A question that is debated quite often:

Is it better to buy a home/apartment or rent?

Financially speaking it is way better to rent a home especially if you don’t plan on living there longer than five years. But if you are looking to start a family or raise a family and are looking to be in the same place or same school district for closer to 10 years, then it makes sense to buy a home versus renting one.

But I wanted to show an analysis of someone who rents versus someone who buys.

I looked all over to find an average home price in America. But as you can imagine home prices vary depending on where they are located in addition to all of the other characteristics of a home. We all know that home prices in California are much higher than homes in the midwest of the United States.

If you look the average home sales in the entire US, it says it is $436,800. And the average sales price in the Midwest is $273,400. If you take an average of these two numbers it is $355,100. You can look at the FRED data here. FRED stands for the Federal Reserve Bank of St. Louis. Which is where a lot of the data used to analyze the housing market comes from.

So after a lot of research and analytics I settled on a home price of $335,000. The reason I chose this number is because the FRED is tracking home sales, not home values per se. According to Zillow the average home VALUE in the US is $334,269 dollars. You can see that research here. I rounded up to $335,000.

Now the question is, is it cheaper to rent a $335,000 home or rent a $335,000 home.

Using the rates as of today. Let’s look at what it would require to purchase this $335,000 home.

**Home price: $335,000Interest Rate: 6.5%Downpayment: 20% **

**Term length: 30 years (360 months)**

Let’s talk about downpayment. I personally believe if you are buying a house you should put at least 20% down. If you do, you won’t have to pay an added fee of property mortgage insurance. PMI as it is called, is usually .05 – 2% of the loan amount.

Let’s just use 10%. A 10% downpayment on this house would equal $33,500 dollars. Which means the loan amount would be $335,000-$33,500 = $301,500.

Assuming a PMI rate of 0.5% per year, the monthly PMI cost would be:

Monthly PMI cost = (Loan amount x PMI rate) / 12

Monthly PMI cost = ($301,500 x 0.005) / 12

Monthly PMI cost = $125.63

$125.63 would be added to your monthly payment on your house for this PMI (Property Mortgage Insurance). Which is required to protect the mortgage company because a buyer doesn’t have enough invested in the deal.

That was a long winded analysis of downpayment. But it has to be said. That is why I say make sure you have at least a 20% downpayment.

Back to the analysis now.

**Home price: $335,000Interest Rate: 6.5%Downpayment: 20% **($67,000)

**Term length: 30 years (360 months)**

**Loan Amount: $335,000 – $67,000 = $268,000**

Monthly mortgage payment:

To calculate this, we need to use the formula for a fixed-rate mortgage:

M = P [ i(1 + i)^n ] / [ (1 + i)^n – 1]

Where: M = monthly mortgage payment

P = loan amount ($268,000)

i = interest rate (6.5% / 12 = 0.0054167)

n = number of payments (30 years x 12 months = 360 payments)

Plugging in these values, we get: M = $1,697.86

Monthly payment on this $335,000 home is $1,697.86.

How much are taxes? You can go to this website here to learn the property tax rate in your state. But for the sake of this post, I am going to use an average. 1.1% is a great average.

$335,000 x 1.1% = $3,685 a year in property taxes. Monthly ($3,685/12)= $307

What about insurance. Now insurance is all over the map across the US, but a solid average on a $335,000 house is about $2,800 dollars a year. I am estimating here. But if you look at this website here it will support the number I am using as a good average.

$2,800 a year for homeowners insurance. Monthly ($2,800/12) = $233

Now let’s add it all up.

Monthly principal and interest payment: $1697.86

Property Taxes: $307

Insurance: $233

Total monthly payment on this house a month (if you escrow, which means you include taxes and insurance in your monthly payment instead of paying it separately)

($1697.86 + $307 + $233) = **$2237.86** is the monthly payment on this $335,000 house.

So the question still remains, it cheaper to rent this $335,000 house or buy it.

Let’s calculate rent. Now this isn’t nearly as easy, because there are so many factors that would determine the rent on this particular house. Things such as sq feet, number of bedrooms, number of bathrooms, year, garage, neighborhood, city, state, condition of the property etc.

According to this website the average house is the US has about 2,273 square feet. This would most likely be a 3 bedroom and 2 bath house. It could be four bedrooms, but most likely it is three.

But the easier metric is to just calculate a price per sq foot. If you look up the states and cities to see what is the price per sq. feet you will see that it is all over the map. With DC being the highest at $2.95 and Alabama being the lowest at .74 cents. But a solid average would be $1-$1.25. In Louisville, where I personally have a lot of properties, the lowest I want is $1 per sq foot and most of our properties are at $1.25.

But for the sake of our example here with the $335,000 house with 2,273 sq feet we will use $1 dollar as the metric.

2,273 sq feet X $1 = $2,273 a month in rent and $27,276 a year in total rent.

So now we know what it costs to rent this house every month and how much it will cost us to purchase it.

Purchase it: **$**2,237.86 monthly

Rent it: $2,273 monthly

What I like to say here is that when you purchase, the price you pay every month $2,237.86 is the floor. Meaning it is the least amount you will pay. If something breaks, or you have to do some kind of maintenance, etc. These costs will add to your monthly expense.

