To Rent or To Buy? Here's The Answer (Formula Included)
Let me ruin your day with seven words: should I rent or buy my home? It’s a decision that a lot of us struggle to make and often overthink to the point where steam is coming out of our ears.
Not only do we have the perpetual fear of being unable to afford the home we actually want, there are additional social and familial pressures barreling us towards the normalized “adult” path of buying a home.
Conversely, while home ownership may provide headaches and cause us to overexert ourselves financially there is always the nagging feeling that we are simply throwing our hard earned cash away by paying rent.
So, with that being said it strikes me as odd that the decision of renting or buying is often dictated and executed primarily based on emotion rather than assessing whether or not the current rental situation is worthwhile. Am I claiming that I have the perfect formula for renting or buying?
Of course not.
However, there is a heuristic that needs to be more widely adopted and understood to help determine whether or not someone should rent or buy. It’s called the price to rent ratio.
The price to rent ratio is calculated by taking the list price of the home and dividing it by the yearly rent: home price / (monthly rent * 12). The value that you get from that equation falls into one of these 3 ranges:
- Price to rent ratio under 15: Buy the home, you’ll save money.
- Price to rent ratio between 16 and 20: It’s more favorable to rent than buy.
- Price to rent ratio over 21: Chuckle to yourself, thank your landlord and keep on renting.
Make sure when you’re calculating the price to rent ratio all costs are taken into consideration. For renting this includes renter’s insurance, and for buying it would include property taxes, required insurance, the mortgage principal & interest amongst other costs.
Now, being the well-informed reader that you are I know what you’re thinking: “why should I listen to some random blog post about making an important decision”. I appreciate the healthy skepticism, so let me provide some empirical evidence that gives credence to the price to rent ratio.
Trulia, a real estate group, tracks the average national price to rent ratio and calculated a value of 24.5 in 2007 before the housing bubble burst. Harkening back to the ranges above, a value of 24.5 clearly indicates to rent and not buy in any way, shape, or form.
In short, the price to rent ratio helped identify that it was a horrible time to buy a home.
So, with all this being said I hope that I managed to provide a quick and easy way to assess your current rent or buy situation, and that you can start your journey towards making the correct decision for yourself.
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