Question

Julie Brown is in her late 20s. She is renting an apartment in the fashionable part of town for $1,200 a month. After much thought, she’s seriously considering buying a condominium for $175,000. She intends to put 20 percent down and expects that closing costs will amount to another $5,000; a commercial bank has agreed to lend her money at the fixed rate of 6 percent on a 15-year mortgage. Julie would have to pay an annual condominium owner’s insurance premium of $600 and property taxes of $1,200 a year (she’s now paying renter’s insurance of $550 per year). In addition, she estimates that annual maintenance expenses will be about 0.5 percent of the price of the condo (which includes a $30 monthly fee to the property owners’ association). Julie’s income puts her in the 25 percent tax bracket (she itemizes her deductions on her tax returns), and she earns an after-tax rate of return on her investments of around 4 percent.

1. Working with a friend who is a realtor, Julie has learned that condos like the one that she’s thinking of buying are appreciating in value at the rate of 3.5 percent a year and are expected to continue doing so. Would such information affect the rent-or-buy decision made in Question 1? Explain.
2. Discuss any other factors that should be considered when making a rent-or-buy decision.
3. Which alternative would you recommend for Julie in light of your analysis?

Answer 1

BUY OR RENT ANALYSIS IS SHOWN BELOW :

BUY OR RENT ANALYSIS
	A	Cost of Renting
	1	Annual Rental cost				14400
	2	Rent Insurance				550
	3	Oppurtunity cost of security deposit			0
		Total Cost of Renting				14950
	B	Cost of Buying
		Purchase of home		175000
	1	Annual Mortage		140000@ 6 %	15 years
		(12 monthly payments )		$1,181.40	14177
	2	Property Taxes ( 2.5 % of home price)		1200
	3	Home Owners's Insurance (0.5 %)		600
	4	Maintainance (0.5 % of home price)		875
	5	After tax cost of interest on down payment and closing cost
		40,000 4% after tax rate of return		1600
	6	Total cost				18452
Less :	7	Principal reduction in loan balance		5777
		tax rate 25 %
	8	Tax savings on interest ( 8400 * 25 %)		2100
	9	Tax savings due to property tax ( 1200*25%)	300
	10	Total Deduction				8177
	11	Annual After Tax cost of ownership			10275
	12	Estimated annual appreciation in value of home
		3.5 % * 175000				6125
		Total cost of buying				4150

working Notes : Monethy mortage payments can be calculated using a calculator, interest is calcualted by 140000 * 6 % = 8400. And to find the principal reduction just deduct the annual interest paid from the annual mortage payments.

• if there was no appreciation in the value of the property cost of buying would have been 10275 , still that is less then paying rent of 14950. So , it won't effect the rent and buy decision for Julie.
• It is advantageous for Julie to buy the condo rather renting it, assusming the quality, space and location of condo space and renting spacing are same , it is advicable that Julie buys the condo rather renting one.
• With the appreciation of the value of condo it will be more profitable for Julie if he buy the condo because will will bring down her annual cost to 4150 of buying the condo as the value appreciates 3.5 % each year.
• Other factor factors Julie should consider is location of the spaces, like how close it is to her work place, how close are the public transport, how convinient it would be for her to got to any grocery or convinient store. If her house is near public transport , she can save a lot of money or fuel cost.
• Another factor she must consider is how long is she willing to stay in the city, if she is planning to move out after 4-5 years to a different city then renting a place would be better rather buying but if she wants to stay here for 15-20 years , buying the place would be a better option.
• But as per our analysis assuming she wants to stay here for long and both renting space and the condo is in same location , it is reccomended that she buys the condo rather renting one.