1. Given the information in this and Case, estimate whether it is financially more attractive for the Bergholts to rent or to purchase the home over a five-year holding period. (Assuming the contract interest rate of 8 percent, monthly interest payments over the five-year period would total $87,574.)
In Case, Kim and Dan Bergholt are government workers. They are considering purchasing a home in the Washington, D.C., area for about $280,000. They estimate monthly expenses for utilities at $220, maintenance at $100, property taxes at $380, and home insurance payments at $50. Their only debt consists of car loans requiring a monthly payment of $350. Kim’s gross income is $55,000 per year and Dan’s is $38,000 per year. They have saved about $60,000 in a money market fund on which they earned $5,840 last year. They plan to use most of this for a 20 percent down payment and closing costs. A lender is offering 30-year variable rate loans with an initial interest rate of 8 percent given a 20 percent down payment and closing costs equal to $1,000 plus three points.
2. Suppose it turns out that they have to relocate after one year. Which is the preferred alternative after one year? (Interest payments over the first year would equal $17,852.)
The real estate agent tells the Bergholts that if they don’t care to purchase, they might consider renting. The rental option would cost $1,400 per month plus utilities estimated at $220 and renter’s insurance of $25 per month.
The Bergholts believe that neither of them is likely to be transferred to another location within the next five years. After that, Dan perceives that he might move out of government service into the private sector. Assuming they remain in the same place for the next five years, the Bergholts would like to know if it is better to buy or rent the home. They expect that the price of housing and rents will rise at an annual rate of 3 percent over the next five years. They expect to earn an annual rate of 5 percent on the money market fund. All other prices, including utilities, maintenance, and taxes are expected to increase at a 3 percent annual rate. After federal, state, and local taxes, they get to keep only 55 percent of a marginal dollar of earnings.