Question

which is better: to rent or to buy? The decision of whether to rent or buy housing is a personal decision that is based on both your lifestyle and your finances. While most financial experts argue that the financial aspect of the decision is important, it is also important not to base your rent-or-buy decision solely on the numbers. Your personal needs and housing market conditions are important. However, it is still necessary to perform the financial analysis. Dmitri and his wife are trying to decide whether to rent or to purchase a new condominium. After looking for several months, they've narrowed their choice down to one particular unit, and the builder is willing to lease or sell - depending upon the preference of the buyer. To perform a rent-or-buy analysis, Dmitri and his wife have collected the following information:

Answer 1

The annual cost of renting will be $17,296 as per table below:

COST OF RENTING	Amount($)
Security deposit	$2,400
Annual rental cost	$14,400
Renter's insurance	$400
Opportunity cost on security deposit	$96
Total annual cost of renting:	$17,296

Working notes:

1. Monthly rent is $1,200 and security deposit is 2 months’ rent = $1,200*2 = $2,400. Also, annual rental cost = $1,200*12 = $14,400.

2. Renter’s insurance is $200 every six months. So, annual renter’s insurance = $200*2 = $400.

3. Opportunity cost on security deposit = 4%*$2,400 = $96

So, adding up all costs, total cost of renting = $17,296

The annual cost of buying will be $4,318.60 as per table below:

COST OF BUYING	Amount($)
Monthly mortgage payment	$408.0
Annual mortgage payments	$4,896.0
Property taxes	$2,550.0
Homeowner's insurance	$425.0
Maintenance expenses	$850.0
Opportunity cost of down payment and closing costs	$820.0
Total costs	$9,541.0
Less:
Reduction of loan principal	$816.0
Tax savings on mortgage interest deduction	$1,142.4
Tax savings on property tax deduction	$714.0
Total deductions	$2,672.4
Annual after-tax cost of homeownership	$6,868.6
Estimated annual appreciation in home value	$2,550.0
Total annual cost of Purchasing:	$4,318.6

Working notes:

1. Monthly mortgage payments = $408. So, annual mortgage payments = $408*12 = $4,896.

2. Property taxes = 3%of the unit’s price = 3%*$85000 = $2,550

3. Homeowner’s insurance = 0.5% of unit’s price = 0.5%*$85,000 = $425

4. Maintenance expenses = 1% of unit’s price = 1%*$85,000 = $850

5. Opportunity cost of down payment and closing costs = 4% of down payment and closing cost. Down payment = 20%*$85,000 = $17,000 and closing cost = $3,500. So, opportunity cost of down payment and closing cost = 4%*($17,000+$3,500) = $820

6. Total costs = Annual mortgage cost+ Property taxes+ Homeowner’s insurance+ Maintenance expenses+ Opportunity cost of down payment and closing costs.

7. Monthly loan payments = $408. Interest on loan is 6% per year. So, per month interest = 6%/12 = 0.5%. So, monthly interest = 0.5%*loan amount. Loan amount = $85,000 – 20%down payment = $68,000. So, monthly interest = 0.5%*$68,000 = $340. So, in $408 monthly loan payments, $340 is the monthly interest and $68 is the principal repayment portion. So, annual reduction of loan principal = $68*12= $816

8. Tax saving on mortgage interest deduction = 28%*annual mortgage interest payment, i.e., 28%*$340*12 = $1,142.40.

9. Tax saving on property tax deduction = 28%*$2,550 = $714

10. Annual after-tax cost of homeownership = Total costs - Total deductions

11. Estimated annual appreciation in home value = 3%*$85,000 = $2,550. This will also be deducted from annual after-tax cost of homeownership to arrive at annual cost of purchasing.

Based on the above analysis, the couple should purchase the home, as the total cost of purchasing is less than the cost of renting.