As we spiral into a decision on getting a house here in Houston, one of the obvious drivers is the best financial choice to make. Let me lead you through my thought process in trying unsuccessfully to decide between buying a townhouse or renting one. Feel free to jump in at any time when you see errors in my logic.
Let's do an easy one first: CNN Money Magazine suggests the following:
1. Determine the cost of buying a property you're interested in. In my case a brand new townhouse 10 minutes drive from work with about 2200 square feet of floor space. We believe we can buy it for $350,000.
2. Determine the price to rent a similar property in relatively the same location. We found a similar townhouse, but older, that rents for $2500 per month. Multiplying by 12 months gives a yearly cost of $30,000.
3. Divide the price in step 1 by the rental cost in step 2, i.e., $350,000 / $30,000, to obtain a ratio of price-to-rent (P/R). In my case the P/R = 11.7.
4. The Magazine says nation-wide if the ratio is below 15.0, it's generally better to buy because house prices have fallen or rental prices have risen or both to the point that historically people who normally rent can afford to buy. That increases demand and house purchase prices start to rise. So, since 11.7 is less than 15.0, we should buy. Money Mag caveats the thing by saying, "... but each region of the country is different.", then they handily provide the historic ratios for cities including Houston. Historically Houston's ratio has been as low as 13, so even taking that into account, we should buy.
But I don't like the townhouse or its location. And I'm not sure we actually WILL be able to sell it for what we paid for it in 1-5 years if I decide to retire. And I definitely don't want to retire in a townhouse.
So I get out my Excel software and start building a cashflow model. Things are about to become out of control. Please fasten your seat belts.
I decide to compare the cash going out the door over the next 20 months between the two options.
1. If we buy we have to put 20% down, $70,000. Mortgage payments are on the order of $1680 per month. Taxes will run about $9000 per year or $750 per month. So $70,000 down plus $2430 (1680+750) for, say, 20 months is $118,600. Renting for 20 months is easy to figure: $2200 times 20 months = $44,000. Obviously we want to rent and not buy if we're only going to be in the place for 20 months. I can live with that even though I don't like the rental place either.
2. But wait, I can write off the mortgage interest and property tax on my federal income tax. A tax deduction -- I've not seen one of those in 15 years. This is exciting. If I'm in a 25% tax bracket, 25% of the interest and 25% of the property tax isn't really going out my door. Interest each month for the first 20 months is about $1375. Add property taxes to that ($750 per month) and multiply by 25% and you get $530. Deduct that from my mortgage payment of $1680 and you get $1150 per month. Now multiply that by 20 ($23,000) and add $70,000 down payment and you find out that net taxes I've laid out $103,000 in 20 months. Still cheaper to rent since $103,000 is lots more than $44,000.
3. But wait again. I own a house if I buy. Assuming I can sell it for what I paid for it, I get my down payment and principle back in 20 months. I pay about $300 per month of principle on the loan each month. Multiply that by 20 and add in the down and you get $76,000. I've paid out $103,000 and gotten back $76,000 so in reality, I've only paid $27,000. NOW buying looks better since $27,000 is lots less than $44,000 I'd've paid in rent. Oh, crap. I still don't want to buy.
4. But wait a third time. If I'm renting, I get to earn interest on the money that would've gone for a down payment. If I can get 5% per year simple interest, on that $70,000 then in 20 months I'd have made very roughly $6600. So I can deduct that from my $44,000 rent costs and I get $37,000. Not good enough -- still better to buy.
5. But but but again, what if house prices don't stay stable? Suppose I can't sell the place for what I paid for it? Let's say the house price falls 10% during the 20 months I own it. So when I try to sell it, I don't get $76,000 profit, I only get $41,000 (76-35=41). Now my cash outlay has been $62,000 (27+35=62), not $27,000 and renting at $37,000 looks better.
6. Oh, heck, though, if house prices actually go UP and I can sell the townhouse in 20 months for more than I paid for it, then buying is definitely better.
7. But wait one last time, if I not only have to make a down payment, but also have to foot some loan and closing fees, then that comes right off the top. Let's say the house price stays the same through out, but that I have to pay $7,500 in fees at closing -- not unheard of. Now I've paid out $34,500 in total in 20 months and that's within the round-off error compared to the $37,000 for renting. And after all this, I still don't have a decision.
And we found a 4-bedroom house to buy that is 45 minutes out of town for only $230,000 which throws everything you've just struggled through into a cocked hat ... except that the house is not new and Wife won't consider it.
Somebody shoot me.
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