Question

Problem 1: Lease vs. Buy

You are doing an analysis of whether to lease a property or purchase a single-family house for personal use. The property can be leased for $1,400 per month on a 12-month lease. The lease rates are expected to raise by 5% per year. As a tenant you are responsible full utility charges like heating, electricity and water/sewer. As a tenant you will also incur renter insurance for $10/month, and the rates are expected to grow at 5% per year.

The same house can be purchased for $225,000. The property value is expected to grow at 4% per year. Property Tax in the area is 1.7% of market value. Property maintenance is expected to be $900/year and expected to escalate at 3.5% per year. Homeowner property insurance (hazard and theft) is $80/month and expected to escalate at the same rate as property maintenance.

When you sell the property you will incur a real estate commission of 6% of the sales price and a flat $1,200 closing charges.

If you decide to purchase the house, you will put down $10,000 as the down payment. The rest of the money required for purchase will be financed thru two mortgages listed below.

Mortgage 1. Loan Amount $160,000. Term 30 years with end of month payments, interest = 7.2 percent.

Mortgage 2. Loan Amount $55,000. Term 15 years with end of month payments, interest = 9 percent.

Assume you are at an incremental Federal Tax rate of 22%.

Comment on how the results of the template output can be used to decide whether you want to lease or buy the house. Discuss the results separately for following 3 scenarios.

1. You plan to live in the house for one year
2. You plan to live in the house for 3 years
3. You plan to live in the house for 5 years

Answer 1

Usually these problems are done with Present Value Factor. But as no input is given, we will ignore time value of money and proceed with just gross cash outflow.

The Template is as follows,

You should use a repayment schedule to figure out the interest to be paid each year and the tax savings from the same @ 22%. A sample repayment schedule looks like this

The Decisions for tenure is as follows

1 Year - Lease

3 Year - Buy

5 Year - Buy

The Formulae are as follows

Repayment Schedule as follows

Good Luck