Should we buy a house or keep renting?

July 4, 2006 9:44 PM

Should we buy a house or keep renting?

Okay, here's our scenario.

My wife and I currently pay ~$850/mo for rent (that includes insurance and any other fees).

What we're having trouble deciding on is if it's worth saving up 20% for a down payment on a house to avoid the PMI, or if we should use that $850/mo towards a mortgage payment.

A few more numbers for you. We currently are saving ~$1,500/mo to go towards said down payment. We're wanting to purchase a house that'd go for around $275,000 in our area (Denver, CO).

It just makes us feel sick to know that in the 3ish years it'd take to save up 20% to avoid the PMI, we will have spent over $30,000 just on rent...and that's if it doesn't go up.

posted by JPigford to work & money (29 comments total)

Buy the house. You'll only pay $175(ish) in PMI per month. Your new home will appreciate and you can pay additional against the mortgage. Once you think you've got a 20% increase in the value of the home or a combination of that and payments against the mortgage you can have the PMI removed. You'll probably have to pay for a inspection, but it's well worth it.
posted by FlamingBore at 9:56 PM on July 4, 2006

I am sort of trying to answer this question for myself, but one big thing you definitely want to factor in is tax savings. The part of your mortgage payment that goes to interest is tax deductible. This is like a hidden 20-30% break on your mortgage payment, and changes the math.
posted by scarabic at 9:57 PM on July 4, 2006

You're in Denver, which has a relatively mild climate (though I do remember a September snowstorm in '95, before the 23rd).


Go for it!
posted by brujita at 9:58 PM on July 4, 2006

Your new home will appreciate

Not necessarily. Given the high rates of homes in foreclosure and preforclosure in the Denver area, in all likelihood you're going to see home prices drop, not rise.

Should buyers not step up in sufficient numbers over the coming weeks to purchase the homes in foreclosure, lenders could be forced to unload them at below-market prices. That would make it more difficult for other home sellers to get their asking price, lengthen the time homes spend on the market and cause the already-high count of unsold homes to grow.[ref]

scarabic is right about the tax benefits, and $850/mo. is a good chunk of change to be shelling out each month just to cover someone else's mortgage. That said, I'd wait at least a month or two and guage the market trends.
posted by Civil_Disobedient at 10:19 PM on July 4, 2006

The part of your mortgage payment that goes to interest is tax deductible.

The part of your mortgage payment that exceeds the standard deduction is tax deductible. Standard deduction for 2005 for a married couple was $10,000. So, if your house payment is $1000 a month (and let's assume it's all interest; this is mostly true) you get to deduct a whopping $2000 more and save maybe $500-$600 off your taxes. As the years roll on you'll pay less interest as you pay down your mortgage, but the standard deduction will rise due to inflation, which means it becomes even less of a tax break until after five or ten years it's not a tax break at all. The only way to get a really nice tax break is to buy a house so expensive that you'll be paying tens of thousands of dollars is interest each year.

A rule of thumb I saw recently is that you should buy about $12,000 worth of house for every $100 of rent you're paying. So, in your case you should be looking at houses that cost about $100,000. If there aren't any houses in your area that cost $100,000 that you'd want to live in, you will (according to this calculation) probably be better off renting.

That said, if you do buy, I would suggest trying to avoid the PMI if at all possible. Putting more down will also allow you to pay less interest overall. If you don't like renting because you're appalled by the idea of "throwing money away," then the dislike should be the same regardless of whether you're throwing away money to a landlord, to a bank (in interest), or to an insurance company (for PMI). With all the increases in housing prices over the last few years, you might expect at least a flat period for a while, so you might be okay waiting and saving a while longer.
posted by kindall at 10:30 PM on July 4, 2006 [1 favorite has favorites]

let's assume it's all interest; this is mostly true

should say this is mostly true at first
posted by kindall at 10:31 PM on July 4, 2006

A rule of thumb I saw recently is that you should buy about $12,000 worth of house for every $100 of rent you're paying. So, in your case you should be looking at houses that cost about $100,000. If there aren't any houses in your area that cost $100,000 that you'd want to live in, you will (according to this calculation) probably be better off renting.

