Financial considerations in purchasing a home

[TXScout2]

Hello,

I am thinking about purchasing a home.  I want to consider it purely as a financial decision; if it's cheaper to rent, I would rather rent.  Here's how I am seeing it play out, let me know if I am getting something wrong.

Mortgage payment which includes property tax and PMI will be about $2000/month.
The place has a 1/1 back-house which I think I can rent out for about $800/month.
So I am left covering about $1200/month on my own.

I will get a mortgage interest deduction, and a property tax deduction. Property tax will be about $4200/year.  I am estimating the mortgage interest the first year will be substantial because the loan is front-loaded, so I think $16,000/year is a safe estimate.  So together those 2 add up to $20,200/year in deductions.  At a 25% tax rate, that would save me $5000/year in taxes.  $5000/12 months = $416 per month.

So $2000 mortgage - $800 from renter - $416 tax breaks = $784/month. 

Obviously I also have to consider repairs, so I need to have an inspection done to make sure the house doesn't have any bad problems.

I could probably rent for $800 a month, with no repairs to worry about.  But in the property case I am building equity and possibly having the property appreciate on a leveraged basis since I am actually renting out a part of it. 

Please let me know if I am missing something. I haven't ever purchased a home before so I am sort of just trying to figure this out in my head.

Thanks!

[johnny847]

You haven't considered the opportunity cost of locking up equity into a home. http://jlcollinsnh.com/2012/02/23/rent-v-owning-your-home-opportunity-cost-and-running-some-numbers/

[AJ]

A few questions:

• Is the rental on it's own utility meters? If not, how will you factor in the additional utilities from the renter?
• What is the principal portion of the mortgage in Month 1, and what is your estimated repair budget (very roughly 1-5% of the value of the house per year depending on the age and condition of the home, it's size, etc.)
• How long do you expect to live in the home?
• Do you already itemize your deductions?
• How much money will you be putting down?

[TXScout2]

I'm not sure about the opportunity cost works.  I am paying the $800/month in rent anyway, so I couldn't gain any interest on that.  Assuming the cost of the house to me is equal to the amount of rent I would pay, there should be no opportunity cost, right?

1.  Hadn't looked at the utility meters, good point.
2.  I am trying to figure this out, the worksheets I got from the mortgage company don't have this information.
3.  I figured I would live in it at least 2 years, and possibly just turn it into a full on rental property after that. 
4.  I've never itemized before, I just take the standard deduction.
5.  Was planning on putting somewhere around $50,000 down. 

[MsFrugalista]

TXScout2 - you might find this useful (if you haven't tried it already)? I know this was a helpful tool for us when deciding to buy a home last year.
http://www.nytimes.com/interactive/2014/upshot/buy-rent-calculator.html

[TXScout2]

I have seen the NYTimes app before; pretty cool.  It tells me that if I can rent for $1000/per month or less, then renting is better.  But it doesn't have any way to account for the fact that I would be renting out the back house.  So maybe it's saying if I can rent for $200/month or less, then renting is better?  In that case it seems I should buy immediately!   I feel like it is better to buy, but the purchase is so large I feel it is fraught with peril. 

[AJ]

2.  I am trying to figure this out, the worksheets I got from the mortgage company don't have this information.

There are calculators online that will tell you this. Or, you could share the amount of the mortgage and expected interest rate and I could look it up for you.

4.  I've never itemized before, I just take the standard deduction.

In that case, you're not really getting $416 "extra" per month from your tax deductions. The standard deduction is $6200, so you would need to factor that part out. $20,200 - $6,200 = $14,000 in extra deductions beyond what you're already getting. Works out to about $292 a month.

5.  Was planning on putting somewhere around $50,000 down.

There will be an opportunity cost on those funds, since you would otherwise have been able to invest them. At 5%, that cost is about $210 a month.

So then the breakdown would be:

Costs:
$2000 (PITI)
$210 (opportunity cost of down payment)
$X (Repair budget)
$Y (Renter's utilities)
TOTAL: $2210 + X + Y

Contribution to Net Worth:
$760 (Rent, less 5% for vacancy)
$292 (Tax benefits)
$Z (anticipated appreciation) (I suppose a rough guess would be 2-3% of the value per year)
$W (Principal portion of payments)
TOTAL: $1052 + Z + W

[MikeBear]

Perhaps you could consider putting some paying housemates in to share the one you'll be living in, for additional rental money. That could make this even better, if conditions are right for it.

