August 24th, 2008Not Time To Buy According To This Unique Rent vs Buy Calculator
There are dozens of rent vs buy mortgage calculators out there, but I will offer one more with a unique way of analyzing the ultimate decision – rent or buy. As we have discovered in the recent news of the housing meltdown, many people claim not to understand the terms of the mortgages they signed up for. If that is indeed the case, I would venture to say that they also do not understand the net present value calculations of all those other rent vs buy calculators.
My calculations are based on an equivalent rent value. Add up all the money that goes into your purchase over a given period of time, subtract out the money that comes out at closing, and divide the result by the number of months/years you’ve owned it. As an example, consider a 5 year equivalent rent calculation for buying a house you are considering. If you can rent an equivalent size place for significantly less then what the 5 year “equivalent rent” calculation shows you, then you may be better off renting. You can download the Excel spreadsheet here. Feel free to modify it for your own liking. All of the assumptions are listed and the calculations are viewable. Here is a view of the input assumptions, and the equivalent rent calculations:
A walk through the calculations:
- 19: Calculations based on years of ownership
- 20: Calculated based on appreciation assumption (8)
- 21-29: Breakdown of payments, and total
- 30-33: Equivalent payment calculations based on tax savings. Also factors in the standard deduction that everyone gets regardless of home ownership. The useful component of your ownership tax benefit is only that amount over the FREE standard deduction.
- 36-46: Calculations for equivalent rent if the property was sold at the end of each year.
- 40: Assumes there are no capital gains if the property is held for > 2 years and then sold.
- 42: Divides the total dollar value capital gain by the number of months you have owned the property.
- 43-45: Calculations for lost opportunity cost based on the size of your down payment
Equivalent monthly rent: This is the final calculation that you can base your decision from. As an example, in many Seattle neighborhoods, a 2 bedroom, 1 bathroom apartment can be rented for about $1000-$1100 per month. An equivalent sized condo would sell for a $300,000 and likely more. The 5 year “equivalent rent” calculation shows an average outlay of $1,753 per month, substantially higher then the $1,000 rental cost. For this scenario, you may be better off renting.
August 25th, 2008 at 8:27 pm
Excellent spreadsheet. Thanks!
August 25th, 2008 at 8:38 pm
Glad you liked it. Feel free to modify to your own liking.
August 25th, 2008 at 10:36 pm
[...] saw threat of mortgage crisis Yakuza, the big winners Not time to buy according to this unique rent vs buy calculator FDIC gets ready for bank failures Appraisers still under the gun to ‘hit the numbers’ [...]
August 25th, 2008 at 10:57 pm
Did you miss the annual calculation in the homeowner dues and insurance?
August 25th, 2008 at 11:24 pm
The main purpose of my calculation is get the final number – equivalent monthly rent. To do this, I only need the monthly homeowner dues and insurance costs.
I can see why it might be misleading because I did calculate annual yearly deduction. But that annual deduction(line 30) was only an interim calculation to get to monthly tax benefit (line 33).
As far as I know, my method of calculating rent vs buy is unique. There are many mortgage calculators and rent vs buy calculators out there. The other ones give you the end result: “BUY” or “RENT”, but they do not show the calculations or all of the assumptions to get there. Also, my method compares the cost of ownership to what you are most familiar with – equivalent monthly outlays or “equivalent rent”.
My analysis method does usually draw initial questions, but after people track the logic and calculations, they usually find it very useful and unique.
August 26th, 2008 at 5:43 am
Great spreadsheet — I’m not customizing it like crazy — but wouldn’t it be very convenient for beginners if you could just enter the number of years of your mortgage, rather than having it assumed to be 30 years? I made a cell with a variable in it, and changed the “30″s that I found in the interest-payment-related cells to a reference to that cell, but people who aren’t familiar with Excel might not be able to do that.
August 26th, 2008 at 6:42 am
However, if tons of dollars are going to be printed… wages, prices, and rents may all go up big time… But that equivalent monthly rent stays the same (it doesn’t go down as appreciation was already included in the sheet). So to me it looks like the Seattle example still shows that real estate has a long way to go, but not that factor 2. More like 25% or 35% or so?
