Billings

Americans believe in the dream of homeownership. With all the foreclosures and bankruptcies taking place, however, is it cheaper for people to rent rather than buy?

When it comes to the decision of renting vs. buying, most people make the decision based upon a comparison of monthly payments. If their rent payment is less than the payment on a home, many decide that it’s cheaper to rent than to buy. This approach, however, fails to take into account a number of other factors that influence the total costs of homeownership, rather than just the monthly payments.

The first step for any person who is considering buying (or selling) a home is to talk to a tax professional. Each person’s tax situation is different. When you purchase a primary residence you can normally reduce your withholding taxes. That is because the interest on your mortgage is tax deductible.

One of the most compelling reasons to buy rather than to rent is to lock in a permanent monthly payment at today’s rates for the next 30 years. If possible, obtain a fixed-rate mortgage for 30 years. This means that your mortgage 20 years from now will be at the same rate as it is today. In contrast, rent payments tend to keep pace with inflation.

The current 10-year average inflation rate is 2.82 percent per year. (The average since 1913 is actually 3.41 percent a year). Assuming the inflation rate continues to average 2.82 percent per year, in 2019 your $1,000 mortgage payment would be the equivalent of $718 in today’s dollars. If your property value keeps pace with inflation, it would have increased in value by approximately 28 percent as well, making it worth $128,000. Furthermore, you would have paid down your loan for 10 years.

Assuming a 6 percent interest rate on a 30-year fully amortized fixed-rate loan, your balance on your original $100,000 loan would be $83,686. Consequently, your equity position after 10 years would be $16,314 ($100,000 minus $83,686) plus $28,000 in appreciation due to inflation, for a total of $44,314. (This calculation does not take into consideration any amount that you would have placed on the property as a downpayment.)

Of course, there are other costs of homeownership to consider, too, such as homeowners association dues, property taxes and utility bills.

Compare the above example to the costs of renting. If your rent payments kept pace with inflation of 2.82 percent per year, your rental costs over the same period would increase 28.2 percent ($1,282 per month vs. $1,000 today.)

Assuming a 2.82 percent inflation rate over the next 20 years, this example becomes even more compelling. Your monthly loan payment of $1,000 would be the same as $436 in today’s dollars. If your property value kept pace with inflation, it would now be worth approximately $156,000.

After 20 years, the balance on your $100,000 fixed-rate loan would be $54,359. Thus, your equity position would be $56,000 due to the inflation-related appreciation increase plus $45,641 in principal reduction, for a total equity position of $101,641.

In terms of rent 20 years from now, if it kept place with inflation you would be paying $1,564 per month. That’s an extra $6,768 per year more than your mortgage payments if you had locked in your 30-year fixed-rate loan at time of purchase.

The wild card in this entire discussion is inflation. Many experts are predicting that the only way our government can pay our debts is to print more money. The result will be increased inflation. Using the 10-year example from above, paying off a $1 billion loan after 10 years of inflation at 2.82 percent means that the real payoff amount is $718 million in today’s dollars.

For an individual, this may be the best reason to purchase real estate. If you hold your property for the long term, it will normally keep pace with inflation, creating additional wealth. When you rent, you pay off your landlord’s mortgage and make him or her wealthy. These are among the reasons that homeowneship remains an American ideal and the norm.