Can you tell me where this rule of thumb comes from? My significant other are in a very similar situation to JPigford, and if you've got anything to back up this "rule of thumb" it could really persuade us.
posted by croutonsupafreak at 10:45 PM on July 4, 2006

If that rule of thumb is at all accurate it basicially confirms that fact that I will never in my life own a house. I pay $1450 rent for a nice house in a good neighborhood of Seattle (Greenlake). Buying a house in the area generally starts at $500,000 and can get up to one or two million (for a fairly normal single family house mind you, these aren't mansions).
posted by Riemann at 10:56 PM on July 4, 2006

That rule of thumb isn't accurate where I live, either. For $2200 a month you can rent a nice house (no frills), but it would cost >$900k to buy the same thing.
posted by acoutu at 10:59 PM on July 4, 2006

So we've established that most people don't care for the rule of thumb (including myself) :-P

How about back to the initial question?
posted by JPigford at 11:03 PM on July 4, 2006

Have you considered a 80/20 (2 loans no $ down) or 80/15/5 (2 loans and 5% down) to avoid PMI?
Will putting 20% down wipe out any reserve funds should you need unexpected work on the house?
posted by sailormouth at 11:15 PM on July 4, 2006

JPigford, this is a complicated question, and you're probably best served by talking to your accountant. (If you don't have one, find one: ask for recommendations from friends.) That said, have you tried any of the rent vs. buy calculators around the web? I've licensed a rent vs. buy calculator for my personal finance site. It's not pretty yet, but it works. There's a more complex calculator here.

My advice is generally: do what works for you. If it's difficult to weight the pros and cons of a financial decision, that sometimes means it's a toss-up, in which case you should do whatever makes you happiest. In this case, it sounds as if you're better off purchasing a house. Do what works for you, and what will make you happy.
posted by jdroth at 11:33 PM on July 4, 2006

This guy says multiply your rent by 220. That's a bit higher than the other rule... which I can't find right now, sigh.
posted by kindall at 11:39 PM on July 4, 2006 [1 favorite has favorites]

In general, buying a house is worse than other asset classes and if it is a strictly financial decision, no, you shouldn't buy the house. Rent is not 'lost' or 'dead' money, it's the valuable price of shelter, so get that psychological barrier out of your head.

The good reasons to buy a house are:
i) security - can't be forced to move
ii ) psychology - a lot of people have been schooled to think that property is the real deal
iii) forced savings - a mortgage is more disciplined than most people give themseles when saving
iv) tax breaks for owners - politicians in some places (like Australia) pander to house owners, as they are the bourgeouis swinging voters.

IF, and it's a big if, you can invest as rigorously into shares as you can into a house, and if you can secure a long-term lease on a house or have a good landlord, the simple fact is that you will be better off financially by continuing to rent. This is borne out by 100 years of experience, these are both mature investment strategies and the evidence is unambiguous.
posted by wilful at 11:51 PM on July 4, 2006

I'm a renter, so I have no vested interest here, but how can you generalize like that Wilful?

Question; a potential home buyer in Los Angeles in 1999 has around $250,000 to invest. Would that person be better off today if he had invested in a home in Los Angeles or in the stock market?
posted by Justinian at 12:05 AM on July 5, 2006

justinian,

The long-term stats everywhere show that stocks beat real-estate hands down for average annualized real rate of return.

Since 1980, for example, money invested in the Standard & Poor's 500 has delivered a return of 10 percent a year on average. Including dividends, the return on the S.& P. 500 rises to 12 percent a year. Even in New York and San Francisco, homes have risen in value only about 7 percent a year over the same span. (link)

And if you look further back, (like to 1900) the difference is even more dramatic (sorry, no link handy).
posted by randomstriker at 12:29 AM on July 5, 2006

Wait for the housing bubble to pop, then buy at fire sale prices.
posted by beth at 1:51 AM on July 5, 2006

There are special programs for first time home buyers where the PMI is waived. I managed to get a loan with Dollar Bank for zero down payment and no PMI just by having good credit. Check around with your local banks. Competition may be intense for new loans.
posted by Alison at 4:06 AM on July 5, 2006

At $275,000, with a 7% interest rate on a 30 year mortgage with $125 PMI and no down payment you will be paying ~ $1,830 in mortgage payments. I have no idea what Taxes and Insurace in your area are like but for my house (which is less than half the value of yours) are a combined $182 per month. So I assume it will be safe to at least double that figure (though it will probably be more than double)...$1,830 + 125 + 364 = $2,319.

Were you to save the 20% you would then have a mortgage payment of $1,464 with those same figures above. That would leave you with a full monthly payment of...$1,464 + 364 = $1,828 a difference of about $500.

PMI will disappear in a few years after you make ontime payments (my lender will re-evaluate my loan-to-equity ratio with an appraisal of the value of my house two years after the closing, at which time I would expect to be owning more than 20% of my house in equity appreciation alone). BUT and this is the kicker -- will you have any leftover cash for the inevitable home repairs and update you will want to do when you own the place? Do not plan on spending any more than 30% of your net/take home pay, or else you are just asking for a whoopin'.
posted by iurodivii at 4:52 AM on July 5, 2006

Since 1980, for example, money invested in the Standard & Poor's 500 has delivered a return of 10 percent a year on average.