August 26th, 2008 at 9:12 am
Customizing it by years is a great tool to have if you only want to figure out your approximate payments, I agree. But the point of this calculator is to let the user see the true costs of ownership – average total outlay per month, and then let the user compare this number themselves to what they believe to be the actual rent they are or will be paying.
Also, I think too many people have been duped by mortgage brokers telling them that its cheaper to buy vs rent. They even “show you the numbers” to “prove” it. But the numbers are almost always misleading, due to:
->Lenders calculate based on artificially low mortgage rates
->Lenders assume interest only or neg.-am for the comparison
->Lenders often leave off property taxes and fees in calculation
->Lenders assume full benefit of mortgage deduction, when only that which is above your standard FREE deduction should be used for any rent vs buy comparison
One final note. The perceived justification for BUYING would be better if you lengthened the loan to 40 yrs. Likewise, RENTING would be a perceived better option if you shortened the loan terms. But I personally believe that the best term for comparison is 30 years, and using true fully weighted market interest rates (not teasers). That is what I personally use. I may opt to take a different loan, and probably even a teaser rate, but regardless of the loan I actually take, my rent vs buy comparisons are always based on 30 years with true market value interest rates.
August 26th, 2008 at 10:10 am
I like what you have done but I would like to make one suggestion to improve the logic used here. The “Equivalent Rent” really represents the “Equivalent Average Rent” paid over the time period. Rent increases with inflation and should also track percentage increase in house price as well. It would be more useful to the end user to give the “Equivalent Present Rent” instead because when you look for a place to rent in the newspaper you get the rental rate now and not the average rental rate over a period of time. Factoring rental inflation of 2.5% into this example the “Equivalent Present Rent” for the 5 yr case would be $1960.49 so that the rent the user needs to look for is considerably less then the rent your model provides.
August 26th, 2008 at 10:48 am
This is good and thank you very much, but there is possibly one thing you need to modify. (I added it on my downloaded one but I’m not sure about my math so won’t upload) – and it is the depreciation and resulting negative equity in the near term. This is missing from all online rent vs buys as well. I was shopping for a home but am now renting (even though moving into another rental house probably cost me $4K) indefinitely because of this issue.
For a near term (less than ten years) calculator, one needs to be able to put in depreciation (and only then recovery). So “appreciation” is better as not one field, but ten fields by year that can be filled with “the real economy”, which is continuing decline followed by recovery (recovery starting next year or even later depending on your pessimism on the tsunami effect of the big Option ARM and Alt-A resets in 2010 and 2011) e.g., -5%, -5%, 0, 0, +2.5%, +2.5%, etc.
You can also put in some fun “negative equity” formatting!
If these images don’t work, please delete the text but feel welcome to parse the ImageVenue links out (especially the credit suisse reset chart).
[URL=http://img249.imagevenue.com/img.php?image=72381_negeq_122_138lo.jpg][IMG]http://img249.imagevenue.com/loc138/th_72381_negeq_122_138lo.jpg[/IMG][/URL]
[URL=http://img246.imagevenue.com/img.php?image=72386_resetst_122_188lo.jpg][IMG]http://img246.imagevenue.com/loc188/th_72386_resetst_122_188lo.jpg[/IMG][/URL]
August 26th, 2008 at 11:22 am
Hi There,
Looks like a really useful spreadsheet, thanks.
Not sure if I’m missing something but can I download it from somewhere, would love to try it out?
Cheers, Digs
August 26th, 2008 at 11:28 am
I like this too. IT’s a slightly different perspective than the NY times calculator that does a similar analysis, but with a different way of framing it. Find it here, under #2 http://patrick.net/housing/crash.html.
Davids point is well taken, but I think obvious, and probably too much to incorporate into his spreadsheet. People know that if the five year equivalent average rent is say $1960, and the rent you would pay for a like property is close, say even $1600, then it might be suggesting a decent buy. The NY times model shows takes this into consideration and shows how long it takes for buying to clearly be better, but it doesn’t show some of the detail that Marketman’s does.
Thanks Marketman
August 26th, 2008 at 12:51 pm
Comment on the video at the bottom of this blog.
Capitalism is not socialism. Those people depending on Housing Assistance need to blame themselves and not the owner.
Note to Owner: Sell High and make the $$$$
August 26th, 2008 at 1:08 pm
Great stuff. Thanks.
