Until interest rates hit 10.5%, Buying remains cheaper than Renting

The recent rise in mortgage rates has made buying a house a little more expensive: the increase in the 30-year fixed rate over the past month from 3.4% to 3.9% (Freddie Mac) raised the monthly payment on a $200,000 mortgage by $56, or 6%. However, because mortgage rates are still near long-term lows, and because prices fell so much after the housing bubble burst and remain low relative to rents even after recent price increases, buying is still much cheaper than renting. That means that the recent jump in rates doesn’t change the rent-versus-buy math much.

Rates are likely to keep rising, but how far must rates rise before buying a home starts to look expensive relative to renting? To answer this, we updated our Rent vs. Buy analysis with the latest asking prices and rents from March, April, and May 2013. Following our standard approach, we calculated the cost of buying and renting for identical sets of properties, including maintenance, insurance, taxes, closing costs, down payment, sales proceeds, and, of course, the monthly mortgage payment on a 30-year fixed-rate loan with 20% down and monthly rent. We assume people will stay in their homes for 7 years, deduct their mortgage interest and property tax payments at the 25% tax bracket, and get modest home price appreciation (see the detailed methodology and example here). Here’s what we found:

Buying remains cheaper than renting so long as mortgage rates are below 10.5%. At 3.9%, the current 30-year fixed rate according to Freddie Mac, buying is 41% cheaper than renting nationally. With a 5% mortgage rate, buying is still 34% cheaper than renting nationally. Mortgage rates would have to rise a huge amount – to 10.5% – to tip the math in favor of renting, which isn’t impossible. Rates were that high throughout the 1980s, but have been consistently below 10.5% since May 1990.

Each local market, of course, has its own mortgage rate “tipping point” when renting becomes cheaper than buying a home. At 3.9%, buying is cheaper than renting in all of the 100 largest metros, which means the tipping point is above 3.9% everywhere. The tipping point is lowest in San Jose, which would tip in favor of renting if rates reach 5.2%. It’s between 5% and 6% in San Francisco and Honolulu, and between 6% and 7% in New York and Orange County, CA.

But for 78 of the 100 largest metros, the tipping point is 10% or higher. In fact the tipping point is above 20% in Cleveland, Memphis, Detroit, and several other metros in the Midwest and South.

Of course, the tipping point also depends on how long you plan to stay in your next home (we assume 7 years) and whether you itemize your deductions (we assume you do). For instance, if you don’t itemize, or if the mortgage interest and property tax deductions were eliminated entirely, buying would still be 29% cheaper than renting at a mortgage rate of 3.9%, and the tipping point when renting becomes cheaper than buying would be 7.5%.

But just because buying is cheaper than renting, it doesn’t mean you can buy. Lots of people who want to buy don’t have the down-payment or can’t get a mortgage. Even people who can swing it financially might not be able to buy right away, before rates rise further, because they might not find the home they want quickly with inventory still so tight.

So if the recent increase in mortgage rates doesn’t change the rent-versus-buy equation substantially, why does it matter? The main effect is to reduce the demand for refinancing. Unlike home buying, refinancing is a relatively straightforward financial decision: although refinancing has upfront costs, refinancing doesn’t require finding a home, thinking hard about your lifestyle, or moving. Since rates have been low for so long, many people who were able to refinance, already have. As a result, the demand for refinancing is now dropping.

For people who haven’t yet refinanced – and for people looking to buy – rising rates do make housing more expensive. Rates are now on the rise and are likely to keep rising, thanks to the strengthening economy and the Fed eventually trying less hard to keep rates low. But it will take big rate increases to turn off prospective homebuyers. At today’s prices and rents, rates would have to rise to levels we haven’t seen in 20 years before renting is cheaper than buying a home on average across the country.
~By Jed Kolko, Trulia Chief Economist

Seattle’s Competitive Housing Market

A real estate rebound is now taking place in Washington, but just how strong it it? KING 5 took that question to experts at the University of Washington.

The state’s housing market has improved steadily for three quarters in a row, and is showing no sign of slowing down. Currently, home sales are about 15% higher than they were at this time last year.

“It’s classic supply and demand,” said Glenn Crellin, who is the associate director for research at the school’s Runstad Center for Real Estate Studies. He says Seattle and King County are experiencing the biggest shortage of listings he’s ever seen.

That lack of inventory is helping sellers, like Noble Hendrix and Anna Dukes. The couple put their three bedroom house on the market in the fall of 2011, and watched seven weeks go by without a single bite.

“At the time when we were looking to move, the market was in such a low point,” said Dukes. “It was looking like even if we did sell, it would be well below what we originally paid for it, so we decided to hold on to it.”
They decided to try again this month, and were stunned by the difference those 18 months made on the housing market. “You know, it was just astounding, the number of realtors that were coming by or people that were looking on their own,” said Hendrix.

After just a week on the market this time around, they had three solid offers. The one they eventually accepted was 10% more than their asking price. “Yeah, this is definitely a much different market,” said Hendrix.
Crellin says sellers can expect that trend to continue as long as the inventory remains where it is.
“The industry generally says a five to seven month supply of homes available for sale, both new construction and re-sale, is what’s normal – and we’re sitting at less than a two month supply in King County,” he said.
Because of that, he said buyers can expect to pay a bit more.

Fortunately, low interest rates are helping make those purchases more affordable.

Crellin says quarter-to-quarter home sales increased in 28 of Washington’s 39 counties at seasonally adjusted annual rates.
~ by Heather Graf, King 5 News