10. Rent versus buy analysis - Part 2 Which is better: to rent or to buy? The decision of whether to rent or buy housing is a personal decision that is based on both your lifestyle and your finances. While most financial experts argue that the financial aspect of the decision is important, it is also important not to base your rent-or-buy decision solely on the numbers. Your personal needs and housing market conditions are important. However, it is still necessary to perform the financial analysis. Lucia and her husband are trying to decide whether to rent or to purchase a new house. After looking for several months, theyve narrowed their choice down to one particular house, and the builder is willing to lease or selldepending upon the preference of the buyer. To perform a rent-or-buy analysis, Lucia and her husband have collected the following information: If they rent, the builder will require monthly rental payments of $1,100 and a security deposit equal to two months of rent. Since they want to be protected against the possible loss of their possessions, they will purchase a renters policy of $200 every six months, while a more comprehensive homeowners policy will cost 0.5% of the homes value per year. Money used to fund the houses security deposit could otherwise be invested to earn 5% per year after taxes. Funds expended for a homes down payment and closing costs also incur an opportunity cost. If the house is purchased, it will cost $200,000 and will require a 20% down payment. The loan will carry an interest rate of 6%, a term of 30 years, and monthly payments of $959. The closing costs associated with the houses mortgage will be $3,500. The property taxes and the maintenance and repair expenses on the house are estimated to be 4% and 1% of the houses total price, respectively. Your ordinary income is taxed at the rate of 28%, and youll be willing to itemize your tax deductions in the event that you purchase your new home. Financial publications report that home values are expected to increase by 3% this year due to inflation. Complete a rent-or-buy analysis worksheet to determine the total cost of renting and the total cost of purchasing Lucia and her husbands prospective house. To complete the worksheet, enter the appropriate values in their corresponding blanks and round each value to the nearest whole dollar. RENT-OR-BUY ANALYSIS FOR HOUSING Amount COST OF RENTING ($) Security deposit 2,200 Annual rental cost 13,200 Renters insurance 400 Opportunity cost on security deposit 44 Total Annual Cost of Renting: 15,844 RENT-OR-BUY ANALYSIS FOR HOUSING Amount COST OF BUYING ($) Monthly mortgage payment 959 Annual mortgage payments 11,508 Property taxes Homeowners insurance Maintenance expenses Opportunity cost of down payment and closing costs Total costs Less Reduction of loan principal Tax savings on mortgage interest deduction Tax saving on property tax deduction Total deductions Annual after-tax cost of homeownership Estimated annual appreciation in home value Total Annual Cost of Purchasing: Based on this analysis, Lucia and her husband should: Purchase the home, as the total cost of purchasing is less than the cost of renting. Rent the home, as its total cost is less than the total cost of purchasing. Purchase the home, as the cost of purchasing is greater than the cost of renting