Deciding whether to buy or rent your home can appear to be a tricky decision if you have yet to get your feet wet in real estate. In reality, however, the decision involves relatively simple math and logic. The basic rule of thumb is as follows: if you are looking to occupy for the short-term, renting makes the most sense; but if you are in it for the long haul, buying is probably your best option.
Here’s why:
In the long run, real estate tends to appreciate in value. The amount of appreciation varies by area and market timing, but over time, most every home will appreciate in value so long as it is in a desirable area. In good markets, appreciation can exceed 10% per year on an annualized basis over a long time frame. The return on your investment that you actually recognize as a homeowner is much greater because of a concept called leverage.
Leverage explained:
Leverage in this case is simply borrowing money in the form of a mortgage to magnify your return on investment. Say you purchase a home for $200,000. To buy this home you decide to put down 20% of the purchase price ($40,000) and take out a mortgage on the rest ($180,000). For simplicity purposes, let's just assume your property appreciates 10% during the year following your purchase, which would be $20,000 (10% of your purchase price multiplied by $200,000). Expenses and interest payments aside, you just made $20,000 on your $40,000 down payment or 50% on your money. Over a five year period, your gain would equate to $122,102 (a 305% return without taking interest, maintenance, tax, and improvement costs into the equation). The interest payments on your mortgage would be tax deductible so long as this was your primary or secondary residence. Therefore, your interest expenses would not punish your return as much as you might think.
The truth behind buying in the short-run:
In the short-run, however, your gains would not be as substantial as they would appear because of the 5-6% real estate commission you would likely incur to sell the home. Six percent of $220,000 = $13,200. After your other expenses (interest, maintenance, property taxes, and improvements), you would be lucky to break even if you sold after the first year.
In the long-run, however, your leveraged gains should far exceed realtor's commissions and other expenses, so buying makes sense in many scenarios.
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