Real Estate Insight

Rent or Own? If You Have The Down Payment, Buy…Here’s Why

After looking at all the costs involved in buying house, you may have begun to have second thoughts: Perhaps, it is better to rent a home.

Real estate in most areas today is not a top investment compared with investment securities. You’re not going to get a 30 percent return on your home today; but so what? The Mortgage Bankers Association of America advises people to think of a home as shelter, not an investment. Wealth accumulation is secondary. You need a place to live. If it happens to appreciate, great. If the value doesn’t go up or worse, goes down, you still need shelter and as you’ll see here, you’re better off owning in a declining market than renting.

As shelter, most experts say if you can afford the down payment, it makes sense to buy your home rather than rent it. That’s because you can deduct mortgage interest on income tax and build equity in your property. This is especially true when mortgage interest rates are low. Mortgage interest rates are deductible up to a $100,000 annual limit.

Example:

1 bedroom condo – market value is $250,000

Rental for this condo – $1400/mo.

A buyer of this condo has a gross annual income of $40,000. The monthly mortgage payment is $1,349 on a 30-year mortgage at 6% interest with 10% down. In the first few years, 80 percent of that payment goes to interest and is therefore tax deductible. In the 35 percent tax bracket, this homeowner will save about $454 more a month in taxes with the home provision versus with only a standard deduction.

What this means is if you were a tenant renting this unit, you would pay $1400 a month. As a tenant, you receive nothing in tax benefits and zero in equity growth.

As an owner, your monthly mortgage payment is $1349. There are other costs associated with owning this condo. Maintenance/Association fees, property taxes, mortgage insurance if less than 20% down payment. Let’s say the Association fees are $300/mo., property taxes are $75/mo., and mortgage insurance is $98/mo., your total monthly expenses associated with owning would be $1821. As an owner, your tax deductions would total about $454 resulting in an effective monthly payment of about $1367 – less than the cost of renting.

If this condo appreciated at 5% a year, you will have gained $12,500 just from the increase in value in the first year of owning it. If the market declines, so what? Again, if you treat your home as shelter, you still paid less each month owning it versus renting it. Any gain is just a bonus.

Additionally, your mortgage payments will never increase for the next 30 years. Think about this: If you could lock the monthly rent you currently pay for the next 30 years, would you? Of course you would. Well buying your home with a 30 year mortgage is exactly the same as locking in your rent for the next 30 years.

The following chart shows average rents of respective size rentals by year:

On average, the rent for a one bedroom condo increased 51% in Honolulu, Hawaii and 21% in Orange County, California. Rental increases are not isolated to these areas either. Recent reports indicate rents have increased 40% during the past two years in New Orleans and 30% on average nationwide.

Hope this helps anyone sitting on the fence wondering what to do. Until next time, happy house hunting!

Elliot Lau