Question

Emma Sanchez is currently renting an apartment for $725 per month and paying $275 annually for renter’s insurance. She just found a small townhouse she can buy for $185,000. She has enough cash for a $10,000 down payment and $4,000 in closing costs. Her bank is offering 30-year mortgages at 5 percent per year. Emma estimates the following costs as a percentage of the home’s price: property taxes, 2.5 percent; homeowner’s insurance, 0.5 percent; and maintenance, 7 percent. She is in the 22 percent tax bracket and does not plan to itemize deductions on her taxes. Emma estimates that the value of the home will appreciate 2 percent per year. Calculate the cost of each alternative and recommend the least costly option—rent or buy—for Emma.

Answer 1

Let's approach the answer with first option that is Rent:

Annual Cost of Rent: $725*12=8700

Add: Renter's Insurance=$275

Total Cost=$8,975

Now if she purchased a house then let's see how much annual cost she need to bear:

EMI=$185000-$10,000=$175000/Total PVIF @5% for 30Years

EMI=$939.44

Hence. Annually it would be $939.44*12=$11273.28

So, it is quite clear that by purchasing the owned home Emma needs to bear extra cost of $2298.28 per year apart from the yearly expenditure that is property taxes insurance and maintenance which is of 10% of total cost of the house that is $18,500($185000*10%).

Hence, to purchase a house is not feasible and to go for the rent option is more viable for Emma.