I am an immigrant to this country and let me tell you, the American Dream resonates with me. For someone who came to this country with next to nothing, the possibility that I can, through just hard work, be able to own my own white picket fence house with the 2 cars, is mind blowing. Of course, for the “Dream” to become reality, it has to be infused with sound numbers and judgement :).
When my husband initially moved to Southern CA, the “dream” was a two storied villa with large picture glass windows overlooking the Pacific. Relaxing in our lounge chairs, drinking martinis, watching the sunset with the cool blue ocean kissing the angry red sun and where the nature’s play of colors beats Picasso, now that’s the life. Being young and naive, we looked up the price of the houses, in Malibu of course, to see how much we had to save. *Kaboom*, we got our first sticker shock, million dollar houses were on the cheap side. Ok, scratch that dream.
We rented for a couple of years. Around 2006, people were encouraging us to buy because the market was so good and real estate is such a great investment. We started looking for houses in the neighborhood we were renting, after all we could afford the rent, so the houses in this area should be affordable right ? Plus we weren’t that far from Malibu. So we couldn’t see the sun kissing the ocean every evening but rolling hills, beautiful SoCal weather, that’s still pretty darn good. That’s when we got our second sticker shock. Everything was way more expensive than we anticipated (I mean like 2X more expensive!).
So what were we doing wrong? Up until that point we were looking for our house based on just emotions. We didn’t actually sit down and do a calculation on what we could afford, how much we needed to save or even whether we should buy at all. Being analytical by nature, I started looking for calculators that would help me analyse the financial aspects of the decision. We decided to give up our “house hunting” (“Dream” on hold, anyone?) and start saving as much as we could for the down payment without getting suckered into all the buying advice.
Fast forward 5 years. We’ve been through a horrible housing crash (thank God we didn’t dive in back in ’06) and now that the housing prices are lower, we’ve been advised to buy again because, after all, the housing market has bottomed out. We are a little older and wiser now. I don’t want to listen to people blindly and let my emotions run the show. I want to analyse:
- How much we could afford and if it is really wise to buy a house right now in the area we currently live in.
- Should we buy or continue to rent?
Buy or Rent Calculators
I have been to different open houses in our area and now have a realistic estimate of house prices. I tried different buy vs rent calculators to run the numbers for our situation. I was not happy with any of them. Some of the deficiencies I found:
- They were either incomplete or overly simplistic. There are a lot more factors to consider than just the rent and the house price, which is what a number of these calculators take into account.
- No information on how the numbers are derived or no breakdown of data. I don’t want someone to make the decision for me, I want the information to aid me with my own decision.
- No control of input other than simple rent/house price. There were a lot of assumptions and numbers behind the black box which I can’t play with.
So I decided to put together my own calculator in Excel.
Download the Excel buy or rent calculator.
As a geek who likes numbers and analysis, I have provided ALL the numbers with a month-by- month breakdown of the cash flow analysis of the buy vs rent equation. Oh yes, I have made assumptions, but I have the assumptions stated and you can easily change all of them. Instead of writing a boring tutorial on how to use this spreadsheet I have made a video tutorial with an example scenario. [For people who don't like videos, here is a PDF cheat sheet for the Excel calculator]
How to use the buy or rent calculator
Where you should buy and where you should rent
Just for fun I decided to try a few major cities in the United States to see how they compare (rent and the house prices are from Trulia.com, Zillow, census.gov).
Assumptions : Average rent for a 2 bed/2 bath town home, stay in the house for 8 years, 20% down payment
The buy or rent decision (based on finances) is driven by the cash flow. For someone disciplined enough to save the difference between the buy cash flow and the rent cash flow, renting is a much better deal in places with very high house prices. All the myths about renters not building equity, renting being the same as throwing money down the drain, etc. are all WRONG.
Buy or Rent : Other considerations
As much as I like numbers, I know buying is not only about numbers. There are several intangible factors that go into the buy or rent decision.
- Distance to work : A lot of us don’t consider this seriously. We see the distance and figure it is not too far away from work. When factoring in the time wasted during peak hour commutes, this could cause some serious time/money damage.
- Mobility : People say buying a house offers stability. I disagree. Buying a house does limit the job potential to just that area. Most people don’t want to sell the house and move. Having strong ties to home prevents people from leaving. According to the SBA, in general, if you are older, married with children and a homeowner, you are less likely to leave your home state. Home ownership decreases the likelihood of mobility by over 12 percent for wage and salary workers and between 22 and 24 percent for the self-employed.
- Doing your own maintenance : For some people house maintenance could be a huge deterrent to buying their own house. While renting, if a pipe breaks, all you have to do is pick up the phone and call the landlord.
To buy or rent is a personal decision based on the money we can afford and other personal priorities. I want to finish this post with 2 things
- At the end of the day, every one of us is different. We might have different incomes, expenses, needs, priorities and dreams. We have to do the analysis based on our OWN situation with our OWN numbers before making a decision. Do not blindly go by people who say it is good to rent or good to buy. Do as much as possible to “know” whether it is good to rent or good to buy.
- Sometimes it might not be financially prudent to buy when the situation favors renting (or vice versa). But we might still want to buy if it is affordable, for non-tangible reasons. That is not wrong, as long as you “know” the numbers and make an informed decision.
Now, this is my first calculator and I could use some help. I have a few things coming up in the second version of the calculator (Ex : Capital gains for the renter’s savings) but I would like you to try it out and let me know if you see any problems. To make it more worthwhile, I am going to pay you. I will give away a $25 Amazon gift card to the person who provides the best suggestions to improve. Bring it on!
Sources used for infographics and other statistics mentioned in this post -
- Irrational Exuberance
- FHFA Housing and Mortgage Markets in 2010 (pdf)
- FHFA Market Data
- Census.gov Historic Housing values