Is it better to buy or to rent?

Whether you choose to live in an apartment, a townhouse, or a house is a matter of personal taste. The decision to purchase or rent, however, is a financial matter.

Calculating the “cost” of renting is simple – you sign a lease and agree to pay a fixed amount each month until the expiration of the lease. Calculating the “cost” of purchasing, however, is more complex and requires greater financial commitment. Whether purchasing a co-op, condo or house, you will be required to make a down payment. It can be a very minimal down payment if you obtain an insured mortgage, sometimes as little as 3.5% as opposed to a conventional mortgage, where you would be required to pay at least 20% of the purchase price.

Obviously, the larger the down payment is the smaller the mortgage needed to finance the balance of the purchase price of the property will be and thus, the smaller the monthly mortgage payment will be. The down payment, however, also creates an “opportunity cost,” since that money could have been invested.

The income that would have been earned by investing the funds instead of using them for the down payment is the opportunity cost. Accordingly, by increasing the down payment you will reduce the monthly mortgage expense, but you will also increase the opportunity cost. Note that there is no precise formula to calculate the opportunity cost, since it will depend on what investments you would have made and what income they would have provided.

Most conventional mortgages (those that are not insured by government or private agencies) require a minimum down payment of twenty percent (20%). Purchasers who do not have the liquid assets needed to give a twenty percent (20%) down payment must obtain an insured mortgage, usually from either the Federal Housing Administration (FHA) or from Private Mortgage Insurance (PMI). These types of mortgages require the purchaser to pay an insurance premium in addition to the principal, interest, taxes, etc., so not only will the monthly cost be greater since the mortgage itself is larger, but the purchaser will incur the additional expense of the insurance premium, as well.

In most cases, I have advised clients seeking residential housing that purchasing is preferable to renting for the following reasons:

Historically, real estate has always appreciated over time, so you benefit from the appreciation; and

Most mortgages are “self-liquidating,” meaning the monthly payments will reduce the total amount owed each month, thus building additional equity; and

When comparing “costs,” purchasers get a tax deduction for the interest and real estate taxes whereas renters cannot deduct any portion of their rent.

Currently, buying is 38% cheaper than renting on a national basis, and 24% cheaper in New York, according to the National Association of Realtors. This is due, in part, to interest rates currently being at historical lows. Should they rise again this might no longer be the case, so if you are contemplating home ownership, you may want to do so before interest rates rise.