Better To Rent? Quite Possible!

If you think that it's always better to buy a house than to rent, then financial adviser Ray Martin has a surprise for you. He shares some interesting insight as part of his regular appearance on The Early Show.

Over the last year, housing prices increased more than 12 percent, while rents increased by less than 2 percent. In some of the bubble areas (such as Seattle and San Francisco), rents have actually fallen.

Also, according to the Census Bureau, rental vacancy rates remain near the record high of more than 10 percent, the highest since they began to collect this data in 1960.

Since before the mid-'90s, the increases in the housing price index and the CPI rent index have tracked closely to each other. But over the past eight years, there has been a significant divergence, where the costs of owning a home have literally sprinted ahead of the pace of increase in rental costs, rising more than 20 percent more.

There have been divergences like this before; in the late '70s and '80s. In both cases, this was followed by periods where the housing price index declined in relation to the CPI rent index.

Typically, the housing price index and CPI rent index move at a similar pace. The Center for Economic and Policy Research explains it this way:

"…if the cost of buying a home rises sharply, as it has in recent years, it would be expected that this would get passed on in higher rents, as owners of rental units attempt to recoup higher purchase prices from their tenants.

"Similarly, if rents begin to fall, or at least not keep pace with inflation, it is reasonable to expect that this would eventually exert downward pressure on home prices. As tenants are able to get better deals on rent, they will be less anxious to rush out to buy homes. Also, potential homebuyers who are interested in renting out housing units would be willing to pay less for homes as rents drop."With the costs of home ownership rising faster than the costs of renting over the past nine years, more people simply cannot afford to buy and are discovering that they can rent a residence at a significantly lower cost. Faced with a lower cost to rent versus own, many are deciding to rent for now, rather than to jump in and buy into what is widely believed to be a frothy real estate market.

There are also more reports of people who have sold their current homes and are renting, while they wait on the sidelines to buy in anticipation of a fall in home prices.

Whatever the situation, here are some guidelines to keep in mind when considering renting versus buying:

When to Buy, When to Rent

The decision to stop renting and to buy a home is traditionally made at the point at which the renter has decided to stay in a location for a few years and has saved up enough money for a down payment. But now some renters are jumping into homeownership, even though the cost of owning is several times more than the rent they are paying. Perhaps they are anxious that the prospect of a continued rise in home prices and mortgage rates will put homeownership out of their reach.

It may be fine for them to buy a house, as long as it's affordable. But when housing costs exceed 35 percent of gross income, and a prospective buyer has to make unsustainable budget cuts to make house payments, this is a problem.

The reality is that everyone pays rent, either to a landlord or to a bank for the use of its money. Everyone also buys houses, either for the landlords or for themselves.

Advantages of Owning Your Home:

• Build Equity through mortgage pay-down and price appreciation. Of course, if you have an interest-only mortgage and your home value falls before you sell, you can lose equity.
• Make Changes. Since you own it, you can remodel, paint and make any changes that make a house your home.
• Tax Breaks. For most people, owning a home means saving money on taxes because they can deduct the costs of mortgage interest and property taxes. Of course, these tax breaks can be offset by increased costs for maintenance, utilities and insurance.

• Rising Costs
• Responsibility for Maintenance
• Having to Sell if you want to move or have to relocate

Advantages of Renting

• Predictable Costs. You'll know what the rent costs will be for the term of the lease.
• Flexibility. You can move with little or no cost or hassle, particularly when your lease is up.
• No Maintenance. The upkeep and maintenance is the landlord's responsibility.

• No Equity Buildup
• No Tax Savings
• You Can Only Make limited changes or alterations.

Buying Vs. Renting: When To Break Even

But most people assume that it's always to their advantage to buy a home, which is usually true, but not always. When considering whether to rent or buy a home, you need to look at more than just your mortgage payment.

Consider the following example: Say your current rent is $1,200 per month. You are considering buying a home for $275,000. After using cash for a down payment and closing costs, you will need to get a mortgage for $253,000 at a 6 percent interest rate. Your monthly payments for a mortgage, property taxes and insurance will be about $2,084, which is $884 more than your current rent payment.

After taking into account the savings in taxes (due to mortgage interest and property tax deductions) and the equity build-up from paying down mortgage debt, the following is a range of the number of years to break even at various home price appreciation rates:

Home Appreciation          Number of Year to Break Even

    5 percent          ................ 2.1 years
    3 percent            ................ 4.1 years
     2 percent            ................ 7.2 years

Clearly, the rate of home price appreciation after you buy has a big impact on the time required to break even, after which buying a home will be a better financial option than renting. The take-away from this analysis is that if you don't plan to stay in your home for more than four to seven years, renting may be a better option for you.

To run your own numbers, consider using a Rent Vs. Buy Break Even Calculator at www.schaeffersresearch.com.