 Personal finance practice problem using OneNote. Buy or rent home decision problem number two. Get ready to get financially fit by practicing personal finance. OneNote. You're not required to, but if you have access and would like to follow along, win the icon on the left hand side practice problems tab in the 7222 Buy or Rent Home Decision problem two part number one. Also take a look at the immersive reader tool or practice problems are in the text area as well with the same name, same number, but with transcripts. Transcripts can be translated into multiple languages and either listened to or read in them. Informations on the left hand side calculations in the blue area on the right and on down below comparing and contrasting the yearly costs and benefits from renting versus purchasing a home. This could be useful if your decision is to go from say renting to purchasing a home or if you're trying to make that decision and or similar kind of scenario. If you're thinking about buying rental property then thinking about the rent as the potential income you might be getting on it. When you're making a decision, a financial decision that has two paths that we can take to alternatives such as renting or purchasing a home. We're focused on those differential factors because those differential factors are the ones that are different that we're going to be making the decision based on. We're focused here not so much on the initial purchase but we're trying to think what's going to be the comparison of the yearly costs and benefits after the initial purchase at this point in time. Also note that there could be non-financial components that you need to consider as well. So clearly if you're moving from renting to purchasing you might be moving to a bigger place that you want to take into consideration or something like that. You might be also thinking about the idea of just owning a home has value to it. So we would like to quantify the values as much as we can because that makes it easier for us to measure things. Abstract things are hard to measure and it makes it hard to make the decision. But those things are something that we have to take into consideration as well of course. So the information is on the left hand side. I'm going to say the home cost for the 300,000 this time. We'll get into basically more detail on putting the amortization schedules and stuff together afterwards. And right now we're just going to try to think about the component of the comparison of the year by year costs and benefits. We got the homeowners association fee per year. So if you in a place that has homeowners association fees those are going to be something we got to take into consideration. The marginal tax rate the rent payment for a house. So now this is going to be the rental side of things. The renter security deposit renters insurance that we have to pay the savings account interest rate. What we earn on our savings account 2% mortgage payments. So this is something that we might calculate if we're trying to do estimates and comparisons. We might calculate this with an amortization schedule and so on. We'll talk about how to do that afterwards. This might be the thing that you do first to get some of these yellow numbers. That's why we made them yellow here. But we're going to assume that we already pulled those numbers to start off with so we can focus first on this comparison. We've got the national average property tax rate. We've got the homeowners insurance payment. We've got the maintenance and repairs as a percentage. If we can do it as a percentage that can be useful if we're putting together a worksheet. Because that allows us to change the numbers and have different projections a lot more easily. So the interest lost on down payment or closing costs. And then we've got the mortgage interest paid in the first year. This is something and we could try to say mortgage interest on average or first year interest will change from year to year. We'll talk more about interest in the end of the end of this problem. Estimated annual depreciation. Appreciation and equity growth from paying down the loan. Equity is the difference between the home value and the loan value. Two factors involved one were paying down the loan increasing the equity to we're hoping the house goes up in value. Okay. So let's think about the rental costs are pretty straightforward typically. So for renting we're going to say OK the monthly payments are going to be 1500. We said for the monthly payments there's 12 months in a year. That means we're paying 1500 times 12 or 18000 a year straightforward. We've got the renters insurance assuming we're required to pay for renters insurance. $80. And then we've got the interest lost on the security deposit. Meaning if I had to put this pretty low security deposit oftentimes this this interest lost calculation might be in material. Meaning small enough that it's not it's not a material factor. But if we had to put money down on a security deposit I couldn't put it into my checking account. So we're losing the earnings if it's only 2% of $125. It's basically in material but you could have a substantially higher interest. So that would be like you know $3. So the $3 18 plus the 80 plus $3 is going to give us then the 1883 for the rental costs. Now obviously the home purchase is going to be a little bit more complex for us to to calculate the benefits and the cost. Now we're not focusing in on the initial purchase right here which would have an initial cash outflow of the purchase price. I mean the down payment that you would have. So you might try to actually do a cash outflow comparison over the life of the loan or something like that. So we're going to go along that you expect to have the loan and kind of compare it to your rental property to do that kind of comparison. But right now we're just comparing what we think the yearly flows will be in general from renting versus after the purchase has taken place. So we're going to say all right then that means that we've got the home purchase. Now we're going to break this out. Also a couple things to know on the on the home purchase. You've got you've got things that are going to be cash related items that are going to have an impact on your cash flow. Other things such as the impact on the equity which are a benefit to you because they increase your net assets. Your