If you’re saving to buy a home, it can be challenging to know when the right time to buy is. There are many factors that influence this decision, but you can use one tool: the price-to-rent ratio in your area.
How the Price-to-Rent Ratio Works
The price-to-rent ratio is one way to determine whether it’s better to rent or buy. First, you’ll need to know how to calculate it to understand how it works.
How to Calculate the Price-to-Rent Ratio
To calculate the price-to-rent ratio in your area, follow this formula:
Median home price / Median annual rent = Price-to-rent ratio
To find these numbers for your area, you will need to do a bit of online research. You can find these numbers on websites like Zillow, RentCafe, the National Association of Realtors, local media, or even government organizations.
How to Interpret the Price-to-Rent Ratio
A price-to-rent ratio of less than 15 indicates that it’s better to buy a home (if you can). On the other hand, a price-to-rent ratio of more than 21 suggests that the housing market may be overpriced, and it might be financially smarter to rent rather than buy.
How to Use the Price-to-Rent Ratio to Make a Decision
You shouldn’t solely rely on the price-to-rent ratio when deciding whether it’s the right time for you to buy a home. The price-to-rent ratio only measures whether the market as a whole favors renting or buying. In other words, you also need to be ready to buy, which depends entirely on your situation. Ultimately, the numbers might suggest it’s generally the right time to buy, but if you don’t have enough saved to afford the down payment or if you can’t manage ongoing expenses associated with homeownership, you might face many challenges in the future. This is called “housing poverty,” and it’s not a pleasant situation.
Here are some other things to consider when deciding if it’s the right time to buy a home:
Can you afford property taxes, homeowners association fees, and insurance? Does buying a home allow you to live a lifestyle that you can’t in a rental? If you upgrade to a larger home, will you be able to handle higher utility bills? Do you have enough savings to cover the down payment, closing costs, moving fees, renovations, new furniture, etc.? Are you ready to conduct home repairs and maintenance yourself instead of calling the landlord? Can you (and remember to) save for home repairs and maintenance?
Another useful tool to gather all this information is the New York Times “Is it Better to Rent or Buy?” calculator. This tool also considers what you might pay for buying compared to renting, but it also takes into account a broader array of factors, like how long you plan to stay in your home, how much property taxes will cost you, recurring home maintenance expenses, and more.
With a Grain of Salt
The price-to-rent ratio can be an important formula to help you make a decision on whether market conditions favor renting or buying from a purely financial perspective. However, it cannot tell you whether it’s the best financial option based on your personal circumstances.
It’s important to note that the price-to-rent ratio cannot determine whether buying or renting is better based on your lifestyle preferences and how much extra money you’ll need to pay if the market doesn’t favor you. Your reasoning for buying a home might be because you truly want to be active in woodworking, gardening, or shooting sports, which could be an investment in your quality of life. Or if you really want to be in the city and prefer not to tie yourself down with property ownership, it may make sense to pay a higher rental price when the market suggests you should buy.
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You find guidance in keeping the price-to-rent ratio as just one factor to consider when making this decision.
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