How Long Will it Take For Buying a House to Pay Off?

Photo courtesy of Ella’s Dad

When it comes to housing, should you rent or should you buy?

This question is much more relevant today than it ever has been. More and more people are realizing that while buying a home CAN be a good long-term financial decision, it’s certainly not guaranteed and it’s not the investment opportunity past generations considered it to be.

And it’s a question that’s especially relevant to new parents. We’re at a stage in our lives where “settling down” and creating a “home” often feels like the “right” thing to do. Which often leads people to buy a house, sometimes before it really makes financial sense.

I’ve written before about why my wife and I have so far decided to rent, and where I think buying a home should fit within your financial priorities. I understand the appeal of owning a home. It’s something we definitely want to do and hopefully we’ll find the right situation in the near future.

But before you make what will probably be the biggest purchase of your life, it makes sense to run some numbers.

Specifically: how long will it take before buying a house becomes a better financial decision than renting?

THE TOOL WE’LL BE USING

The NY Times has a great and easy-to-use calculator to help you figure this out. You can get to it here: NY Times – Is it better to buy or rent?

What it does is take your specific inputs, make some assumptions, and give you a ballpark estimate for how long it would take for a home purchase to come out ahead of renting. It’s a GREAT tool for anyone who’s in the process of deciding whether buying a house is right for them.

To lead you through it, I’ll show you how I would use it for my personal situation. We just moved to Gulf Breeze, FL, and while we only really considered renting (for a variety of reasons I won’t get into here), it’s an interesting exercise to compare the rental we picked to what we could have paid for a similar house.

So, here we go…

OUR BASIC STATS

The main part of the calculator has 5 variables that drive most of the evaluation. Here are our numbers:

Rent – We’re paying $850 per month in rent.

Home price – A quick look at realtor.com shows a house very similar to the one we’re renting and just down the street from us that’s on the market for $118,000 (prices here are low!).

Down payment – I’m assuming we’d put the standard 20% down.

Mortgage rate – If you’re already shopping around for mortgages, you probably already have a good idea of what this would be. But if you’re just trying to get a ballpark number, Bankrate has a pretty good tool you can use to get an idea of mortgage rates in your area. In our area, the average seemed to be around 4.3% if you have good credit.

Annual property taxes – I googled “Gulf Breeze, FL property tax rates” and eventually found this site that let me estimate our annual property tax bill, which came to $1,886.03. Now, the NYT calculator requires you to enter a percentage in this field, but the nice part is that it also tells you the absolute dollar amount that your percentage equates to. With a little fiddling, I found that a rate of 1.6% hit that annual amount almost exactly.

Based on just these inputs, the calculator said that buying would come out ahead of renting after 3 years. But there were some other assumptions the calculator was making that weren’t 100% correct for my personal situation. I wanted to take the time to make sure I got those as accurate as possible, so on we go…

WHAT OTHER ASSUMPTIONS NEEDED TO BE UPDATED?

Just above the graph to the right, there’s a button titled “Advanced Settings”. Clicking that opens up a window that lets you change some of the other assumptions in the calculator. Here’s a quick rundown of the variables I changed, and why I changed them. Anything I don’t talk about here was just left as the default value.

“BUYING” SECTION

Condo fee/common charge – The house I found is part of a homeowner’s association, and according to realtor.com the annual fee is $198. The calculator wants it as a monthly fee, so I entered 16.5 here.

Annual maintenance costs – The default of 0.5% here seemed low based on what I’ve read (see here and here for examples). I put 1.75% here as a compromise between a big range of suggestions.

Homeowner’s insurance rate – I reached out to my insurance company and they quoted me an annual premium of $1,206.80 plus about $350 for flood insurance. Since the NYT calculation asks you to enter this as a percentage, I simply divided that total ($1,556.8) by $118,000 to get 1.3%.

Additional monthly utilities – Our landlord doesn’t pay for any utilities, so I changed this to $0.

“RENTING” SECTION

Rental broker’s fee – We didn’t have to pay a broker’s fee, but we did have to pay a non-refundable $600 fee for our two cats. Since that fee was non-refundable, I put it here instead of in the “Rent deposit” field.

Renter’s insurance rate – Our actual renter’s insurance premium is 2.32% of the annual cost of rent.

“OTHER” SECTION

Rate of return on investments – This one requires a little explanation and thought.

Buying a house requires that you pay more money up front than renting does. And by spending that money instead of holding onto it for a little while, you’re giving up the chance for any investment returns you could have earned on it. That’s called an “opportunity cost” and it’s something that has to be factored into the equation.

Now, the real question here is not what investment returns you might earn generally across all of your different investments. The question is what returns you might earn on the specific money that you would use to pay for the house.

For our personal example, if we decided to buy the money for the down payment would come out of a savings account we have at Ally bank that’s being used specifically to save for a house. If we don’t buy a house, that money will keep sitting in that savings account until we ARE ready to buy. So our specific return on investment is the interest rate we’re earning in that savings account (currently 0.87%). If we were instead investing that money in the stock market, the return we entered here would be higher.

So you need to think a little bit about what you would be doing with the money if you weren’t using it to pay for a house. The larger the return you enter here, the more favorable it will be to renting.

THE FINAL RESULT?

Okay, so after personalizing all of that information, the calculator tells me that buying will become a better financial decision than renting after….

Drumroll please…

4 years!

But it gives you even more detail than that. You can actually see the breakdown after each year, assuming you sell your house/leave your rental at the end of that year (that is, you decide to move after that many years).

Here’s what the numbers looked like in my example:

SOME WARNINGS

Now, there are four big warnings here.

Warning #1: 4 years is just the result of my particular example here. If you run your own numbers for your own situation you might get something completely different. So there’s no intent here to say that 4 years is in any way typical.

Warning #2: Whatever result you get is nothing more than a rough estimate. In particular, the assumptions about inflation, investment returns, and the rise of housing costs and rent can be hugely variable and make the actual result much different from what you get here. In some cases buying could be a better decision sooner. In some cases it will take much longer. It just depends.

Warning #3: This is NOT saying that buying a house becomes a good investment after 4 years. Even after selling the house, we still would have spent over $41,000 on the house. So we would have lost money. It’s just that we would have lost less money than renting. Once again, buying a house might be a good financial decision, but it is not a good investment.

Warning #4: Buying a house has a much bigger upside than renting. But it also has much bigger downside. That doesn’t necessarily argue one way or the other, but it’s something to keep in mind.

HOW SHOULD YOU USE THIS INFORMATION?

While the result you get is far from gospel, it will give you a good sense of how long you would need to stay in your home before it would pay off compared to the alternative of renting.

If you feel confident that you would be living in that home for at least that many years, then you can probably feel pretty good about buying. If not, then you should probably look hard at finding a good rental.