Buy or Sell

Topics: Real estate, Inflation, Net present value Pages: 5 (1729 words) Published: March 5, 2013
There are several factors to consider when deciding whether to rent or buy a home. In our case study, Beth and Jon Linton are considering the critical decision of buying or renting at Stedman Place in Newton, which is a western suburb of Boston, Massachusetts. The timing of this decision is important, as the decision is being made in July of 2006, before the housing market downturn. The case gives insight into the couple’s decision-making process, and the pros and cons of buying versus renting are weighed. There are a few important benefits associated with buying a home that Beth and Jon will want to consider. First, as Beth’s father has mentioned, building equity in a home can be preferable to renting, where there is no chance of recouping the cost. While the benefit of building equity is certainly valuable, the Lintons will be financing with an interest-only loan for the first five years, which means that the only way they will gain equity is though profits of the sale, if the value of the home increases over their intended ownership period. There are other benefits of buying, such as the tax break on both the mortgage interest and property taxes. On the contrary, there are also risks associated with buying a home that the Linton family must also consider. First, additional costs must be factored in when purchasing a home, such as maintenance and increased insurance premiums. As long as the family rents, these costs are minimal. The other key consideration is the decreased liquidity of assets for the family, as they will be investing a significant portion of their savings in a down payment for their home. There are factors to consider when making the decision to buy or rent that are not discussed in the case. First, the case indicated that sources were predicting a softening in the housing market; however, the financial viability of the plan to purchase the house is dependent on the home maintaining a certain value. If the market softens more than anticipated, the Lintons could end up losing money on the transaction given that they have a fixed time frame for selling the house. Also, if the Lintons’ plans change, either to remain longer or shorter, the family also faces negative consequences due to their method of financing. If the family ends up staying longer, maybe due to Jon’s extended residency, the adjustable rate mortgage may be problematic and cause the monthly payments on the house to increase significantly. Using the Net Present Value of cash flows as a tool for analysis, the couple will be better off buying the townhouse than to continue renting their current house (See Fig. 1). The couple may want to make certain assumptions concerning the inputs in trying to find the current cost of either decision. For the rate of inflation they may want to assume 2.56%1 which is the average inflation rate for the 5 years prior to 2006. The appropriate discount rate for the various cash flows is also assumed to be 4.99% which was the average interest rate of public debt in the U.S. as of July 20062. The Net Present Value of the decision to rent their current house for the next 5 years is -$175,102, which means that the decision is equivalent to paying this amount today(July 2006). However, the Net Present Value of the decision to buy the house is $170,591, which means that assuming the Lintons successfully sell their house after 5 years their decision to buy is worth this amount today( July 2006). The calculations in Fig 1are based on a few assumptions; property taxes remain constant for the 5 years reviewed since it is assumed the couple will not have their house assessed again until they are ready to sell the house. Maintenance costs are assumed to increase with perceived inflation of 2.56% per year, the yearly incomes from the bonds have been adjusted for taxes and the sale value of the house after the 5 years assumes a growth rate of 4% per year. The growth rate of home prices in the United States for the 5 years prior...
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