Kim and Dan Bergholt are both government workers. They are considering purchasing a home in the Washington D.C. area for about $280,000. They estimate monthly expenses for utilities at $220, maintenance at $100, property taxes at $380, and home insurance payments at $50. Their only debt consists of car loans requiring a monthly payment of $350.
Kim's gross income is $55,000/year and Dan's is $38,000/year. They have saved about $60,000 in a money market fund on which they earned $5,840 last year. They plan to use most of this for a 20% down payment and closing costs. A lender is offering 30-year variable rate loans with an initial interest rate of 8% given a 20% down payment and closing costs equal to $1,000 plus 3 points.
Estimate whether it is financially more attractive for the Bergholts to rent or to purchase the home over a five-year holding period. (Assuming the contract interest rate of 8%, monthly interest payments over the five-year period would total $87,574.)
The Rent Vs Buy Option
Rent at $1,400 per month will cost $16,800 per year.
Utilities will cost $2,640 per year
Insurance will cost $300 per year.
Therefore the rent option will cost the Bergholts $19,740 per year.
Assuming a 3% rise in rent and utilities,
Year 1 costs = $19,740
Year 2 costs = 19,440 * 103% + 25 = $20,048
Year 3 costs = 20,048 * 103% + 25 = $20,675
Year 4 costs = 20,675 * 103% + 25 = $21,320
Year 5 costs = 21,320 * 103% + ...
This provides an example of working with the numbers to determine if it's better to rent or buy.