[Earthling]

This is one of those topics that is rife with default rules which, over my lifetime, I've found to be basically correct.

Rule #1: A home is not an investment.

Rule #2: Unless you intend to live in a house for at least 5 years, do not purchase it.

Rule #3: Despite Rules ##1 & 2 above, the most money I have ever made in my life were real estate investments -- more specifically, homes that we lived in. And currently one-third of our net worth is reflected in the equity in our paid-off/debt-free home which we have lived in for going on 21 years now. If we had to sell and downsize to a double-wide in another part of the country with a lower cost of living tomorrow, we could do so in a heartbeat, thereby liberating and living off of our equity for decades to come. So our paid-for house is our Helm's Deep back-up plan.

[Goldielocks]

You did not mention net impact on your transportation costs.

Many of us don't include it in the analysis, but it is very real.

Also things like closet shelves, lawnmower, garden hose, garbage can, fence repair, pruning diseased tree...

Maintenance fund is really just for doors, roof, windows, heating, etc.

[Scotch & CPA]

You should also figure that you should include the rent income on your taxes. You can then deduct certain expenses, but this won't even out. While I'm sure many people do not include rental income on their taxes, it's an easy way to get dinged. Some cities require that you register with the Licenses department to rent any part of your home. Again, I'm sure there are a ton of people who skip this step, but if things go sour with your tenant, you don't want to have to go through the eviction process, while not in compliance with the regulations in the city.

To be conservative, I would also throw in: Rent $800 * (1 - 25% tax rate) = 600 in net rent.

[TXScout2]

Okay so I did some research.  The house is $370K, $320 of that would be the loan.  So it looks like on month 1, about $480 is principal. 

And from the amortization schedule it looks like I fairly accurately estimated the mortgage interest at close to $12,000 during the first year. 

I did not realize that the mortgage interest deduction is offset by the standard deduction, that significantly impacts the calculation.  I also have the opportunity to pay extra the first year until I have gotten to 20% equity and then I can drop the PMI. 

I do have the option of potentially renting out a room in the front house also to cover more of the mortgage. 

Re: counting the rent as income, is that right?  I am thinking about it, it seems like if the backhouse was truly a rental income property, I shouldn't deduct whatever value it is worth as a mortgage interest payment since I don't occupy the place.  So I would lose money on the mortgage interest deduction.  On the other hand, if it's truly an income property, the $800/month shouldn't really count as income because it would be offset by the cost of the property to me, i.e., the mortgage payment on it.  I'm not exactly sure how that would work...

If I add in equity as the W variable, I get this:

Costs:
$2000 (PITI)
$210 (opportunity cost of down payment)
$X (Repair budget)
$Y (Renter's utilities)
TOTAL: $2210 + X + Y

Contribution to Net Worth:
$760 (Rent, less 5% for vacancy)
$292 (Tax benefits)
$Z (anticipated appreciation) (I suppose a rough guess would be 2-3% of the value per year)
$480 (Principal portion of payments)
TOTAL: $1532 + Z

So it's not as good as a purchase as it seems.  Although renting out the other room would help.  As would paying off the PMI.  The calculation sort of changes each month with the amortization schedule. 

Re: transportation costs, it's actually less than 2 miles from my work so I could bike it.  But should I rent I would probably live equally as close so it's sort of a wash.  This is a growing area so I am kind of hoping for a greater than 2-3% appreciation, so

[Scotch & CPA]

Re: Rental Income

This may help with the expense side, but generally, if you're receiving income, you should claim it.

http://www.irs.gov/taxtopics/tc415.html

"Used as a home and rented 15 days or more.   If you use a dwelling unit as a home and rent it 15 days or more during the year, include all your rental income in your income. Since you used the dwelling unit for personal purposes, you must divide your expenses between the rental use and the personal use as described earlier in this chapter under Dividing Expenses . The expenses for personal use are not deductible as rental expenses."

http://www.irs.gov/publications/p527/ch05.html#en_US_2014_publink1000285446

[TXScout2]

That's good tax information, thanks for that.  I wonder if I started an LLC and had it own the property instead of me, if that would change the tax information.  I guess I would lose the whole mortgage interest deduction, but be able to discount all the rental income with the mortgage cost.