BUY VS. LEASE

Ann plans on living in NYC for exactly 1 year. Ann is considering whether she should buy or rent.

If Ann chooses to own, she will buy in year 0 (now) and sell in year 1 (one year from now).

If Ann chooses to rent, she will pay rent once in year 1 (one year from now).

Rent costs $6,000 for the entire year.

If she buys the apartment it will cost $120,000 now. If Ann buys, assume she will get a 30-year interest only (IO) loan , with no prepayment penalty, with annual payments, for $90,000 at 5%. There are no closing costs or points for the mortgage.

There are no buying or selling costs.

Other costs of ownership:

o Property taxes = 1.5% of the property price.

o Insurance = 1% of the property price.

o Maintenance = 1.5% of the property price.

Anns average income tax rate is 27%, her marginal income tax rate is 30%.

Suppose the apartment price will grow 5% over the year.

Ann will pay taxes/insurance/maintenance in year 1, based on the property value in year 1.

Ann will pay the down-payment and purchase costs from her savings.

a) If Ann buys, what is her total cost of ownership for the first year? (DO NOT include the cost of buying or selling the apartment.)

b) If Ann buys, what is her total benefit from ownership in the first year?

- Benefits equal saved rent plus tax-shield.

- Mortgage interest and property taxes are income tax deductible.

- DO NOT include proceeds from selling the apartment.