assets go up when your equity goes up. Your net your equity goes up. Basically your assets minus liabilities your net worth goes up when your equity goes up. But to tap that equity to cash it to pay your bills with it. You'd have to sell the home or refinance. So that's not cash flow. So you got to think about the two things. One you know what are my benefits what are my costs in total. And two what's my cash flow situation. Can I cover the cash flow. Okay. So if we purchased the home the costs on a yearly basis after the purchase would be the mortgage payments that we're going to be paying. So and we got that up here. This is something that we might get in practice from an amortization table. We'll take a look at that calculation down below. We've looked at it in prior presentations how you might come up with the payments that you would have based on your loan type and so on. We'll get back into that later but we're focused on the costs now. And then if months in the year are 12. So that means that the annual mortgage payments are 175001. Notice that I'm not thinking here about whether it be interest or principal because from from a cash flow standpoint at this point. We're just going to say that's going to be a cash outflow that we're going to have of the 17501. Okay. And so then we've got the property taxes that we're going to pay. And we've got the home value at the 300,000. And this is something that you might estimate you'd have to basically estimate it based on where you're where you currently live because the property taxes are going to be state and local taxes. So we said that it was going to be 1.2% of the home cost. So if I say the home cost is 300,000, I can calculate the property taxes to be 3600. If we can get the property taxes as a percentage of the home cost that could be useful because if I build an Excel worksheet that we're then going to basically adjust and put some projections out there. I can then adjust the home cost up top, which will automatically adjust things like the property taxes to an appropriate number of hopefully so that we can do comparisons and adjust things. We do do this in Excel so you can take a look at it there too. And then we've got the homeowners insurance. Now you might also say, well, the interest portion of the of the payments has a tax impact. We're going to talk about that over here. Same with the property taxes. There's a tax impact on it. So we'll talk about that on the benefits side of things. The homeowners insurance, we're going to say was $75, $75 up top a month. And so we had a monthly homeowners insurance. So we're going to have to pay for it for 12 months. So 75 times 12 is going to be a outflow of $900. And then the repairs and maintenance 300 times the 1.5. Again, we put the repairs and maintenance as a percentage of the home value. And if we can do that, that will also change once I change this number up top, if it were in an Excel worksheet, allowing us to have a more flexible worksheet. So if you have a variable costs like that, that can be useful so you can make multiple projections. And so then we have the interest lost on down payment and the closing costs. So that means that we had to put a down payment of what we didn't have. We didn't show the down payment here. So whatever the down payment was, that's our initial cash outflow. And then from a year by year basis, we're going to we're going to lose that down payment times the interest that we could have gotten on it. Meaning if I had to put 20% down on the home, I can no longer put that into a savings account. And so I would have had income on the savings account or in the stocks and bonds, which I'm losing. So this would be, you know, a cost we can think of it here, which we just gave at this point in time instead of calculating the loss on it, which we saw that calculation in a prior presentation. So if I add this up 17501 plus the 36 plus the 900 plus the 45 plus the 950, there's the 27451 27451. And then on the benefit side of things, we're going to have some benefits from being homeowners. We've got the equity growth for paying down the loan. So one of the benefits is going to be when we look at the balance sheet side of things, we're going to have the loan going down. Therefore, from our balance sheet side of things from the balance sheet of assets minus the liability, the bigger difference between that value of the home and the loan amount is going to be a benefit to us. And you can think about that as kind of like part of this outflow that we had over here for our cash payments is going to interest. And it kind of goes away, although we might have a tax benefit, which we'll look at. And the other side is basically paying down the loan, which is increasing kind of our balance sheet perspective assets minus liabilities increasing the equity. So but realize that this equity component here is not something we can tap into it. So from a cash flow standpoint, it's a lot more difficult to get to this than other types of assets. We'd have to refinance the house or sell it or something like that. And then we got the estimated annual depreciation. This means that we're estimating that the home value is going to go up by the 2700 each year. So that's an estimate. So we don't really know that that's going to happen. And even if it did happen again, we couldn't really tap that unless we refinanced the home or sold the home. So one more time, the equity represents the difference between the cost of the home and the loan of the home. You could think about two components that are increasing that gap. And one is going to be if you think about the home value staying the same as when you purchased it and you pay down the loan, the amount that you pay down the loan is going to increase the equity because it's going to lower the liability. The other thing that increases equity is we're hoping in that the home goes up in value. If the home goes up in value, then of course that will increase the equity as well. So tax savings from mortgage interest. So we're going to assume that 12,000 mortgage interest was paid. Now the mortgage interest, notice we put here that was for the first year. So imagine that that means that we're counting the mortgage interest at its highest point. So that might not be the best way to go to look at the mortgage interest for the first year. You might want to take like an average