August 2, 2000, Revised October 2, 2007

Whether a prospective homeowner should buy now, or wait until they can save for a down payment, depends on many factors. These include the expected rate of house appreciation, the difference in interest rate and mortgage insurance between a no-down payment loan and a loan with a down payment, and the buyer's tax rate. The sub-prime crisis in 2007 shifted these factors toward waiting.

Factors Affecting the Buy Versus Rent Decision

"Please settle an argument. I believe that we should buy our house now, even though we have no money for a down payment, because our credit is good and we can get a 100% loan. House prices have been rising in our area by about 4% a year. My wife thinks we should save for a year first to accumulate enough to put 5% down. What do you think?"

The question, “How long should I continue to rent before I buy” keeps popping up in my mailbox. There are a lot of “Rent Versus Buy” calculators on the web, but they all assume that people want either to rent or own for the remainder of their lives. To answer the question that people actually ask, Charles Freedenberg and I developed calculator 6a, Buy Now or Save First.

Whether you would you be better off buying first or saving first will depend on which option results in the lower net cost over the period you expect to be in the house. I assume you will be in your house 6 years if you buy now, 5 years if you wait a year.

An important factor influencing the result is the expected rate of house appreciation. Higher appreciation increases the cost of waiting. I use your assumption of 4% appreciation, with an initial price of $100,000.

A second important factor is the difference in interest rate and mortgage insurance between a no-down payment loan and a loan with 5% down. A larger difference in rate and insurance premium increases the cost of buying now rather than waiting. I assume a rate of 8% and an insurance premium of .78% with 5% down, and a rate of 9% with an insurance premium of .9% with zero down. The loans are for 30 years.

A third important factor is your income tax bracket. Tax savings on mortgage interest reduce the effect of the higher rate paid when buying now. I assume you are in the 15% bracket.

The fourth important factor is the interest opportunity cost: the interest rate you could earn on the money you save for a down payment, on the rent, and on the monthly payments. The higher the rate, the higher the cost of buying now. I assume a rate of 4%.

Other assumptions that affect the result are the rent you pay during the year you are waiting to buy ($400), real estate taxes ($100), home owners insurance ($30), rental insurance ($15), points paid on both loans (zero), and other closing costs (zero).

Based on these assumptions, the cost of buying now would exceed the cost of saving first by $1411. You can use the calculator to vary the assumptions so that they correspond more precisely to your situation. For example, if you are in the 28% tax bracket, the cost of buying now would be $973 less than the cost of saving first.

Impact of the Sub-Prime Crisis in 2007

House price appreciation ended in 2007 in most areas, which removed one of the major factors inducing prospective home buyers to act before they were quite ready. Furthermore, the difference in cost between a no-down payment loan and a down payment loan widened markedly -- indeed, no-down payment loans became very difficult to obtain. This reinforced the advantage of waiting before buying.