Rent vs Mortgage Costs – It’s Complicated

It appears that the cost to own is less than the cost to rent in many markets. According to Redfin, the average December rental bill was $1,877. That compares with a $1,553 median monthly mortgage payment for those who buy with 5% down.

“Rents,” said a scary headline in The Washington Post, “are up more than 30 percent in some cities, forcing millions to find another place to live.”

“Average rents rose 14 percent last year, to $1,877 a month, with cities like Austin, New York and Miami notching increases of as much as 40 percent,” said the paper.

According to Redfin, annual rents were up 39.9% in Austin, 34% in Miami, and 34.5% in New York. If the average rent increase is 14.1% then 30% and 40% increases are simply not the norm.

The Redfin study also showed that rents increased just 1.3% in St. Louis, 6.7% in San Jose, and 7.5% in Columbus, OH. They fell in Kansas City, MO by .8%. The most representative metro area for rents is Nashville, where lease costs were up 13.9%.

Context

The comparison between rental and ownership costs is complicated. The raw numbers may not tell us everything we want to know.

“Year–over-year rent-price increases outpaced year-over-year mortgage payment increases for new homebuyers in just 16 of the 50 largest U.S. metro areas in December,” said Redfin. That also means in 34 of the 50 largest metro areas, mortgage payment increases for new home buyers were greater than the higher costs faced by renters.

Context is important. If we accept that rental rates increased 14.1% during the past year, is it unfair to point out that the consumer price index rose 7.0% during 2021? Might we also mention that rental rates do not exist in isolation, that property taxes, insurance costs, and repair bills are hardly flat?

Mortgage rates

If we are to compare rental and ownership costs, then why not say that mortgage costs for new financing have also been rising? They were up 37.5% in Austin, 29% in Miami, and 14.5% in New York, according to Redfin. Nationally, says the company, rental costs were up 14.1% while monthly mortgages for new financing rose 21.6%.

New buyers who financed in January 2021 paid, on average, 2.74% for fixed-rate financing. That’s the lowest monthly cost recorded by Freddie Mac since 1971. In the final week of January 2022 the typical rate was 3.55%, a huge increase.

But, mortgage costs did not rise for all borrowers. Mortgage rates for most borrowers are fixed. In fact, mortgage costs fell for quite a few. According to the Mortgage Bankers Association (MBA), mortgage balances worth $2.32 trillion were refinanced in 2021. What is the typical refinancing result? It’s surely not higher mortgage costs.

Rent-versus-own cost comparisons

A confounding problem with rent-versus-own cost comparisons is that rent and monthly mortgage costs are not the same thing.

An $1,877 rental cost means 100% of the payment goes from the tenant to the real estate investor. Rent often includes utilities and sometimes cable. There is typically not an additional cost for taxes or property insurance.

Mortgage payments are different. Redfin defines “monthly mortgage payment” to mean principal and interest. In practice, homeowners with mortgage financing also pay property taxes and property insurance, either directly or as part of their mortgage payment. Utilities and cable in most cases are additional costs for property owners.

But, not all of a mortgage payment is a “cost” in the usual sense of the term.

“Suppose you buy an existing home for $355,000 with 5% down,” said Rick Sharga, Executive Vice President with RealtyTrac, “There’s a $337,250 mortgage. At 3.6% interest, the monthly cost for principal and interest is $1,533. On one hand, taxes and insurance are extra. On the other, because of monthly principal reductions, the owner cuts the loan balance by roughly $6,350 in the first year of the mortgage term. Principal payments can be seen as a form of enforced savings.”

These monthly and yearly differences add up. According to the Federal Reserve, property owners in 2019 had a typical net worth of $255,000 versus $6,300 for tenants.

And, of course, it’s possible to pay off a mortgage, to have no monthly cost for principal and interest. The National Association of Realtors reports that in December cash purchases accounted for 23% of all existing home purchases. The Census Bureau says 37.3% of all homes are owned free and clear.

Is renting more or less expensive than ownership or vice versa? There’s no easy answer, it depends on how costs are counted, but one thing is certain: Given that the 2021 inflation rate reached a 39-year high and recognizing that we have a shortage of both rental and owner units, higher prices for shelter are just what one would expect.