Owning a home or renting one is the most thought about topic from the investment point of view. The mortgage rates are very attractive at the moment and so are the prices of the property. But which option makes more economic sense depends upon various factors. The two major factors being cost of renting and cost of owning which differ from city to city and locality to locality. One of the best ways to find out if it’s really worth to buy a home than to rent in a given city is ‘price to rent ratio’.
Price/Rent ratio = Price of the property/Annual rent of the same or similar property
For example, you find a home that costs you $2, 50, 000. However if you wish to rent it, you will need to pay $1200 as a monthly rent. The P/R ratio will be as follows.
Price/Rent ratio = 250000/1200 * 12 = 17.3611
The P/R ratio comes to 17.3611. Now all you have to do is interpret this number. The P/R ratio below 20 means the cost of renting a home will exceed the cost of ownership. So in this case it can be said that the home is fairly priced and buying can be a better decision. You also need to analyze what it would be like selling off the property after three years, six years or eight years.
Owning a home gives you freedom and you are not at the mercy of a landlord. However, if you are planning to own the home for not more than 3-5 years then buying it isn’t the right decision in the first place. This is because buying a home will incur you other costs like closing costs, broker’s fees, interest on the mortgage, insurance premiums, property tax, repairs and maintenance, selling costs, moving costs and so on, which are sure to outpace the cost of renting. Lost opportunity cost from not investing the down payment and yearly costs will also come into picture.
Renting has its own pros and cons. You have to kiss your freedom to do anything goodbye. You may have neighbors and you just cannot party loud throughout the night. Here initial cost is the refundable security deposit that you may have to keep with the landlord, while renter’s insurance and the rent you pay will form a part of yearly costs. Lost opportunity cost is applicable here as well. But the major expenses like maintenance and repairs are to be taken care of by the landlord.
Similarly you made go ahead and purchase a home in case the property is fairly priced and the cost of rent is high. For example, in cities like Detroit in Michigan and Toledo in Ohio the approximate monthly cost of owning a home is $350 and $475, respectively. Whereas the approximate monthly cost of renting is $1150 and $1220. Hence, owning a home makes more sense provided you do not sell off the home for 7 years; according to the report from a renowned real estate website.
Owning a home is a big financial decision. It’s better to keep emotions at bay and think rationally. If the cost of rent in your city is lower than that of owning a home, there is no harm going in for a rented place and save several thousand dollars.