With home prices in Los Angeles nearly as high as they’ve ever been and rents hovering at levels many residents can’t afford, Angelenos wondering whether to rent or buy aren’t faced with an easy choice.
Each option comes with its own advantages and disadvantages, and one—buying—requires a financial commitment quite a few people are simply unable to make.
Assuming you’ve got some savings lying around, which option makes the most sense from a financial perspective?
“There’s no right or wrong answer,” says Eric Sussman, adjunct professor of real estate and accounting at UCLA. “But you’d better be thoughtful about it.”
Tools from Zillow and the New York Times offer some guidance on this question. The Zillow calculator determines the break-even point, when buying a house becomes cheaper than renting due to equity gained by the homeowner since the purchase.
More simply put, as you pay off more of your home, you have access to more of its total value when you decide to sell. Assuming rent and mortgage payments are equal, then buying will save you money if the amount you end up with when selling is more than you would have been able to make by putting your down payment into an investment fund and continuing to write checks to your landlord each month.
If you were to buy a median-priced home in Los Angeles County (around $605,000), rather than pay for a $2,000-per-month apartment, it would take five years and three months to hit the break-even point when buying pays off over renting. But buying a pricier residence or signing a cheaper lease can change the calculation dramatically.
Under the same scenario, it only takes just two years and seven months to break even if your monthly rental payments are $3,000. On the other hand, if your choice is a $605,000 home or a $1,500-per-month apartment, buying will never be cheaper than renting.
Of course, these examples assume buyers are ready to make a 20 percent down payment. For a $605,000 home, that’s more than $120,000.
“How many people have $120,000 lying around?” Sussman asks. That’s one reason why he says the question of whether it’s better to buy or rent depends on a host of other factors, including how much buyers have saved up and whether they are willing to make such a large financial commitment.
It is possible to get a mortgage without putting 20 percent down, but a lower down payment generally means higher monthly costs. That’s because most banks will require you to pay for private mortgage insurance until you build up to 20 percent equity in your home. Like rental payments, those costs also do not add to the equity you have in your home.
A low down payment can also impact the financial viability of a purchase, since buyers have less equity from the get-go. With a 5 or 10 percent down payment, a drop in home prices is more likely to leave homeowners stuck owing as much or more than their house is worth.
“It doesn’t take a lot to put a hole in your balloon,” Sussman says.
For some people, the chance to buy with lower up-front costs might be worth the risk, especially if they're already stuck with high rental payments. The New York Times calculator helps to assess whether your rent is high enough that it makes more sense to buy.
Assuming that you plan to stay for at least five years, the calculator finds that buying a median-priced home in Los Angeles is the way to go if you’d be paying more than $2,425 in rent for something similar.
That calculation would look much different if mortgage interest rates were higher. According to Freddie Mac, interest rates for a conventional home loan now stand at 3.84 percent, well shy of the 4.5 percent or higher many analysts were predicting at the start of the year. Using the higher rate, the New York Times calculator finds renting makes more sense up to $2,617 per month.
Interest rates are one of the key variables that can affect the overall cost of buying at a given time. A high interest rate means costlier mortgage payments, which add up over time.
Right now, interest rates are low, and homes are taking a bit longer to sell than they did this time last year, according to data published by the California Association of Realtors. Prices are also climbing at a more modest pace; LA’s median sale price rose 3 percent between May 2018 and May 2019, according to CoreLogic. That’s significantly lower than the 8.4 percent increase seen a year earlier.
Those factors point to a market that’s shifting toward buyers—though prices are still high enough that the number of people capable of buying is discouragingly small.
Sussman stresses that the decision to rent or buy depends entirely on what people are looking for in a home and how long they’d like to stay there.
“For the right person, if your financial wherewithal is solid, and if you're going to be in the house for more than five years, go ahead and buy,” he says. “Prices will be higher 10 years from now than they are today.”