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It’s Cheaper for Me to Rent! Is It?
By: Bernice Ross

Americans believe in the dream of homeownership. With all the foreclosures and bankruptcies taking place, however, is it cheaper for people to rent rather than buying?

When it comes to the decision of renting vs. buying, most people make the decision based upon a comparison of monthly payments. If their rent payment is less than the payment on a home, many decide that it’s cheaper to rent than it is to buy. This approach, however, fails to take into account a number of other factors that influence the total costs of homeownership rather than just the monthly payments.

The first step for any person who is considering buying or selling a home is to talk to a tax professional. Each person’s tax situation is different. For example, when you purchase a primary residence, you can normally reduce your withholding taxes. The reason for this is that the interest on your mortgage is tax deductible. When you first purchase your home, almost all your monthly payment will go to interest. If you are in the 25 percent tax bracket, that means that Uncle Sam is essentially paying 25 percent of the interest on your home. This means that if you’re currently paying $1,000 per month in rent, you could afford approximately $1,250 in mortgage payments due to the tax breaks. Again, check with a tax professional to see how this applies to your situation. (There are some exceptions if you fall under the Alternative Minimum Tax law that may limit home mortgage deductions).

One of the most compelling reasons to buy rather than rent is to lock in a permanent monthly payment at today’s rates for the next 30 years. If possible, obtain a fixed rate mortgage for 30 years. This means that your mortgage 20 years from now will be at the same rate as it is today. In contrast, rent payments almost always keep pace with inflation. That payment you had to stretch to make today will be miniscule compared to payments 15 or 20 years from now.

To illustrate this point, the current 10-year average inflation rate is 2.82 percent per year. http://www.usinflationcalculator.com/inflation/current-inflation-rates/ (The average since 1913 is actually 3.41 percent a year http://www.inflationdata.com/Inflation/Inflation/AnnualInflation.asp). Assume that the inflation rate continues to average 2.82 percent per year. In 2019, your $1,000 mortgage payment would be the equivalent of $718 in today’s dollars. If your property value keeps pace with inflation, it would have increased in value by approximately 28 percent as well, making it worth $128,000. Furthermore, you would have paid down your loan for ten years. Assuming a six percent interest rate on a 30-year fully amortized fixed rate loan, your balance on your original $100,000 loan would be $83,686. Consequently, your equity position after 10 years would be $16,314 ($100,000-$83,686) plus $28,000 in appreciation due to inflation for a total of $44,314. (This calculation does not take into consideration any amount that you would have placed on the property as a down payment. That amount would be added to the $44,314).

Now compare this situation to what would happen if you were renting. If your rent payments kept pace with the inflation of 2.82 percent per year, your rent payments would increase 28.2 percent ($1,282 per month vs. $1,000 today).

Assuming a 2.82 percent inflation rate over the next 20 years, this example becomes even more compelling. Your monthly payment of $1,000 would be the same as $436 in today’s dollars. If your property value kept pace with inflation, it would now be worth approximately $156,000. After 20 years, the balance on your $100,000 fixed rate loan would be $54,359. Thus, your equity position would be $56,000 due to the inflation-related appreciation increase plus $45,641 in principal reduction for a total equity position of $101,641.

In terms of rent 20 years from now, if it kept place with inflation, you would be paying $1,564 per month. That’s an extra $6,768 per year more than if you had locked in your 30-year fixed rate loan at time of purchase.

The wild card in this entire discussion is the inflation rate. Many experts are predicting that the only way the government can pay the country’s debts is to print more money. The result will be increased inflation. Using the ten-year example from above, paying off a $1 billion dollar loan after 10 years of inflation at 2.82 percent means that the real payoff amount is $718 million in today’s dollars.

For an individual, this may be the best reason to purchase real estate. In most places, real estate is one of the few investments that keeps pace with inflation. Owning a home lets you build wealth by paying down your mortgage. If you hold your property for the long-term, it will normally keep pace with inflation creating additional wealth. When you rent, you pay off your landlord’s mortgage and make him wealthy. The choice seems obvious—build your wealth someone else’s.

United Real Estate
We specialize in helping renters become homeowners.

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