Rent vs. buy comparisons are very common and have been already discussed in length. However, the impact of several common assumptions on costs and opportunities has yet to be fully uncovered and explained. I’ve recently compared the two alternatives and have decided to share my experience.
We all know that in rent vs. buy the alternative cost of each option should be compared. When deciding to rent the primary cost is the rent itself. When buying a property the primary cost is the interest paid on the mortgage.
However, there are no less significant costs and opportunities to consider. We usually refer to these as alternative costs or opportunity costs. When considering these costs and opportunities we usually make assumptions and let the internet calculator do its thing. You must be aware your assumptions greatly affect the end result. One must use sensitivity analysis in order to examine the impact of these assumptions on the comparison as a whole.
When considering buying a property the most significant assumptions, other then interest rate on mortgages, are:
1. The alternative return on investment – Consider your equity invested in alternative financial assets. Assuming a 4% or 8% annual return rate on equity invested elsewhere amounts an ROI of 48% vs. and ROI of 115% respectively.
2. The prospected return on investment on the property bought – The assumption on the rate of return on your property is crucial. This is due to the fact buying a home with a mortgage is actually a leveraged buy which makes use of the bank’s money. Every percent returned is gained on the bank’s money as well. Thus a 0.5 % or 2% annual return rate on your house amounts to 5% or 25% increase in your entire property’s worth.
When considering renting a property the most significant assumptions, other then monthly rent payments, are respectively:
1. The return on equity (that was not used to buy the property)
2. The return on monthly savings generated by not buying the property
The significant affect these assumptions have on the end results is due to the following:
1. The nature of compound interest (The strongest force on earth according to Einstein)
2. The length of the prospective period examined in rent vs. buy (which actually kicks in
For a more detailed analysis of how to financially compare rent vs. buy correctly have a look at: Should you Rent or Buy a Home
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