Online calculators aid rent vs. buy decision

Knight Ridder - Monday, January 24, 2005

Knight Ridder Newspapers

By Jeff Brown

Q. I'm trying to decide whether to buy a home or to rent. What issues should I consider? Is there a rule of thumb about how much of one's income can go to housing?

A. If you could buy a home today and live in it for the rest of your life _ say, 30, 40 or 50 years _ owning would make better financial sense than renting.

That's because you'd freeze the lion's share of your housing cost by getting a fixed-rate loan with monthly principal and interest payments that would never go up. As a renter, you'd likely have to pay more every time you sign a new lease.

As an owner, you'd eventually finish making payments and own your home. And the property's value probably would go up, giving you a valuable asset.

As a renter, you'd continue making payments but never build this kind of wealth.

But most people don't stay in their homes for 30 or 40 years. And buying a home means tying up money for a down payment that could be used for something else if you rent.

Fortunately, computers and the Internet make it fairly easy to evaluate the two options. Type "buy or rent calculator" into your search engine and you'll find plenty. There's a good one at http://www.visualcalc.com.

Basically, you provide information on the price of the home, size of the down payment, interest rate on the mortgage and how long you expect to own the home.

Then you fill in the rent you'd pay. And you make a number of assumptions, such as the rates at which housing prices and rents will rise and the average annual rate of return you expect on money you invest. You also answer questions about tax rates used to figure deductions and after-tax investment returns.

The calculator crunches all this and tells you what each option would cost over the period specified.

Imagine, for example, you could buy a $250,000 home with 10 percent down and a 5.5 percent, 30-year mortgage. Or you could rent for $1,277 a month, the same as you'd pay for principal and interest payment on a $225,000 mortgage.

And assume you'd be in the home for five years, that it would appreciate by 3 percent a year, that you can get a 6 percent return on investments and that your combined federal and state tax rate is 30 percent. Also assume rent would increase by 3 percent a year. And let's say you'd pay $5,000 a year in property taxes and other home-ownership expenses.

Result: Cost of renting would be $63,523; cost of owning $51,579.

For the renter, this considers such factors as the investment gains on the $25,000 that was not used for down payment. For the owner, it includes things like profit from the home's rising value, less the realtor's commission when the house was sold.

Obviously, fiddling with the assumptions changes the results. Keep everything the same but say you'll own the home for two years instead of five, and you'll find it pays to rent. Renting would cost $26,639, owning $29,418.

Use a 10-year period and renting would cost $124,985, owning $84,188.

You'd have to be a math whiz to figure this out with pencil and paper. So, if you don't have an Internet-connected computer, find someone who does or go to a library that has one.

On the question of how much income can go to housing costs: Generally, you won't qualify for a mortgage if your debt payments _ mortgage, car loan, credit-card bills and so on _ come to more than 36 percent of your monthly income. Lenders generally don't want the mortgage payment, by itself, to be more than 28 percent of monthly income.

Your prospective landlord will probably have similar limits, though they could be higher.

Of course, this doesn't mean it's wise to spend the most you're allowed. Assess your whole financial picture and keep housing costs low enough so that you can put some money away every month for long-term investments and emergencies.

There's great comfort in living within your means.