When deciding between renting and buying, individuals often fret about missing out on home equity if they do the former.
In other words, for all those years they choose to rent instead of own, they’re not gaining any equity, and their money is simply being thrown out the window.
And while that argument might be sound, it’s often blown out of proportion. Or skewed in favor of buying as opposed to renting.
Lately, there’s been a lot of talk about housing bubbles and froth. After some stellar gains, home price gains have moderated a bit.
And now there’s even fear home prices could pull back in places where appreciation got a little ahead of itself. Or a lot ahead of itself, depending on how you look at it.
So can you rent for a while during this period of uncertainty and still come out ahead? Let’s break it down.
Say home prices in the area where you want to buy are hovering around $250,000. You pull the trigger and get your offer accepted, pledging to put down 20%, or $50,000.
That leaves you with a loan amount of $200,000. Let’s also assume your interest rate is 4.5% on a 30-year fixed-rate mortgage.
Your monthly mortgage payment would be around $1,013, not including taxes and insurance.
After five years of on-time payments, your loan balance would fall to around $182,315.
But what if home prices fall in the next couple of years, even slightly. Would it actually be better to rent for a couple years and then buy at a marginally lower price?
Rent Now, Buy Later?
Say you decide to rent for $1,000 a month for two years (around the same cost of the mortgage sans taxes/insurance), spending $24,000 during that time and earning nothing in the way of home equity, not to mention any tax breaks.
After two years, you find a house for $237,500 and decide to put 20% down. That leaves you with a $190,000 loan amount and a mortgage payment around $963.
Let’s assume you go with the same loan program as our prior example and get the same interest rate.
After three years of holding the mortgage, you would only pay $9,624 toward your principal balance, but in doing so it would drop to $180,376, which is about $2,000 lower than the balance of the aforementioned mortgage.
So after five years, two years renting plus three years owning, you’d be ahead of the person who decided to purchase a home right away at a higher price.
After 10 years, the early buyer would have a principal balance of $160,179, compared to $161,153 for the renter-turned-buyer.
If we consider the down payment, $50,000 on the $250,000 home purchase and $47,500 on the $237,500 purchase, the renter is still ahead.
But over time, the person who purchased the home first, even at the higher price, would grow their equity faster because they’d be deeper into paying off their mortgage, which would accelerate payments toward principal.
After 15 years, the early buyer would have a principal balance of $132,468, compared to $137,089 for the renter.
However, the late buyer would enjoy a monthly mortgage payment around $50 lower thanks to that five percent home price drop initially.
If they were to make the same monthly payment as the early buyer by putting that extra $50 toward principal each month, they’d actually come out ahead and pay off their mortgage in about 27 years, or 29 years counting the two years when they rented.
They’d also only pay around $401,000, compared to $415,000 for the early buyer, factoring in rent, down payment, and total mortgage payments.
Of course, my little scenario banks on mortgage rates staying in place and home prices dropping about five percent. If both go up, the equation changes quite a bit.
Still, it’s okay to rent if you can’t find a suitable home to purchase. You won’t necessarily miss out on anything. And you can always make slightly higher mortgage payments to play catch up if need be.
There might also be a better selection of homes in a year or two, once this recent housing bonanza settles down again.