between the two. Let’s assume that you don’t think you’ll get the tax savings (either because you think the deduction will go away or because you can’t take advantage of it) and you don’t believe the home will appreciate in value. You will still be ahead by a lot even if the home never appreciates and get no benefit from the mortgage interest.

Note the difference in initial monthly payments:

Rent: $2,000/month

Buy: $1,986/month

 

An Investor Centric View

 

How would an investor look at buying versus renting? An investor implicitly understands time value of money, discount rates and calculating the value of money streams. I don’t mean to imply that buying a home is an investment or that you should look at it that way. But what I am saying is that you should take a hard look at all the costs over the long term to get an idea of what you will actually be spending. This will help you to make more informed decisions. Here’s how my investor brain looks at buying right now.

In the first example I provided, you earned a financial advantage over the long term. However, there isn’t much margin of error here. From a cash flow point of view, paying $3,800 per month versus $2,000 puts you at a bigger risk if you lose your job, become sick or disabled. All the long term financial benefits aren’t worth much if you can’t meet the immediate cash flow requirement. So, I wouldn’t buy under those financial conditions or I would look for a more cost effective option.

Also, the benefits of ownership would be realized only under assumptions of reasonable home price appreciation or tax detectability of the interest payments. My investor brain says don’t put your financial health on such accounting items which may never actually occur. I want a good transaction from a cash flow point of view.

Enter the second example, where the numbers are compelling. The initial mortgage payment is actually lower than rent! (note that this amount does not include the maintenance expenses assumed in the buy versus rent calculation). It gets better. From the first month’s payment, you put over $500/month in your pocket in principal payments, after which it increases every month. Even after accounting for $250/month you would earn on your down payment if you didn’t buy, you come out ahead about $300/month on a cash basis from the first month.

It’s hard to argue about the merits when it makes sense from a cash flow point of view from day one. You don’t need any price appreciation to make the numbers work.

However, if you are an investor that can get a better return than 3% used in the model, the numbers look less compelling. At 7% investment return, which can still be had investing in corporate debt, there is still an advantage but it is about break even if you take out tax savings and appreciation.

But then again this doesn’t have to be just about numbers. Buying the home offers a good return on its own as well as all the benefits of living in better housing.

 

 

 

 

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