How To Use A Rent Vs. Buy Calculator – Forbes

December 25, 2021 By admin

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Published: Oct 18, 2021, 9:06am
For most people, buying a home is the biggest financial move they’ll ever make.
The upsides are obvious: A permanent residence with fixed costs that will typically gain in value over time. Pay off your mortgage, and you can mosey into retirement with a major asset and low housing costs
Still, there are risks: You’re handing over a big chunk of change without knowing the future. Will you lose your job? Need to move soon? Unexpectedly have twins?
Uncertainties like these are why millions of potential home buyers turn to rent vs buy calculators. Shelling out hundreds of thousands of dollars is a scary proposition, and renters want to see whether or not they can really make it work when you factor in all the costs of renting vs buying.
But here’s the problem: A rent vs buy calculator turns a key long-term financial decision with major ramifications for retirement into a short-term cost/benefit analysis that could mislead some would-be buyers on the benefits of homeownership.
Here’s the unavoidable truth we all need to remember: One day soon, we won’t be earning a paycheck, but we’ll still need a place to live. One of the big benefits of homeownership is that with good planning, it’s possible to minimize your housing costs in retirement. That’s huge.
A recent Harvard study reinforces the point: Just 17% of people over 65 who own their home outright are “housing cost burdened,” defined as paying more than 30% of their gross income toward housing costs, compared to 55% of retired renters.
“It could be OK to have a mortgage in retirement, just as long as you can pay it off in a quick minute,” said Catherine Collinson, chief executive of the Transamerica Center for Retirement Studies.
Another advantage is the value of the home itself. Home equity is the third biggest asset for households helmed by pre-retirees, after Social Security and private pension benefits, according to analysis by the Boston College’s Center for Retirement Research. (Sadly, 401(k)/IRA holdings lag behind in a distant fourth, a result of too few opening accounts at all and saving too little when they do.)
The thing is, most Americans don’t have a private pension, and you don’t exactly own your Social Security benefits. That means a house might be the most financially important asset in your life. And you can’t build home equity when you rent.
In addition, a fixed-rate mortgage can be a hedge against inflation. Your monthly payment stays the same for 30 years, while renters will only see increasing costs to keep living in the same place as prices rise. This helps you plan better for retirement and ultimately save more.
Plus many people like to live in the same place for a long time, said Collinson. A house has an intangible value as the place that feels like home.
Use Personal Capital’s Retirement Planner to calculate how much you would need to save for your retirement
Rent vs. buy calculators tell you whether it’s more or less expensive to buy or rent over a given period of time. To do that, you need to factor in a bunch of assumptions, which are broadly similar no matter which online calculator you use.
On the buy side of the equation, a rent vs. buy calculator tallies the costs and benefits of homeownership. By subtracting the costs (interest payments, closing costs, maintenance spending and taxes, among others) from the benefits (how much home equity you build, appreciation in the market value of your home), the calculator aims to show whether buying makes sense, given the parameters you choose.
On the rent side of the equation, the calculations are easier: Tally up the costs of your monthly rent payment, total security deposit and renter’s insurance fees. In addition, the average growth in rent and the impact of inflation are factored into the overall picture.
Helpfully, a popular calculator from the New York Times also looks at opportunity cost. How much you would have earned if you had invested your down payment (or security deposit) in a basket of stocks and bonds, rather than plunking it into your home.
The problem with rent vs. buy calculators is that they analyze homeownership over a period of time: is it cheaper to rent or buy over, say, five years? But buying a home isn’t a discrete financial decision, rather one in a series of choices that will affect your finances over a lifetime. In other words, what are you supposed to do after five years?
Let’s say you find a home for $375,000, put 10% on a down payment and receive a 3% 30-year fixed-rate mortgage for the remaining amount, all typical amounts for Americans, and plan to stay in the home for about five years. The New York Times calculator says you’re better off renting if you can find a place for $1,400.
Here’s the gist of what happens to the homeowner in real life:
Subtract the amount you still owe on your house, and that leaves you with $135,000. Take away closing costs when you buy, and then sell, your home and you have roughly $100,000 left over.
That’s a big deal. You could put that lump sum toward an even nicer $700,000 house—it equates to a 14% down payment—and thereby increase your standard of living by more than half in the span of a half decade.
The renter, on the other hand, would find herself in a very different position. One big difference is that the renter wasn’t “buying” more of their home with a portion of each rent check, which is just another way to describe building home equity. They were just paying their landlord.
Even if they invested the $37,500 down payment and earned 4%, they’d only have about $45,600 after five years. Factor in 20% long-term capital gains on their earnings, and that leaves the renter with about $44,000, or half of the homeowner’s cache.
Of course, there are other costs involved for homeowners, including taxes, insurance, maintenance/renovations and higher utility bills. In the scenario from above, that amounts to about $10,500 per year for homeowners.
But those costs aren’t all the same.
While some maintenance will simply drain your wallet, renovations will almost certainly add value to your home. Simply categorizing them as a cost, then is incomplete. If you spent $20,000 to remodel your kitchen, you aren’t exactly out that money since it increases the value of your home. (The return on investment tends to be at least 50% on kitchens, for instance.) Plus you get to enjoy a better kitchen!
Sure, you may have to spend on lawn care and a cleaning service, but you might endure those costs as a renter, too. There’s no guarantee that a renter will get their security deposit back in full.
Taxes and insurance are a cost, though that’s typically the price you pay for quality public schools in your neighborhood. But landlords embed their property tax bills in the rent they charge, which increases costs for renters.
A calculator may tell you it’s better to rent a place for $1,400, but that doesn’t mean a $1,400 apartment will be as attractive as a $375,000 home. How long can a growing family stand living in a tiny apartment with twitchy toddlers?
There’s no free lunch here.
Homeownership means paying potentially higher costs. But the multiple costs occur on a monthly basis, and homeowners have a very clear grasp on the amount they’re spending on each discrete line item, which helps them factor the costs into their monthly budgets.
On the other hand, it’s unlikely that renters realize how much they’re not spending on, say, property taxes, and then direct that amount into savings each month. Most people let their spending rise and fall depending on how much money they have available. If you spend the extra money not allocated to taxes, you’re not getting the cost/saving benefit assumed by rent vs. buy calculators.
The calculators also largely ignore the present-day advantages of homeownership. Homeowners can tap their home equity if they need cash, for instance, while capital gains on your home are treated much more favorably than is the case with stocks and bonds.
In the current climate, homeownership has been much more advantageous than renting. Inflation, depending on how you measure it, is soaring between 4% and 5% on an annual basis. As noted above, that’s bad news for renters with a yearly lease, while it makes little difference for homeowners with a fixed-rate mortgage.
Rent vs. buy calculators also typically have a conservative estimate that home prices gain 3% annually, but recent history has been much different. According to the S&P/Case–Shiller U.S. National Home Price Index, home prices have shot up by more than 3% compared to the year prior in every month since September 2012 (of course, that came after the index spent years in the red following the 2007-08 housing market meltdown).
This trend skyrocketed in the Covid era. Home values have shot up by almost 20% over the past 12 months, thanks to lots of stimulus money and a lack of available housing supply.
There’s a right way and a wrong way to use rent vs. buy calculators to help you decide. Let’s take a closer look at when renting makes more sense:
Use Personal Capital’s Retirement Planner to calculate how much you would need to save for your retirement
Taylor is an award-winning journalist who has covered a range of personal finance topics in the New York Times, Newsweek, Fortune, Money magazine, Bloomberg, and NPR. He lives in Dripping Springs, TX with his wife and kids and welcomes bbq tips.