Renting vs. Buying
The California housing market conditions make a strong and compelling case for homeownership. With prices still well below the historic highs of just a few years ago, and attractive mortgage rates, qualified buyers have a unique opportunity to own their own home at a huge cost savings. In addition, existing tax laws allow homeowners to itemize and deduct the mortgage interest and property taxes from their taxable income. For example, compare the tax implications for two households both earning $63,430 a year, the minimum income required to purchase the statewide median-priced home of $301,430. The household that purchases the home with a 20% down payment and finances the mortgage at the current rate of 4.62% will receive a tax deduction of over $14,000 in the first year of ownership. The renter household will most likely utilize the IRS Standard deduction of $11,400, $2,600 less than their homeowner counterparts. The homebuyer reduces their total tax liability by $400 compared to the renter in the first year of ownership. Accounting for the out-of-pocket savings as well as the tax savings, the homebuyer saves over $3,000 in their first year of ownership.
The mortgage rate is a significant factor in determining just how much a homebuyer can afford. Today’s low mortgage rate environment tips the scale—for some—in favor of buying versus renting. For a home priced at $400,000, with a 20% down payment and a 4% mortgage rate, the monthly PITI will be $1,990 for the homebuyer. The monthly PITI jumps to $2,180 at 5% and to $2,380 at 6%. For each one percentage point increase in the mortgage rate, the payment goes up by almost $200 under these assumptions. Even for a lower priced home at $200,000, the difference in the monthly payment is significant as each percentage point rise in the mortgage rate tacks on $100 to the monthly PITI.
As a final thought, there are many tools online (Zillow.com, Trulia.com or Realtor.com) and books to walk potential buyers through the jungle of metrics. One place to start is the price-to-rent ratio. The ratio represents the price of the house divided by the annual cost of renting a similar one. For example, in a market where a three-bedroom house costs $500,000 and the monthly rent for a similar home is $2,000 or $24,000 annually, the price-to-rent ratio is about 21. Generally, if the ratio is above 20, the scales tip toward renting, especially if there are other factors that could cause you to move sooner. If the ratio is below 15, then home ownership starts to be more attractive.
Ken Kellogg