Where as your monthly rent payment is the ceiling. It is the most you will pay every month.

I will carry this post on in some future posting. But to put a bow on this discussion. I want to just look at a five plan on either buying this house or renting this house. And which one is cheaper.

Let’s start with rent.

Year 1 rent is $2,273 a month and $27,276 a year.

Let’s assume a 5% rent growth each year on this.

Year 2 rent is $2,386.65 a month and $28,639.9 a year

Year 3 rent is $2,505.98 a month and $30,071.79 a year

Year 4 rent is $2,631.28 a month and $31,575.34 a year

Year 5 rent is $2,762.84 a month and $33,154.12 a year

**Total rent paid over 5 years = $150,717.15 **

Now let’s look at purchasing. It’s a little easier because you locked in your rate at 6.5% and your payment is the same for 360 months. Most likely insurance premiums and taxes will go up each year on your property, but to keep it simple here. I am going to assume your payment will be the same for five years or 60 months.

**Total mortgage payment and interest/taxes/home insurance premiums ****$2237.86 x 60 months = $134,271.6 **

Now we have to add in the downpayment you put down to purchase this house. $67,000 + $134,271.6 = **$201,271.6**

So the real costs in this scenario over a five year period equals:

**Purchase: $201,271.60Rent: $150,717.15**

**It is $50,554.45 dollars cheaper in real dollars to rent this house. **

Now, at the end of five years the renter has nothing, right? And the buyer has a house that is worth more than they paid for it and they have definitely paid down the debt on it. So lets look at this.

In this case we have to pull out the amount that was being paid monthly/yearly for insurance and taxes. We want to just look at monthly payment towards principal and interest.

That number is $1697.86.

$1697.86 x 60 months = $101,871.6 total

Of the $101,871.6, $58,032.66 went to interest. Which means the loan was paid down by $101,871.6 – $58,032.66 = **$43,838.94 **in loan pay down, or equity.

Also, let’s assume the house went up by 5% a year because of appreciation as well.

Year 1 the house is worth $335,000

Year 2 the house is worth $351,750

Year 3 the house is worth $369,337.5

Year 4 the house is worth $387,804.37

Year 5 the house is worth $407,194.58

The house is now worth $407,194.58

Your original loan amount was $268,000. You paid that down by $43,838.94 over the five years. The loan amount now is $268,000 – $43,838.94 = $224,161.06.

So you now have a home worth $407,194.58 and you owe $224,161.06. That means you have $183,033.52 in equity in this home.

But how much of that equity in that home did you personally pay for? That’s simple. Your original down payment of $67,000 + the $43,838.94 in debt pay down = $110,838.94.

We already know that renting vs buying when you just look at the total dollars spent over five years it is less expensive to rent.

**Purchase: $201,271.60Rent: $150,717.15**

Where does a majority of the increase in real dollars in buying versus renting come from? Well, it is easy to see that the biggest factor in this equation is the downpayment. In this case, the $67,000 dollars.

You could now say, well. What if I just put less down. And you could, but it changes everything above. Every single number would be different. Your payment would be higher, your loan amount would be higher, you would have to pay PMI, etc. So I am not going to change the numbers for the sake of that argument.

According to statistics, a first time home buyer usually lives in their home less than five years. Check out this site to learn more about average length people stay in their home.

It is probably easy to say that the home we have been using as an example would be considered a starter home for a lot of people in our country. So let’s say the person who bought this home decides to sell it after five years.

The house is worth $407,194.58 and you owe $224,161.06.

Let’s say you get the asking price of $407,194.58. As you know as the seller you have to pay the commissions on this deal. Most likely it will be 6%.

6% of $407,194.58 = $24,431.67

So let’s see how much you would receive.

$407,194.58 – $24,431.67(sales commissions) = $382,762.91

$382,762.91 – $224,161.06 (what you still owe) = $158,601.85

You get a check for $158,601.85.

How much of this was money you invested in the deal.

Downpayment $67,000 + the amount of principal pay down $43,838.94 = $110,838.94.

Now we take your check $158,601.85 – $110,838.94 (down payment and your payment that paid down the loan) = $47,762.9

So if you sell it after five years you technically made $47,762.9

I am not a stock guy, but what if you would have put your $67,000 dollars into a solid performing index fund. According to investopedia if you account for inflation the S&P has delivered an 8.5% return for most of its inception.

So take your $67,000 at 8.5% compounded over five years =

FV = $67,000 x (1 + 0.085)^5

FV = $93,798.66

You could have made $26,798 without all of the hassle of buying this home. And if you add this to the amount you saved renting:

**Purchase: $201,271.60Rent: $150,717.15**

The difference of $50,554.45 + $26,798 = $77,352.45. You would actually be $10,000 ahead.

We covered a lot of numbers in this example. A whole lot. There are about twenty other reasons I would rather rent where I live and own what I rent to others, but I will save that post for another day. Also, if you bought this same $335,000 house as an income producing property it would generate significant returns as well. But that is another post for another day.

I think I made the point though. If you just look at real dollars spent or invested, it doesn’t make sense to buy a home unless you intend on being there for at least five years. Unless we see another crazy market like we have had the last three years, but I don’t think that will happen again anytime soon.

Please question my analysis. I love the banter.

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To your success and your future.

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