Ellie Dumaine is currently renting an apartment for $725 per month and paying $2

Question

Ellie Dumaine is currently renting an apartment for $725 per month and paying $275 annually for renter's insurance. She just found a small townhouse she can buy for $185,500. She has enough cash for a $10,000down payment and $4,000 in closing costs. Ellie estimated the following costs as a percentage of the home's price: property taxes, 2.5 percent; homeowner's insurance, 0.5 percent; and maintenance, 0.7 percent. She is in the 25 percent tax bracket. Calculate the cost of each alternative and recommend the least costly option - rent or buy - for Ellie.

Explanation / Answer

The question has been solved with the use of some assumptions, mentioned in the notes below the table.

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The rent versus buy analysis is given below:

Ellie should rent the property as it results in a lower total cost.

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Notes:

1) After-Tax Savings Rate is assumed to be 4% and Interest on Loan is taken at 6%. Period of mortgage is 30 Years.

2) The annual mortgage payment has been calculated with the use of PMT(Payment) function/formula of EXCEL/Financial Calculator. The function/formula for PMT is PMT(Rate,Nper,PV,FV) where Rate = Interest Rate, Nper = Period, PV = Loan Amount and FV = Future Value (if any).

Here, Rate = 6%/12, Nper = 30*12 = 360, PV = 185,500 - 10,000 (Downpayment) = $175,500 and FV = 0

Using these values in the above function/formula for PMT, we get,

Annual Mortgage Payment = PMT(6%/12,360,175500)*12 = $12,626.53

Rent Versus Buy Analysis Cost of Renting Annual Rental Costs (725*12) 8,700 Renter's Insurance 275 Opportunity Cost of Security Deposit (725*4%) 29 Total Cost of Renting $9,004 Cost of Buying Annual Mortgage Payment (Calculations Below) 12,623.53 Property Taxes (185,500*2.5%) 4,637.5 Homeowner's Insurance (185,500*.5%) 927.5 Maintenance (185,500*.7%) 1,298.5 After-Tax Cost of Interest on Down payment and Closing Costs (14,000*4%) 560 Total Costs (A) 20,047.03 Principal Reduction in the Loan Balance (12,623.53 – 6%*175,500) 2,093.53 Tax Savings on Interest (175,500*6%*25%) 2,632.5 Tax Savings from Property Deductions (4637.50*25%) 1,159.375 Total Deductions (B) 5,885.405 Annual After-Tax Cost of Home Ownership 14,161.625 Less Estimated Annual Appreciation (185,500*2%) 3,710 Total Cost of Buying 10,451.625

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