Renting Vs. Buying: Do The Math

Why is it good to buy vs. rent? Let’s give an example:

* Average home prices decrease 20% in the next two years.
* Interest rate goes up 1% from 2009 to 2011.

1st Scenario:

1. John is renting at $2500 per month. He wants to buy a $600,000 home but wants to wait because he believes the market will decrease 20% in the next two years. John wants to buy a house with the value being at $480,000 (20% decreases). John has the intention of staying at least 10 years in his house and getting a 10 year interest only loan.

Example:

John waits 2 years before buying a house. Interest rate goes up 1% in the next 2 years.
He buys the house at $480,000 with a 7.5% interest rate.

Expenses:

Rent: $2500 x 12 = $30,000 x 2 = $60,000 (No tax write-off for 2 years).

Difference between getting a loan at 6.5% and 7.5% interest only for 10 years is 17% of the purchase price. So, if John buys the house at $480,000 x 17% = $81,600. John ends up paying $81,600 in a period of 10 year which comes to $680 more per month. So, $60,000 (rent) + $81,600 (7.5% interest rate) + $480,000 = $621,600.

John ends up paying $21,600 more.

2nd Scenario:

1. John decides to buy now. The inventory in his area is pretty high and some houses have been on the market for a while. John’s agent manages to negotiate with the other listing agent and seller and close the deal with an offer 10% below the asking price.

Example:

John buys the house now at $540,000 (10% below the asking price $600,000).Gets the interest rate at 6.5% with a 10 year interest only.

Advantages:

John gets his house at a better rate. He also gets the tax write off with the interest rate and property taxes. He also gets the full freedom of owning his property.

Tax Write-off VS Renting:

John makes $100,000 per year with an income tax bracket of 38%. John is paying $38,000 in taxes per year with no right offs.

If he buys a house today at $540,000 with an interest rate of 6.5% on a 10 year interest only, John puts a 20% down payment to get a loan of $432,000.

Property tax is 1.25% in California, so, $540,000 x 1.25% = $6,750 ($562.50 per month).

Payments per month for mortgage: $2,340 ($28,080 per year).

So, $28,080 (Interest Only per year) + 6,750(Property tax per year) = $34,830

Tax Write-off:

$100,000 – $34,830 = $65,170 x 38% (Income tax bracket) = $24, 764.60.

So, by owning a house john save $13,235.40 per year ($38,000 – $24,764.60) or $1,102.95 per month with tax write-off.