Natalie Warren is in her late 20 s. She is renting an apartment in the fashionable part of town for $1,500 a month. After much thought, she's seriously considering buying a condominium for $325,000. She intends to put 20 percent down and expects that closing costs will amount to another $6,500; a commercial bank has agreed to lend her money at the fixed rate of 5 percent on a 15 -year mortgage. Natalie would have to pay an annual condominium owner's insurance premium of $800 and property taxes of $1,200 a year (she's now paying renter's insurance of $550 per year). In addition, she estimates that annual maintenance expenses will be about 0.5 percent of the price of the condo (which includes a $30 monthly fee to the property owners' association). Natalie's income puts her in the 24 percent tax bracket (she does not itemize her deductions on her tax returns), and she earns an after-tax rate of return on her investments of around 4 percent. Critical Thinking Questions 1. Given the information provided, use Worksheet 5.2 to evaluate and compare Natalie's alternatives of remaining in the apartment or purchasing the condo. 2. Working with a friend who is a realtor, Natalie has learned that condos like the one that she's thinking of buying are appreciating in value at the rate of 3.5 percent a year and are expected to continue doing so. Would such information affect the rent-or-buy decision made in Question 1? Explain. 3. Discuss any other factors that should be considered when making a rent-or-buy decision. 4. Which alternative would you recommend for Natalie considering your analysis? RENT-OR-BUY ANALYSIS A. COST OF RENTING 1. Annual rental costs (12 monthly rental rate of $1,500) 2. Renter's insurance 3. Opportunity cost of security deposit: $1,000 after-tax savings rate 0.030 $18,630 B. COST OF BUYING 1. Annual mortgage payments (Terms: $200,000,360 months, %) (12 monthly mortgage payment of $954.83 ) 2. Property taxes 5,000 (2.0\% of price of home) 3. Homeowner's insurance 1,250 ( 0,5% of price of home) 4. Maintenance 2,000 ( 0.8% of price of home) 5. After-tax cost of interest foregone on down payment and closing costs 1,725 ( $57.5003.0% after-tax rate of return) 6. Total costs (sum of lines B.1 through B.5) $21,433 Less: 7. Principal reduction in loan balance (see note below) 8. Estimated annual appreciation in value of home 4\$ 3,4585,000 (2% of price of home) 9. Total deductions (sum of lines B.7 and B.8) 8,458 Total cost of buying (line B.6 - line B.9) $12,975 SUMMARY: COST OF RENTING VS. BUYING A. Cost of renting $18,630 B. Cost of buying $12,975 Cost of renting - cost of buying \#\$, 555
