Is Homeownership A Smart Investment Again?
One year ago, Trulia's Rent vs. Buy Report, released by online real estate aggregator Trulia, found it was 44% cheaper to buy a house than to rent. Today, the gap has narrowed, due in part to rising interest rates and home prices. The newest edition of the report finds that buying a home is now 38% cheaper than renting. The report compares costs for a seven-year period using five calculations:
- The average rent and sale prices for an identical set of properties;
- The initial total monthly costs of owning (assuming 20% down and a 30-year fixed-rate mortgage at 3.5% interest, as well as annual maintenance, insurance, utility, and property tax expenses) and renting (monthly rent plus renter's insurance);
- The future total monthly costs of owning and renting;
- One-time costs and proceeds (for owning, this includes closing costs and capital gains tax of 15% for gains above the $500,000 annual exclusion; for renting, this includes one month's security deposit); and
- The net present value to account for opportunity cost of money (this compares cash flows over time).
According to the report, homeownership remains cheaper across the nation and in all of the 100 largest metro markets. However, these findings speak broadly to the national market, and there are several situations where it still makes more sense to rent. Here, we look at some of the reasons why it's a good time to buy for many Americans, and circumstances when it might make more sense to rent.
Reasons to Buy
Peggy Jennings, a Broker/Realtor with Prudential Great Smokys Realty in Sylva, North Carolina, cites favorable interest rates, good inventory and relaxed loan requirements as good reasons to buy now. "Interest rates are still good. The inventory is improving as more people are deciding it's time to sell. There's going to be a lot of good inventory coming up, especially since the foreclosures from a couple years ago are now rehabbed and ready to sell," says Jennings.
"Interest rates are still very appealing," says Jennings. Even a small change in interest rates has a significant effect on what you'll pay each month and over the life of a 30-year mortgage. Take a $172,000 30-year mortgage, for example ($172,000 is 80% of the median sales price for existing homes of $215,000 after a 20% down payment). With an interest rate of 4%, you would pay $821.15 each month. At an interest rate of 5%, the monthly payment would be $923.33, and at 6%, the payment rises to $1031.23. If you do the math, the 6% loan will cost more than $75,000 extra over the course of the loan than the 4% mortgage would.
Low mortgage rates continue to keep ownership less expensive than renting. "At the end of the day you will see your money being more productive if you can obtain a good mortgage versus paying a large amount month to month for rent," says Jennings.
In many places it's still a buyer's market due to the number of homes already on the market and coming to the market. "This is supply and demand at work. In many markets, inventories are full, which makes it beneficial for the buyers, not the sellers," says Jennings. Many homeowners, who were reluctant to sell because they had been under water on their mortgages (or close to it) are now in a better position to put their homes on the market and recoup some of their investments.
In addition, there is a lot of inventory hitting the market today that comes from yesterday's foreclosures. The glut of foreclosures on the market following the 2008 financial crisis brought many good opportunities to the table, mostly for the institutional investors. Many of these properties were purchased at discount prices by investors who had the capital to make all-cash deals. Although the low prices were appealing, many would-be homebuyers were unable to get loans because of lender requirements regarding the condition of the home.
"Many foreclosures are abandoned or vacant properties that need quite a bit of money to fix up," says Jennings. "They might need repairs, or maybe the appliances are missing. And there are requirements for loans that require that a house be habitable, with a refrigerator, oven/range water source and a heat source. People couldn't get loans on houses that weren't habitable, so investors came in and swept up properties in all-cash deals, making it harder for everyone else to buy."
Foreclosure rates have been declining since reaching their peak in 2010 at 1.05 million homes. Many of the properties that were previously bought as foreclosures have been fixed up and are ready to sell, adding quality homes to the inventory in many markets across the nation. All this inventory is good for buyers. "With so many homes on the market to choose from, sellers have more competition, hence they have to price their properties to sell," says Jennings.
Relaxed Lending Standards
Relaxed lending also makes it a good time to buy. According to a Federal Reserve survey, more than 25% of banks that took part in the survey indicated they have eased the credit standards on residential mortgages during the second half of 2013. At the same time, there has been a decline in the demand for refinancing. For 2014, mortgages will be dominated by purchases rather than refinance activity for the first time since 2000. For buyers, this can make the mortgage process a bit faster. About 44% of the lenders included in the Fed survey report that it now takes less time to complete the loan process - from the day of application to the closing - since the volume of refinances fell.
A concern for homebuyers in some markets is whether or not they'll be able to sell a property should they need to. Even when prices fell to historic lows, many were still reluctant to buy, because they were afraid they wouldn't be able to sell if they moved or got a job transfer. "You always need to consider what happens if something changes and you need to sell the house," says Jennings. With a stabilizing market, however, chances are better now than a few years ago that you would be able to sell. "Now it seems a little less risky to buy a house because it will probably be easier to sell if you need to."
Reasons to Rent
Even though it is a buyer's market in many areas, homeownership is not the right choice for everyone. A primary consideration is how long you plan on being in an area. "I tell people if they are planning on living in an area for at least three to five years, then it makes sense to buy versus rent," says Jennings. "When you go to buy," Jennings says, "you have to pay quite a bit of closing costs. For a typical sale of $150,000 or $200,000, you're looking at somewhere between $3,500 to $5,000 in closing costs. So it doesn't necessarily make sense to buy a house and then within two years try to sell it, unless it's a really awesome market and you think you'll be able to sell at a good price."
Even if you are planning to stay in one place for a while, renting can still make more sense. For one thing, no matter how you look at it, homeownership carries a significant financial obligation, from the mortgage to the maintenance, insurance and taxes. It's a lot easier to walk away from an apartment that no longer fits your budget than a home that you can no longer afford.
Regardless of financial situation, some people simply prefer the benefits and flexibility of renting. For example, some rental properties offer certain amenities that provide social, business and fitness opportunities for tenants. These might include after-school programs for children, community gardens, concierge services, fitness centers and spa facilities, swimming pools and resident programs.
In addition, many renters enjoy the predictability of their monthly expenses. Rent payments are often the same each month and utilities are similar, if not equal, each month. And landlords are typically responsible for maintenance and repair issues both inside the property (whether it's a rental apartment, condo or house) and in the common areas.
The Bottom Line
Low interest rates, better inventory and relaxed lending standards make now a good time buy a home. In many markets, it is considerably cheaper to buy than rent. Although the Trulia report finds it is 38% cheaper to buy than rent nationwide, it's important to note that individual markets can vary greatly. For instance, it's 66% cheaper to buy in still-struggling Detroit versus only 5% cheaper in Honolulu. Even though the numbers show it is generally better to buy than rent, you should always consider the individual market and your own situation and preferences when making the decision to buy or rent.