How Long you should Rent before you Buy a House

When to buy real estate can be as tricky as when to invest in a stock. How do you time your purchase? Today, the markets are precarious. There are a few things you can use to determine when you’ve rented long enough. These things can help you time your buying decision and determine a price.

When buying a home is also a financial decision, there are three aspects of the financial markets that can help you better time your purchase and determine a price.

1. The economic indicators are a good tool to use for timing.
2. Inflation is something to keep in mind because inflation is going to make timing the market more difficult.
3. Comparing the financial benefit of owning a home to renting can help you determine what you are willing to pay a month.

Usually, we are trying to buy before the market turns around or just after the market turns around. How can we identify when housing prices have stop declining? The financial economic indicators can be a great tool to time the markets. There are three types of financial economic indicators: leading, coincident, and lagging economic indicators. You’ll be concerned with the leading and lagging economic indicators.

Leading indicators will change direction first. These indicators can indicate that the economy is changing direction. The LEI (leading economic indicators) need to start slowing down on their current direction and then reverse. Some of the critical items to watch include: Monetary Policy (interest rates) and Money Supply Growth (M2). Other indicators which usually lead to an economic recovery are the ISM report (manufacturing and non-manufacturing).

In the LEI, Monetary Policy and Money Supply are key FED indicators that can foreshadow a change in the economy. When the FED begins to encourage spending through interest rate cuts and increase money supply, they are trying to stimulate the economy.

The FED is encouraging spending and increasing money supply right now. These two indicators have turned around. Start watching the rest of the Leading Economic Indicators to see if they follow. When most of the indicators start to show a recovery, we may be in a recovery.

The lagging indicators are: housing prices, consumer spending and the unemployment rate (overall number of unemployed individuals). These indicators are usually last to turn around. After the economy starts to recover, housing prices can take as long as six months to a year to stop falling. Unemployment rates can take as long as a year to two years to start declining.

Because housing prices are a lagging indicator, the indicator is easier to follow. When you feel that the leading indicators are showing a recovery, housing prices need to show some type of stabilization.

Using the financial economic indicators can help you make a decision whether we are in a recovery or a temporary rebound in a declining market.

Before hitting a recovery, we will have a couple rebounds that are quickly followed by a continued decline. In the first rebounds, we will see a race to buy as investors try to get in before the market takes off again. But the market doesn’t take off. The market turns around and continues to decline. We already saw, last year, a couple of these rebounds in the housing market. Many of those buyers are already upside down on their purchase.

Not using the financial economic indicators to help make your purchase decision can make you like many investors. When housing prices began to rise in earnest, you’ll be gun shy and miss the first, second, and sometimes the third run. Stay on top of the economic indicators. They can help you determine where we are in the financial cycle and help you make a better purchase decision.

The second item that will help you time your purchase is inflation. Inflation is throwing a wrench into predictive tools. Most of us grew up learning increased demand and limited supply created inflation. That can create inflation. The larger contributor to inflation is printing money also known as devaluing of currency.

M2, the supply of US dollars into the global economy, has been increasing for a long time. The FED has the ability to print money. Today, it happens with an electronic entry into a computer system. The FED increases the supply of dollars into the global economy with these entries.

Historically, we’ve exported our increased supply of dollars through the sell of treasuries. In the last six months, we’ve printed more money than most of us can count. Thank goodness we have computers. The question is, “How long will these surplus dollars be in circulation before we start seeing inflation?”

It’s an interesting question. We haven’t been here before. We’ve seen other countries experience a devaluation of currency and the impact in their economy. Germany’s Weimar Republic is an example of devaluing currency. Germany’s currency devaluation was also the key impetuous to WWII. The fall of Rome follows Rome’s devaluation of currency.

At some point and time, all the money that we’ve been printing will come back to roost in the US as inflation. An example is we started printing dollars under President Clinton. We printed even more dollars under President Bush. It took 12 years for the effects to come back to the US. President Bush definitely thought he was going to be out of office before all the dollars he had printed came back to the US.

We don’t really have a way of predicting when the inflation will come back to us. It’s reasonable to assume we will feel the effects of the dollars we printed much sooner than 12 years. It may just be a year or two.

Why would this inflation hit us so much faster than 12 years? Today, we’ve increased the supply of treasuries to a point where we’ve outpaced demand. The FED prints money and buys the excess securities and calls it Quantitative Easing. The surplus dollars stay in the US and are not exported. This time, we don’t have to wait for the money to come back to the US.

Inflation is a very tricky fellow. The CPI tracks inflation until we are experiencing inflation. Then the government removes the items which caused price inflation and calls the reduced set the “core CPI”.

Another indirect measure of inflation may be the US dollar index. The index is a weighting of global currencies. The index takes the currency weighting (called a basket) and values the US dollar against the basket. The index isn’t a one-for-one measurement. It can only give you an idea of the value of the dollar.

In September 2000, the U.S. dollar index was 114% which means the dollar was strongly valued against other currencies. After 2000, we started printing money in earnest. Today, the index is at 86%. When the US began to feel the effects of inflation, during the last term of President Bush, the dollar index went under 74%. There is a correlation between a lower index value and a higher price of goods and services.

Inflation will happen. When it will happen is a big question mark. You’re going to have to make a call on inflation when you decide to purchase a home. The whole world has been printing money to try a maintain currency values. All the new money makes it reasonable to believe the next inflation will be much more serious than 2008. Yet, it is also reasonable to assume that housing prices will be one of the last things to inflate.

Finally, between renting and buying, try and create a modified lease vs. buy assessment. This is just to get an idea of what price you want to pay. You can make it as easy as comparing your rent payment to your mortgage payment.

Five years ago, to rent or buy was an easy decision to make. Housing prices were sky-rocketing and rents on comparable homes were falling. In my area, rents were about 40% of the mortgage, tax, and insurance payments on comparable homes. Here is one way you could look at the situation.

Does it make more financial sense to rent or buy?

Mortgage: $2,200/mo x 12 months = $26,400 annual outlays for about $7,900 tax deduction.

Rent: 900/mo x 12 months = $10,800 annual outlay

Mortgage Rent = the additional money being spent to get a $7,900 tax deduction.

(Mortgage)$26,400 annually – (Rent) $10,800 = $15,600 additional spent on the mortgage.

Adjust the $15,600 by the tax deduction of $7,900 and the owner is paying an additional $7,700 to own the home. It makes more sense to rent.

To determine when buying a house is more efficient than renting, reverse this assessment.

Rent: 900/mo x 12 months = $10,800 annual outlay.

You will want your mortgage, insurance, and taxes MINUS the tax deduction to equal or be less than the $10,800 spent annually on rent (This is assuming that rent is a fair indicator of value and you think the market is still going down).

(Mortgage/insurance/taxes) – 30% (mortgage/insurance/taxes) = $10,800

This formula gives:

70% (Mortgage/insurance/taxes = $10,800

Which gives:

(Mortgage/insurance/taxes) = $10,800/70%

This calculates to: $15,428 annually divided by 12 months to get $1,285/mo.

So, when you can pay $1,285 a month for a comparable home, that could be a good time to buy. Yet, if your indicators haven’t turned around and inflation hasn’t taken off, you may want to wait. Housing prices may be going lower.

These are some suggestions on how to time the market and make your purchase. Other noise is going on in the market which may positively or negatively impact a purchase decision such as the buying up of assets by the government. Yet, by following these steps you will know what to negotiate and will be better informed. That makes you a better consumer and will help ease the stress of buying a house in today’s market.