The decision to buy or rent a home is really a choice between buying a home that you hope will appreciate in value; or renting a home, spending less on housing – at least in the early years – and potentially investing the difference in stocks or bonds instead.
Both options have a number of costs and benefits, so we calculate the Breakeven Horizon as a tool to help make this crucial housing decision.
The median Breakeven Horizon tells us the number of years you would have to live in a home for the accumulating costs of renting the same exact home to exceed those of buying in a given area. In other words, after buying and living in a home for longer than the Breakeven Horizon, we would expect homeowners would begin to have more money and assets than if they had rented the same home over the same time (figure 1).
There are a number of factors that can shrink or expand your personal breakeven:
Apples and Oranges
When we estimate the median Breakeven Horizon for a given ZIP code, neighborhood, city or metro, we compare the costs and benefits associated with buying or renting the same property. This makes sense on an analytical level, because we cannot assume what your preferences are. For example, while some buyers may set out to make the tradeoff between buying a two bedroom home versus renting a one bedroom apartment, other households, might not be willing to make the same sacrifices.
Let’s say you are willing to rent a more modest property than what you’d be willing to buy: In this scenario, your Breakeven Horizon is lengthened because the rent is lower and it will take longer for the costs of renting to exceed the costs of buying.
Depending on your circumstances and preferences, you’ll have to consider – on your own – how much more you would enjoy living in the nicer home you own, rather than the lesser property you rent.
Personal Credit
The higher your mortgage interest rate, the more interest accrues and the more costly it is to purchase a home. Our algorithm assumes a 20-percent down payment on a 30-year fixed rate mortgage. We apply the prevailing interest rate to estimate the monthly payment[1]. But to qualify for the best rates, a borrower’s credit has to be quite strong. Home buyers with lower credit scores may be unable to attain the prevailing rate and may have to settle for a higher rate, which will increase monthly costs and serve to lengthen their individual Breakeven Horizon.
Other Savings and Investments
The Breakeven Horizon is primarily a way of comparing different combinations of something you consume (housing) and an investment you make (the equity in your home or the value of other assets). The investment component of the home purchase is your growing share of equity as you pay down the principal each month together with home value appreciation. The rate of return on the investment component of renting is the interest rate earned on other kinds of assets, including stocks and bonds.
If, when renting, you increase your consumption of other goods and services – say, by purchasing a car, rather than investing all those upfront costs you avoided – then your rate of return when renting is zero (or negative as your car depreciates) and you’ll break even on a home very quickly. In this scenario, paying down some mortgage principal every month through homeownership functions as forced savings that grows with your home’s value.
Our algorithm assumes a 5 percent rate of return on investments when renting. Anything less will make your Breakeven Horizon shorter. Savings accounts and certificates of deposit currently earn less than 5 percent interest, meaning renters holding their assets in these kinds of accounts could likely break even on a home more quickly than if they pursued other kinds of investment products. If you are a savvy, renting investor able to earn a high rate of return on stocks and bonds, the Breakeven Horizon can lengthen considerably, making renting a more viable option for a longer period.
[1] At the time of this analysis, the prevailing rate on a 30-year, fixed-rate mortgage was 3.71 percent.
