Buy vs. Rent: Borrowers' Rights

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Is it smarter to rent or buy?Until the housing crisis of the late 2000s, buying a home was equated with making a prudent real estate investment, especially if you were set on putting down your roots in one place for the next 15 to 30 years. But then conventional wisdom was defied. Over the past few years, homeowners entangled in risky, high-rate mortgages saw values plummet, foreclosures hit all-time highs, and soaring unemployment lead to more underwater mortgages and homes lost.

Fast-forwarding to today, many of us -- tainted by this experience -- are conflicted by the "rent vs. buy" debate. While there are uncertainties and exceptions, this guide will help you determine what's best for your own situation. (By the way, your circumstances probably aren't the same as those of your friend, who just bought a McMansion with 5 percent down).


Determining What You Can Afford

According to a general rule-of-thumb, prospective buyers can afford to buy a place that costs up to three times their annual household income. Let's play out this example. If you will make $50,000 this year, you can look for a place in the $150,000 range. With a conservative 20 percent down payment of $30,000 on a 30-year-fixed loan, you have roughly a monthly mortgage payment of $800 per month, which over the course of the year is $9,600.

After property taxes, utilities, homeowners insurance, and condo fees, a real estate purchase takes a sizable chunk of a homeowner's annual income. For someone without a savings account or with a substantial amount of debt, buying at three-times your income may be too risky. To figure out what you can afford -- accounting for debt obligations and new loan assumptions -- try this home affordability calculator.

For renting, guidelines are less strict because it is not as difficult to be approved as a solvent renter. In Manhattan, many landlords require that a tenant make an annual income 40 times their monthly rent. However, in other parts of the country many financial planners say that housing, including utilities and insurance, should be less than a quarter of your month's expenses. Here's a rent calculator that gives you a low to high range of what you should spend.


The Time Factor

This is the million-dollar question, but the answer is that the cost for renting versus buying needs to be compared over time. But thanks to some really nifty online interfaces, such as this "Rent vs. Buy" calculator, it's easy to see the extra burdens of buying real estate in the short term.

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Remember the $150,000 condo that you can hypothetically afford, let's plug it in along with a rent value. For simplicity, let's make the rent $1,000, equivalent to what you would be paying in mortgage, plus utilities and property tax per month. According to this calculator, it takes six years for buying to become more economical. After 20 years of owning a property, you are saving $6,143. (You can click on "advanced settings" to manipulate some of the criteria that's been preselected for you).

Some of the downfalls of becoming a homeowner are the upfront expenses, such as closing costs, and the ownership responsibilities, like maintenance, condo fees or property taxes. As a renter, sometimes part or all of your utilities are included. In the long term, however, appreciation and tax incentives should redeem your financial investment in buying a home or condo. At a certain breaking point, you will save money. Some say that on average it takes at least four years for your real estate investment to become worthwhile. But after the housing crisis of late, there are no guarantees.


It's a Lifestyle Choice

According to the U.S. Census Bureau, the average American moves every seven years. Some people from the nature of their profession or their personal preferences may never be the ideal candidate to reap the benefits from buying. If you just graduated from college and have no clue where you are going to be over the next couple of years, buying a home probably isn't for you. Did you just get a promotion out West? A career-minded, jet-setter may have enough money to buy and sell every few years, but they probably are not going to save money in the process. As long as housing needs change, whether in size or location, renting may be your best option.


Give Me More -- Rent Ratio

OK, you get it. You're not looking to flip your next house for some ungodly profit, but when you're nearing 70 years old, you're hoping to trade it in for a beach house. To hone in on what to do about renting vs. buying, you might be interested in the rent ratio, defined as the price of a house divided by the annual cost of renting a similar one. The key number is 20 because a ratio more than 20 means you should consider renting, especially if it's for the short term, and a ratio below 20 means that you're a viable candidate to buy.

According to the The New York Times, the rent ratio in some of the biggest U.S. cities was 25 at the top of the bubble and now the average ratio in places like New York, Los Angeles, Chicago, Dallas, Houston and South Florida is 16. With interest rates low and looking like they're on their way up, some argue that a ratio of 16 or less means you should buy.

Let's go back to our example to see what we should do about the rent-vs.-buy dilemma. You are looking to buy a condo for $150,000 or rent a place for $1,000 (or $12,000 for the year). The rent ratio is 12.5, which means in this hypothetical, buying is the route to go. But don't forget, that buying is for the long haul.


Nation of Buyers vs. Renters

Despite our country's strong affection for homeownership, the U.S. hasn't always been a nation of buyers. In the 1940s, homeownership was less than 45 percent, a far cry from the 69 percent level reached in 2004. According to a research report by the Federal Reserve Bank of St. Louis, the U.S. has a relatively high rate of homeownership, but is surpassed globally by Ireland, Spain and Italy.

Traditionally, buying a home was a right reserved for the wealthy. As larger, more diversified banking systems evolved and quasi-governmental agencies, Freddie Mac and Fannie Mae, helped make mortgages accessible to all Americans, our country's mindset evolved. In the early 2000s, an unprecedented period of low interest rates made it increasingly easy and affordable to get a mortgage -- or even a second mortgage.

But today, the housing crisis is still fresh in our minds. There's an abundant supply of both homes and rentals on the market, which makes it a "buyer's market," and many of us -- including you -- may be uncertain about plunging in to buy. Only time can tell how our country's tradition of buying will be disrupted by a generation of consumers uncertain about the future, the economy and obligations of owning.

Interested in more into to help you decide whether to rent or buy? AOL Real Estate has other great guides that might help:


More on AOL Real Estate:
Find out how to calculate mortgage payments.
Find homes for sale in your area.
Find foreclosures in your area.
Get property tax help from our experts.


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