Buying can still beat renting, even with mortgage rates above 7%

With mortgage rates above 7%, it's easy to assume that renting must be the better deal.

After all, every percentage point added to a mortgage rate increases a buyer's monthly payment. Compared with the ultra-low rates available a few years ago, today's financing costs can feel daunting.

But mortgage rates are only one piece of the buy-versus-rent decision. A more important question is whether home prices are high or low relative to rents.

Looking back at the mid-1990s helps answer that question. Mortgage rates during much of that period ranged from roughly 7% to 9%, not very different from today's conditions. Yet, many households who bought homes during those years ultimately came out ahead financially.

But why? When I analyzed the market from that period, a clear pattern emerged: Homes that were inexpensive relative to their rents almost always favored buying. Homes that were expensive relative to their rents often favored renting and investing the difference.

My analysis looked at two otherwise identical households: One buys a home with a 20% down payment and finances the rest with a traditional 30-year mortgage. The other rents a comparable home and invests all the money not spent on housing. My calculations accounted for property taxes, insurance, maintenance, transaction costs, the mortgage-interest deduction and the option to refinance, as well as taxes on investment returns.

Let’s look at today’s homes market.

Think of the ratio as a home's price divided by a year's worth of rent. A $300,000 home that would rent for $2,500 a month sells for about 10 times its annual rent.

In the lowest-priced fifth of today's market, the typical home sells for about nine times its annual rent. In the middle of the market, the figure is about 13 times its annual rent.

Historically, homes selling at multiples like those almost always favored buying, even when mortgage rates were similar to today's. Only among the most expensive homes (the shaded area) did renting and investing turn out to be competitive with buying.

One reason is that rents don’t rise as quickly as prices do as you move up the housing market. Using Homes.com data, the priciest fifth of homes rents for about 5.7% of its price each year, compared with 10.8% for the least expensive fifth. The amount people are willing to pay to own a home tends to increase faster than the amount they’re willing to pay to rent one.

Historically, buying has looked most attractive at the lower multiples and least attractive at the higher ones.

You can check any home you’re considering the same way. Look up its price on Homes.com, along with what similar homes nearby rent for, and divide the price by a year’s rent. For buyers in the mid-1990s:

• If the home cost less than about 14 times its annual rent, buying usually produced more wealth.
• If the home cost less than 14 to 20 times its annual rent, it was a toss-up that depended on how the renter invested.
• If the home cost more than 20 times its annual rent, renting and investing the difference generally came out ahead.

That helps explain why the case for buying appears strongest in the lower and middle segments of today's housing market and much less clear-cut at the top end. Higher-priced homes are not necessarily poor investments; they simply sit much closer to the range where renting and investing the difference can produce comparable financial results.

 

For prospective buyers, the lesson is simple: Don't let mortgage rates alone make the decision for you.

A 7% mortgage rate is certainly expensive compared with the recent past, but history suggests that buyers of lower- and middle-priced homes have often come out ahead financially over the long run, even when mortgage rates were above 7%.

One caution: Those 1990s buyers also benefited from refinancing as mortgage rates fell over the following decades. That may happen for today’s buyers, too, but they shouldn’t count on it — so a home near the threshold is closer to a toss-up than history suggests.

For renters, the story is more nuanced: Renting may remain financially attractive for higher-priced homes, particularly for households that consistently invest their savings and expect to move again within a few years.

The key point is that mortgage rates alone don’t determine whether buying makes sense. Even with rates above 7%, the financial case for ownership can be surprisingly strong, especially in the lower and middle portions of the market.

What matters most is not just the cost of borrowing, but how much home value you're getting for the price you pay.

The Consumer Price Index inflation report, due Oct. 14. Inflation remains one of the biggest influences on long-term interest and mortgage rates. A softer-than-expected reading could encourage lower bond yields and improve the outlook for homebuyers. A higher reading could reinforce expectations that borrowing costs will remain elevated. Either way, the report will provide an important clue about where housing affordability may be headed.