The Buy v. Rent Conundrum

By Carla Fried

It turns out that plenty of Americans are still sold on the American Dream. In Fannie Mae’s latest survey, 62% of folks said that if they were planning to move right now they would buy, rather than rent. Moreover, 69% of the same survey respondents believe that right now is a good time to buy a home. Indeed it is. With mortgage rates at historic lows and prices having seriously deflated since the bursting of a bubble, prospective buyers face an enticing market. The economic forecasting firm FiServ notes that the national median home price is now back to within 5% of its 2003 level.

From a straight-up cost perspective, buying can in fact be the better deal these days. While home prices have fallen, rents haven’t. Real estate forecasting firm Reis, Inc. predicts 2011 apartment rental rates will rise 6% or more in major markets including San Jose, Washington D.C. and New York City, and foresees average apartment rental rates bumping up another 3% in 2012. According to real estate research firm Trulia, buying beats renting in more than 70% of the metro markets it tracks. (That link to Trulia takes you to a way-cool interactive map that; it’s well worth taking a spin.)

But let’s face it, pulling the trigger is anything but easy these days. For starters, there’s the not-so-small worry that prices could head even lower. And then there’s the high-jump challenge of getting approved for a loan.

To help you wade through your options, think through these factors:

1. Am I going to stay put for at least five to seven years? Even if prices are stabilizing in your area, you’re not likely to see big price gains in the next few years. In a recent survey of more than 100 housing economists, the general consensus was for prices to inch along at a 1.1% annualized rate gain through 2015. That’s actually good news, compared to the losses since 2006, but it also means you can’t expect to have strong appreciation to cover the costs of eventually selling. Remember, there’s going to be the agent’s fee to sell, which typically is 5% to 6%, combined with moving costs etc. So you only want to be buying today if you intend to stay in that home for a good chunk of time. There’s a terrific free rent v. buy calculator at the New York Times that allows you to play with all sorts of variables to get a sense of what might make the most sense given your financial situation and what you expect to happen with locak housing (and rental) prices.
2. Will I pass muster with a lender? Let’s just say lenders have swung to the other end of the pendulum the past few years. After spending the bubble years handing out mortgages to just about anybody who wanted one, now you must actually prove you qualify. And those qualifying standards have gotten much tougher. To have a shot at a great interest rate you’ll need a FICO credit score of at least 720-740 and be able to make a down payment of at least 10%, though 20% is what is going to give you the best shot at getting a conventional mortgage. If that down payment hurdle seems impossible high, you should definitely look into an FHA-insured loan; most lenders offer ‘em. Because of the government backing, the lending standards for these loans are way more lenient. Many lenders will consider an FHA-insured loan if your FICO credit score is at least 660 or so, and the down payment can be as low as 3.5%. Just keep in mind that with the FHA option you pay an upfront 1% fee for the insurance and an ongoing annual charge of 1.1% (1.15% if your down payment is less than 5%) until you have at least 22 percent equity in the home.
3. What’s my all-in ownership cost? Just because you can afford the $1,500 rent does not mean you can afford a home with a $1,500 base mortgage. Make sure you factor in the cost of property tax; yes it’s deductible if you file an itemized return, but it’s still a hefty annual charge that can be 1.5% or more of your home’s value. And then there’s home insurance; a solid policy—you want to ask for extended replacement cost coverage; do not settle for actual cash value-is going to be more expensive than any renter’s policy. And let’s not forget all the maintenance costs once you settle into your own place. Get estimate for all those costs-ask friends what they pay. This exercise isn’t to talk you out of buying, but rather to help you buy smart: you might find you want to lower your shopping price point a little bit to make sure your total all-in monthly costs won’t be a stress on your finances.