Question

5.3 Julie’s Rent-or-Buy Decision

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.

Critical Thinking Questions

1. Given the information provided, use Worksheet 5.2 to evaluate and compare Julie’s alternatives of remaining in the apartment or purchasing the condo.

2. 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.

3. Discuss any other factors that should be considered when making a rent-or-buy decision.

4. Which alternative would you recommend for Julie in light of your analysis?

Answer 1

Answer:

Solution 1:-

On analyzing the alternatives of remaining in the apartment or purchasing the condo, it can be concluded that Julie should continue to live in her current apartment. She should plan to buy two or three flats apartment so that she can use or apartment for residential purpose and other apartment for renting purpose. If she plans to buy condo today it will impose extra burden on Julie. Along with condo fee, many other restrictions may be imposed.

Solution 2. Expected rate or appreciation for the condominium will further lower its annual cost. When the rate of 3.5% appreciation rate, the cost of condominium will decline by $ 6125 in the first year which is calculated as follows:-

= 3.5% * $ 175000 .

Buying the condominium is good option because buying the condominium will lower the annual cost even after appreciation as compared to the renting

Solution 3. Other factors that should be considered when making a rent-or-buy decision are:-

a. Pride of home ownership as well as security that own house will provide will not be offered in the renting decision

b. Purchasing a house on loan will provide several tax benefits on loan payments which cannot be availed in renting the house

c. Resale market for the own house after few years must also be calculated in order to estimate the future income from sale of own house.

d. Geographic conditions like metro areas, rural areas in nearby towns etc must be considered.

Solution:-4

Julie should check her credit score and if she is eligible for mortgage then should find how much loan she can afford.

Considering the benefits and drawbacks in buying and renting she must chose the option suited for her. The condominium will provide appreciation potential. In mortgage fixed payments will be paid. Apart from the fact that operating cost of condominium will be higher, it will be best suited because several other benefits will outweigh the disadvantages of the factor.