Renting vs. Buying a Home

From an article in the WSJ, "First-Timers Begin Looking At Houses Again: Lower Prices, Mortgage Rates Lure Buyers Off the Sidelines:"

"The share of first-time home buyers dropped earlier this year to its lowest level since 1987. First-time home buyers now account for 36% of home purchases, down from 40% in the three previous years.

High home prices have helped drive many first-time buyers out of the housing market. Now, with prices falling in many areas, there are some signs that buyers are beginning to drift back."

By definition, first-time home buyers are renters, and make a rent-buy decision based on the relative cost of renting a house or apartment vs. buying a house or condo. Therefore, there is significant competition between the two real estate markets: rental market vs. home buying market.

As the table above shows, the cost of renting an apartment, relative to buying a home, has decreased in all cities (except Indiapolis) over the last 5 years, due mostly to the 42% rise in home prices over this period. The table also show that in 2001, it was about 2% more expensive to rent than buy on average, but now it is about 21% less expensive to rent than buy. However, as home prices and interest rates fall, the advantage is shifting back towards buying, and the first-time home buyers are shifting from renting to buying, as the article points out.

For example, a year ago, the monthly payment for a home at the median price of $229,000, at the average 30-year mortgage rate of 6.33%, with a 20% down payment, was $1138. Today, the monthly payment for a median price home of $221,000, at the current rate of 6.16%, would be $1,078, or 5.3% lower than a year ago.

Bottom Line: There probably won't ever be a significant crash in home prices, because of a powerful self-correcting mechanism in place: Once home prices start to fall enough, the advantage shifts towards owning a home vs. renting, first-time homebuyers are attracted by the falling prices, and the demand for buying houses increases. Right now, it's as if houses are "on sale" at a 5% discount compared to a year ago because of falling home prices and falling interest rates. If Macy's can have a sale, why not the real estate market? It's a great time to buy a house.