That's bit of statistics is incredibly disengenuous. Know what year the stock market topped 1,000? Here's a hint: it topped 10,000 in 1999. Take a guess. Hover for answer.
posted by Civil_Disobedient at 5:07 AM on July 5, 2006

in the 3ish years it'd take to save up 20% to avoid the PMI, we will have spent over $30,000 just on rent

You can console yourselves with the thought that you'd be paying something like $44,169 in mortgage interest (30-year loan for 250k at 6%) in the first 3 years. Plus all the other expenses of home ownership, of course. At those prices it's cheaper to rent the house than to rent the money to buy one.
posted by sfenders at 5:31 AM on July 5, 2006

sfenders how did you come up $44k for the PMI on that loan? Our credit score is literally about as high as they come and from talking to various lenders our PMI per month would never be over $200...which isn't anywhere close to $44k in 3 years.
posted by JPigford at 6:17 AM on July 5, 2006

Just one more quick note about PMI. I live in DE so the rules could obviously be different in CO, but our lender would NOT consider plain old appreciation when figuring out if we still owed them PMI. The change in value of the house for calculating PMI had to come from actual improvements made.
posted by chrisubus at 6:51 AM on July 5, 2006

That's $44k in accrued interest on the loan. I didn't consider PMI at all. It isn't necessary to make it obvious that short-term financial gain is not a reason to buy a house at that price when you can rent for so much less. In the long run, it's more complicated, but still probably not as good an investment as putting that money elsewhere. There are plenty good reasons for buying a house, but financial gain is not among them unless you expect continued price appreciation.
posted by sfenders at 7:35 AM on July 5, 2006

I have recommended this site before, but I think you should really check out The Mortgage Professor. This is a site done by a retiring Wharton Finance Professor that talks about every aspect of the home buying process.

He has a bunch of great calculators,including a Down Payment Calculator that calculates the cost of using a small down payment now, versus a larger one later.
posted by bove at 10:44 AM on July 5, 2006

Willful has a really good answer. On a strictly financial comparison, apples to apples, history indicates that if you invest the cost difference between renting and owning a house, renting comes out ahead. And as Kindall points out, the mortgage interest deduction is no longer the bargain most people think it is. You shouldn't feel pressured to buy a house because you are "throwing away money in rent." The odds are that you could be wealthier by renting if you have the discipline to invest regularly just as if you were paying a mortgage.

But when it comes to the psychological comparison, buying vs renting is not apples to apples. Depending on your temperament, owning a house may have a greater value than renting. For example, you like gardening, remodeling, handyman repairs, not being at the whim of a landlord, etc.

So although owning a house is more expensive, it may give you more rewards. It is like buying an economy car or luxury car. One will make you poorer, but only you can decide if the extra cost is worth it.

As far as PMI goes, I don't think it is a deal breaker either way. If you decide to buy, the PMI will run you a little less than 1% per year. The historical average annual appreciation of houses, smoothing out the bubbles, is about 3% to 4% per year. So delaying just to avoid PMI does not make sense. This assumes you have the income to comfortably support the payments.

Don't automatically assume that you can get rid of PMI in a couple of years due to appreciation. While Denver doesn't seem to have as big a real estate bubble as the coasts, you may find that the value of your home in five years is no more than the present.
posted by JackFlash at 11:16 AM on July 5, 2006

For every $100 you spend in rent a month, you’d be better off buying up to $12,500 in property instead.

This rule of thumb seem to only apply if you can afford more than you actually have to pay in rent for a place you like and that you invest the difference.

This isn't really meant to be a rent payment to mortgage calculation.
posted by thedward at 11:18 AM on July 5, 2006

If you're a first time homebuyer, to avoid PMI, look into what I believe is called an 80/10/10. It's two mortgages, one for 80% and one for 10%, and the balance is what you put down. My brother did this (in MD) and it worked well for him.
posted by elisabeth r at 5:28 PM on July 5, 2006

We just did an 80/10/10 for our first home purchase, and I'm quite convinced aside from the pain of moving that it is one of the best thing we've done for ourselves to date.

An 80/10/10 allows you to avoid the PMI, we opted for it because we are swinging extra cash in to our second every month to pay it off faster. situations vary from person to person, I would suggest that if you do decide to purchase a home insure that you have at least 4 months mortgage/utilities/taxes/etc available in an asset that will not lose value and can be liquidated quickly if needed (401k, Cash, Trained Pirate Monkeys).

Good luck with your decision, we were in a similar place about 4 months ago and just decided to do it.
posted by iamabot at 9:03 PM on July 5, 2006