Moving is always the time of big decisions. Should you buy a home or rent instead? Some people think that it’s extremely important to purchase a place to live. For others, rent is the best option. To make a choice, you should first determine whether you can afford to buy. The financial aspect of your decision is crucial here. As for personal factors, if you aren’t married and don’t know where life will take you in a couple of years, it is more wisely to rent. But let’s focus on financial aspects and decide whether it’s better to rent or buy your dream house or apartment.
Financial Aspects
As we have said, the first step is to determine whether you can afford to buy a home. No matter how much you earn, you will be really surprised to hear the price of the dream place to live. Moreover, real estate prices in New York keep rising. Let’s have a look at these important aspects of buying a property and living in NYC, and decide if it’s better to rent or buy:
- Time: If you don’t know how long you’re going to own an apartment or house, renting is a better option. Are you sure that you will own your home for at least five years? It is one of the most important factors to consider when you are making a decision between renting and buying.
- Price Tendencies: Do you think that that sale and rental prices will rise or fall and by how much? According to the report from StreetEasy, “the typical household in New York City is expected to spend 65.2 percent of its total income on market-rate rent in 2016”, which is up from 59.7 percent in 2015. Thus, a common household would have to spend 2/3 of the total income on rent. The prices seem to be too high for lots of people in NYC.
According to a recent survey from WNYC and Public Agenda, there are lots of financial aspects worrying New Yorkers:
- Income: Do you have a steady income? Financial experts say that your monthly mortgage payment should not be more than 28 percent of your monthly income.
- Job: If anything happens, will you be able to quickly find another job with the same salary?
- Are you doing this alone? Do you rely on two incomes to pay all the bills?
- Kids: Will your kids go to college?
- Car: Are you planning to buy a new car?
- Vacations: Do you usually go on yearly vacations?
- Monthly Payments: As for the total monthly debt payments, they should not be more than 36 percent of your gross monthly income. We have discussed it when talking about how much mortgage you can afford. There is a general rule saying that you can afford a mortgage of 2 or 2.5 times your gross income. According to this formula, if you earn about $110,000 per year, your mortgage can be between $220,000 and $275,000. But it is a very rough estimation, the amount certainly changes when you enter all of your detailed criteria.
- Down Payment: Will you be able to make a down payment that makes between 5% and 20% of the purchase price? It’s also important so have some money left for unforeseen expenses and home repairs.
- Insurance: If the down payment if less than 20%, you’ll have to buy mortgage insurance.
- Closing costs and Transaction Fees: They are expenses above the price of the property and usually make about 4% or 5% of the sale price.
- Maintenance: Before making a choice between renting and buying, think about how much it may cost you to maintain the house or apartment and do some repairs. There’s always something to improve in your home, as nothing lasts forever and every fixing and improvement needs money. From this standpoint, renting is an easier way to live, as you pay just a fixed monthly rent.
Considering all these expenses, it’s so easy to become “house poor”. House poor is a term that describes homeowners who spend most of their income on housing costs, such as mortgage payments, property taxes, maintenance and utilities. Becoming house poor doesn’t happen out of a sudden. If you’re spending more than 40% of your income on housing expenses, you are endangering yourself to become house poor.
Will you be able to change your lifestyle to make the process of buying a property not so wallet-emptying? It is likely that you will have to cut lots of your expenses to buy a home.
Another extremely important thing about buying is realizing the fact that you will have to pay off your mortgage for 15 or 30 years. Will you be able to sleep at night with this thought? Some people can, but it’s a hard task for those who can’t stand the mere thought of it.
Buying Vs. Renting. Numbers
There are various calculators to help you decide if it’s better to rent or buy. But let’s have a look at the approximate numbers of our simplified analysis.
Let’s say that you’re renting a house for $1,700 per month. The house you want to buy costs $400,000. You have already saved some $100,000 and can make the down payment. The remaining $300,000 will be taken out as a loan.
You can take a 15 or 30 years fixed mortgage. In a traditional mortgage, the most part of the mortgage monthly payment will go towards paying down the interest at the beginning of the paying-off process, while the remaining part will go to pay down the loan. So, if your mortgage payment is $1,700 per month, around $1,400 would go towards paying the interest and $300 to will go to paying down the loan.
At the end of the mortgage term, when you have paid the most part of the loan, $1,400 will go towards paying the loan, and the interest will be only $300, as the interest is on a lower amount now.
To simplify things, let’s assume that we have got an interest-only mortgage. In this type of mortgage, the debtor is required to pay a fixed interest during the entire mortgage period. Let’s say our interest is 5%. In this case, your annual interest payment is going to be $15,000.
You can usually deduct mortgage interest from your income. If your annual income is $100,000, your taxable income will be $85,000 ($100,000 minus $15,000). Thus, you will save around $5,000 on taxes. This means that the effective cost of interest will be $10,000.
You will also have to pay a property tax of around 1% of the property price, which makes $4,000. The house maintenance may take up to $2,000 per year.
Thus, the interest payment $10,000, plus property tax of $4,000, plus apartment or house upkeep of $2,000 will cost $16,000 on the annual basis.
Now, let’s take a look at our renting option. If our rent is $1,700 per month, it will be $20,400 per year. Keep in mind that we have $100,000 meant for the down payment in case we want to buy a property. We can invest it somewhere and get a 2% return, which will make $2,000. This will knock down the annual rent to $18,400.
Since rental prices keep rising every year, we may say that buying is a better option here. Of course, the result will change with other initial data, but it’s a simplified analysis to help you understand how to calculate the difference between renting and buying costs. If your choice is buying, make sure you know how to buy an apartment or house in New York City.
On the other hand, price-to-rent ratio is another important aspect to consider when you choose between renting and buying. It’s the average sale price of a home divided by the average annual rent for a comparable one. The ratio is represented by the following equation:
Price-to-rent ratio = Average sale price / (Average Rent * 12)
If price-to-rent ratio is from 1 to 15, it is better to buy than rent.
When the ratio is 16 to 20, it’s better to rent than buy. When price-to-rent ratio is 21 or more, it’s much better to rent. New York has shown a price-to-rent ratio of 35.65, which is one of the highest in the world. Thus, rent is a common choice in NYC.
Rent or buy? It’s a simple question that has no simple answer. There are so many factors to consider before making the right choice. Do careful calculation before making this important decision.
