Beware The Rent Versus Buy Calculator

You probably have seen a rent-versus-buy calculator here and there online, and you may have even used one. They are supposed to help you decide if buying a house makes financial sense for you, but do they really tell you what you need to know? Let's take a look at how they work, and how they sometimes don't.

To Rent Versus Buy

The idea of these calculators is to take into account all the costs of both renting and buying over a given time, to compare them and see which option is better. There are a number of criteria involved, though, and this means there will always be some guessing. How many years will you be in the home? How much will rent be up to in ten years? How high will your property taxes be? These fields will be filled in by default in most calculators, and you'll change them as needed.

I just went to the U.S. Government's site, ginniemae.gov to see their rent-versus-buy calculator. Their fields start (mid 2007) with an assumption of ten years in a house, a 7.5% interest rate, and 2% annual appreciation - all very conservative guesses. Here is what all of the criteria were preset at:

Your Current Monthly Rent: $750
The Price of Home: $150,000
The Down Payment: $15,000 (10%)
Term Of Loan (years): 30
Interest Rate On Loan: 7.5%
Estimated Years In The Home: 10
Annual Property Tax Rate: 1%
Annual Home Value Increase: 2%

You can change any of these. For example, property taxes are closer to 2% of property value in some areas. Over 10 years appreciation will probably be more than 2% annually (although it could well be a negative number this year and next). Hitting the "calculate" button, this is what was shown:

Home Value In Ten Years: $182,849
Loan Balance After 10 Years: $117,340
Your Equity: $65,509
Tax Savings (at 28%): $32,549
The Average Monthly Payment Over Time: Rent: $834 - Buy: $550
Total Payments Over Ten Years: Rent: $100,080 - Buy: $66,017
Your Total Savings On: Buying - $34,063

Confusing. My amortization table shows that the payment on a 30-year, 7.5% loan would be $944 per month, not $550 - and this doesn't include mortgage insurance, property taxes or home owner's insurance. They may take into account the tax savings, but that still doesn't explain how they arrive at $550. There is this little note at the bottom:

"The above rent-versus-buy calculator uses the following in its calculations: homeowner's insurance, loan costs, mortgage insurance, cost to sell the home, property tax, homeowner's tax savings, and increases in rent. Results are estimates. "

Well, that certainly doesn't clear things up, but it does point out some other issues, like the fact that there is no calculation at all for repair costs. Having owned several homes, I can tell you that there will be repairs and maintenance. We also don't know if rising property taxes were taken into account. Also if you are in the 15% tax bracket (likely if you're renting a $750 apartment), the tax savings would be about $15,000 less than calculated - a little bit of difference.

Now, even at a more reasonable 6.5% interest rate, the monthly cost of owning a $150,000 home (with taxes, insurance, and minor repairs) is a minimum $1,150 - and probably higher than that. Using the above example, this is $400 more per month than renting. My guess is they take into account the "opportunity cost" of not having that $400 per month to invest over 10 years. That might even surpass the equity gain from owning.

Buying is often a good idea, especially since you probably won't invest that $400 monthly in extra cash flow you get from renting. But do some of your own thinking, understand what criteria are being used, and be skeptical of these rent-versus-buy calculators.