August 26th, 2008 at 3:55 pm
Hi Marketman,
Good work. Thanks for the detailed spreadsheet. I am new to home buying calculations so please correct me if I am wrong.
I see a major flaw in this by not considering ‘equity’ that I would have earned at the end. Consider that, I am seeing my house after 5 years, according to your spreadsheet, I would have earned total equity (amount paid towards principal) of (269*12) + (287*12) + (307*12) + (327*12) + (349*12) = 18,468 Now, add this to your net profit (#F39) and you arrive at equivalent monthly rent of 1,754
am I missing something here?
August 26th, 2008 at 8:14 pm
Good catch Frank, thanks. I just updated the post, and the attached spreadsheet. Lines 46-47 now offset your “equivalent monthly rent” by subtracting out the average monthly built up equity.
February 12th, 2009 at 3:14 pm
[...] The total monthly cost of ownership must be a maximum of 5% larger than the cost of renting a near equivalent place. Regardless of what financing and down payment is actually used, the monthly cost of ownership should be calculated separately assuming a ZERO DOWN loan, with a 30 year fixed MARKET interest rate (NOT TEASER). Include principal and interest payments, real estate taxes, insurance, association dues, and special charges (i.e. flood insurance) in the monthly cost of ownership. Also see the Geldpress Rent vs Buy calculator. [...]
February 18th, 2009 at 11:51 pm
One other factor is that if I buy a house in the price range I can afford, I will most likely need to sink a lot of time and money into it to fix it up. While that may increase the value of the house, over the short term these are direct cash outlays. There are also moving costs, title insurance, points, and other loan fees. Can anyone suggest a way to incorporate this into the spreadsheet?
February 19th, 2009 at 9:22 am
You could easily add another row to the spreadsheet for “Miscellaneous expenses”. I would suggest coming up with what you think is a fair percentage of the home value per year to use as your misc. expenses. If you say it is 1% – 2500 per year on a 250k home or roughly 200 per month – then just throw that 1% into the spreadsheet and let it grow over time (or shrink) as the home appreciates(depreciates).
February 20th, 2009 at 11:57 am
I have a question here about the calculation. For the renter case, apart from the monthly gain I have on the down-payment (that I did not spend), I also have the amount available at the end of the comparison period. For example if I don’t put $60K down (by not buying), at the end of 5 years I have $1000 (60000/(12*5)) available per month. If I had put in the down payment, I would not have the money. So, shouldn’t the equivalent rent also have this factored in. If we factor this amount then the equivalent rent actually increases. Is there a reason you left this amount out of the calculation?
Maybe I am missing something very basic and hence asking a dumb question. But, I am looking forward to the answer.
February 22nd, 2009 at 12:20 am
If I understand you right, you are talking about the lost opportunity cost from your down payment. By putting the $60k down, you lose potential interest earnings from that money. The spreadsheet is not perfect but it does help people to better understand the true cost of ownership. And none of the calculations are hidden – UNLIKE THE BIASED rent vs own calculators from real estate sites. You can freely change the assumptions or calculations to your own liking.
August 17th, 2009 at 11:51 am
Hello,
I am a first time home buyer in California.
We plan to pay around 2400$ for a 3BR , 2Bath in Bay area -Santa Clara community.
We are thinking if buying might be a better option.
Our target buy in max 750000$
From all of above comments, you seem to have lot of knowledge on this.
Could you help us to calculate if renting is good or buying for us?
Thanks a lot for your help,
Sakhi
August 20th, 2009 at 11:21 am
The choice of buying vs renting is really a personal decision. The information in the post are some guidelines to think about, but ultimately you need to make your own decision. Both renting and buying are risky by nature, but which one do you perceive as the bigger risk? If you sign a 12 month lease and rents drop by 20% you could be stuck overpaying by a few thousand dollars over the course of a year. On the other hand, if you put 20% down on a 500k house and it drops in value by 20%, then you are out $100,000! Sure leverage works in both directions and the upside of buying sounds very appealing when your house appreciates by 10, 20 or 30% over the course of several years. But those false appreciation models are now widely known to be built on nothing but wide scale fraud and rampant deception in lies across all steps of the housing industry.
My only advice is to think about it objectively. Consider both sides of the equation and whatever you decide, be prepared and fully understand the risks of your decisions.