I have had the pleasure of recently working with a 61 year old man who has rented his entire life, AKA a "rent-a-genarian." He was referred to me by a Nashville TN real estate agent who told me that the debt-averse client will rely heavily on my ability to educate him on the finer points of mortgages, etc, and then see if he wants to proceed with a purchase. I actually got to dust off the old calculator!
He is considering buying a condo in metropolitan Nashville TN. Real estate prices for condos here can range from $60k up to $2 million. Based on his down payment of $7k and his overall housing payment target of $750/mo we settled on a price range of $90k. His 30 fixed mortgage payment would include property taxes, condo "interior" insurance (covers fixtures, cabinets, flooring, etc), required FHA loan monthly mortgage insurance, and an allowance for $150/mo for condo homeowner's association (HOA) fee. All of these totalled about $760/mo, and we'll call this his total "buy" payment. His rent payment is currently $614/mo, which is relatively inexpensive for a 1 bedroom apartment in Nashville.
We will assume that his rent will increase at a reasonable pace of 5% per year and that his property taxes will go up about 25% every 5 years. We'll also assume that the home's value will increase 3% per year, which is a conservative estimate historically, especially for Nashville TN real estate. Finally, figure that he won't pay any additional principal on his mortgage, just the normal payment.
After year 1, here is what it would look like:
Cumulative rent: $ 7368
Cumulative "buy" payments: $9130
So it would appear based on these figures alone, that renting holds up well in the short term. And actually, that is a pretty decent theory, because if he had to sell in a year or two, he would likely have to pay realtor commissions, closing costs, and of course he might have to deal with home value swings. All these can eat into or eliminate any profits he might have had. But he still has to consider the potential appreciation and principal reduction which creates the EQUITY (home appreciation plus loan principal reduction) increase in the short term. By the end of year 1, he would potentially have equity of $3844. Adding the equity back to his "buy" payments in year 1, he would actually be ahead of the rent scenario by about $2082.
As the rent continues to increase annually at 5%, if you simultaneously watch the home value go up 3% each year if he buys, you really begins to see the difference compounding. For example, after 5 years, here is what it would look like:
Total Rent: $41,585 (actual monthly rent pmt becomes more than "buy" pmt after the 5th year)
Total Buy Pmts: $45,649
Factor in the equity increase he'd have, and his cumulative net benefit of buying goes to $8200.
After 10 years, the increasing rent payments really take over, and the numbers look like this:
Rent: $96,138
Buy: $92,619
After calculating his equity increase, his net buying benefit shoots up to $49,616. After 15 years, his net "buy" benefit would be about $104k! Wow.
Isn't it scary to look back and consider the total amount of rent one pays over several years? And then to have nothing to show for it but an address in the white pages? On top of that, what if we had considered the huge benefit of the $8000 tax credit for 1st time buyers (expires after 6/30/10) or the mortgage interest tax deduction? Then it really swings the pendulum even further to the "buy" side.
People might say, "well, look what's gone on the last couple of years with home values". While it's true that the last 2 years we've seen some declines in values in Nashville TN real estate, they are no where near what we've seen in CA, NV, AZ, or FL, and therefore, by comparison, they've remained somewhat stable (we can thank the music biz, professional sports franchises, and the healthcare industry for much of that). That's why over the longer term, you'll see these numbers balance out. If you're looking to buy, and you think you're only going to live there a year or two, I'd say hold off, unless you're going to pay cash. But how many of us can do that?
In conclusion, my hope is that the above scenario clearly shows that when you have a mortgage, you don't have an ever-increasing payment and you get to participate in the increasing value of the home and have some equity to show for it at the end. With rent over time, your payments are simply going to go up, up, up- landlords have to increase the payments consistently to account for inflation and maintenance cost increases. If you consider the bigger picture rather than just looking at the monthly payment, you'll agree that over the medium (3 years) to long term, buying your piece of Nashville TN real estate can pay huge financial rewards, and taking out a mortgage can be just what debt-fearing folks like my client need to do.
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