The rent vs. buy ratio is a helpful heuristic for first time home buyers who are trying to decide between moving into a new home and living in an apartment. It's a nice tool for guiding the decision-making process, but there are several crucial factors to consider. Here are a few things to keep in mind as you make your decision.
The Basics of the Ratio
The rent vs. buy ratio is a simple way to help people decide whether to purchase property or to rent it instead. The basic premise is to compare the costs of two similar properties (condo, apartment, house, etc.): one for sale and one for rent. Find the ratio by dividing the sale price of the for-sale property, combined with all one-time costs such as closing costs and down payments, and recurring costs such as insurance and taxes, by the annual rent for the property that is for rent, including deposits and insurance.
The resulting number is the rent vs. buy ratio. A number above 20 generally indicates the monthly costs of owning the property will exceed the cost to rent. For instance: A $200,000 home would be compared to an apartment renting for $1,000 per month. The rent vs. buy ratio is 16.7. In this case it seems it would be more economical to buy.
But there are other factors to consider as well.
In the grand scheme of figuring out the most efficient use of your money, the rent vs buy ratio is certainly helpful. It puts the annual cost into perspective, but that doesn't necessarily mean that home ownership is right for you. Even if the rent vs. buy ratio is a 14, renting still may still be your best bet.
For example, renting comes with certain perks. The 24-hour on-call maintenance staff, off-street parking, and the ability to write one monthly check for rent as opposed mortgage, insurance and tax payments each month are certainly appealing to many renters. Many apartment dwellers also enjoy the camaraderie that comes with living in a building with a dozen other people. It's a great way to make friends, and you'll never feel alone.
On the other hand, it really is like a box of chocolates -- you never know what you're gonna get. Living that close to your neighbors can be a nightmare. Homeowners usually enjoy having more control than renters do as far as service providers for electric and cable providers. Apartment complexes are often more limited in the selection of ISPs available, but you'll probably still find Verizon high-speed Internet available in most major markets.
Market Stability and How Long You Plan to Stick Around
If the rent vs buy ratio is favorable now, you're probably tempted to go ahead and buy. Before you do that, really look at your current circumstances. Do you see yourself staying where you are for at least seven years? What does your job look like? Will you need to find different work during that time? Does your family have children, or plan to within the next several years? Look at the local school districts. Are you comfortable sending any future children there?
These are the questions you'll in inevitably ask yourself over the next decade or so. Plan ahead and ask them now. If it seems you'll be making moves during that time, it's probably not in your best interests to buy any property now.
However, if the market is stable and you're confident you'll be able to sell quickly and efficiently when the time comes, you may be singing a different tune. As is any investment, buying a home can be a bit of a gamble. Closely analyze your current financial standing, and the projection you see it going over the course of the next several years before diving into such a major decision.
Tax Deductibility Perks
While they usually aren't large enough to be stand-alone reasons for buying a home, the tax deductions and credits that come from owning a home can certainly be a nice perk come tax season. Homeowners can deduct property taxes and mortgage interest from their income taxes when they are filing for both federal and state income taxes. This factor isn't accounted for in the rent vs. own index, but it should be taken into consideration.
Whether you're looking to move across town or across the world, it's important to consider all aspects of the situation before diving in. Buying a home is certainly a great investment, but it's also a big commitment. Anyone considering it should do so under the right circumstances, and after considering every aspect of the scenario. Have you ever used the rent v. buy ratio to make a home ownership decision? Tell your story in the comments below.
Joe Fortunato is a freelance writer from Tampa, Florida. He enjoys learning about new subjects, following his Baltimore Orioles, and traveling the country for fishing. You can find Joe on Twitter at @joey_fort.
Image via Flickr by Ken Shuman