because, you know, this is a long-term investment. And if you take the first year, you're really looking at the highest number. So we'll talk more about how you can kind of derive that number, where that number is coming from when we build an amortization schedule. And then we've got the marginal tax rate. This is your highest tax bracket on your tax return. We have an average tax rate and a marginal tax rate because you're taxed at multiple brackets due to a progressive tax rate. And the next decision that you make will have an impact on your highest tax bracket. So the marginal tax rate is your highest tax rate. However, remember that taxes are more complex than this. Like if you talk to someone that's trying to convince you to purchase the home, they're going to say that you're going to get a benefit, for example, of the $3,000. However, if you were standardizing, if you had a standard deduction before purchasing the home, then the gap between your standard deductions and the itemized deduction, which can be quite large, is something that really isn't benefiting. It would lower this amount of actual benefit. So the only way to really get this down or the best way I think to get it down is to use tax software. Use tax software, do a projection, make sure if this is a substantial reason that you're purchasing a home, that you understand what that number really is by actually doing a calculation in tax software and or using a tax professional to help you do that calculation in the tax software. And a lot of people these days are doing taxes with a CPA firm or an accountant or they're using tax software so you can clearly just put in the different number and at least in the same year, look at the difference if you were itemizing and make sure you have an idea of what that number practically is. It will also change over time because this number will change over time. Property taxes, same thing. These are the two big items that hit that push most people from standard deduction to itemized deduction. But the question is how much over is it going to push you before how much benefit you're going to really get from it. So but we're going to assume the 3600 times the 25, that's going to give us the 9000 that we're getting on a tax benefit from these costs. Also just realize that taxes could change over time. They might change the standard deduction. They did that before it could be a beneficial or non beneficial and they could try to put a cap on the state taxes which they've done, but the state tax is pretty high for most average people. But if you're in a high tax state, California, New York, you could hit that cap fairly easily these days, especially in an inflationary standpoint. So that uncertainty on the tax code is something you got to take into consideration too. So if we add these up, we're going to say the benefits are going to be the 5000 plus the 27 plus 3000 plus the 9,9116. So we got the 116 on the benefit side of things. If we take the home purchase costs less the benefits, meaning this number of the costs and then we've got the benefits. We've got the 27451 minus the 11600. So now we've got the 15851 versus on the rental side of things. We had the 1883. So that's good. But notice that this number is taking into consideration the equity component and part of the equity component is assuming a fairly substantial growth of 2700 per year on the home, which we don't really know the home. It's a guess, right? The home could go down in value, but hopefully it doesn't, but it could. And then the other side is us paying down the loan, which we know we're going to pay down the loan because we're locked into that. But it's also something that I can't tap into and pay my bills with from a cash flow perspective. So you also might want to look at this from a cash flow perspective and say, okay, if I look at these equity components and I take them into consideration to add them back in, we would be at that plus the 5000 plus the 27. So we're at the 23755. So when we do this comparison, we can do it from a net asset standpoint. Where do we stand from that component? And then we can also do it from like a cash flow standpoint so that we can do it from our budgeting standpoint. And so then let's take a look at our amortization table. So if I take the same data and I said, okay, we have a $300,000 home. We've got the down payment. I'm going to assume was 20%. That would give us the down payment of 60,000. So that would give us our loan amount of the 240,000. So if I purchased the home for the 300,000, it's 20% down. We're going to have the 240,000 of the loan amount. And then the mortgage payment is going to be the 1485. Now this is the number that you would usually be calculating, meaning you'd be looking at the home value of the 300. And you'd be saying, okay, that means I need to finance 240,000. And then you'd use your payment calculation or an online calculator to come up with the payment in your worksheet. Here just kind of to switch things up. We made the unknown be the rate because I'm kind of backing into this data that we already had on the left-hand side. So to back into the data, I put the unknown as the rate. And that's why we got this rate calculation. But if you are building this from top to bottom, this might be the first thing that you do. And then you would be taking this 300,000 would be coming from what we want the home value to be. Then we would calculate the loan amount. And then we would calculate the mortgage payment, which would help us to populate this number, which we use with our analysis up top. So then if we did our amortization table, this is something that can be done online using your online tools. And it can be done in Excel. I think it's better to be done in Excel because if you're really getting into it, I won't go through the amortization in detail again because we saw it in the past. But we can make this amortization table on a monthly basis down breaking it out by year, for example, such as this. So now I can break this out on a yearly basis. We do do this in Excel if you want to check it out. And this information makes it a lot easier for us to pull from to do our analysis like we did up top. So now I can look at my payments for the year, which are 17501, which is just all the payments for year one. We can use it to look at the interest for the year instead of month by month. You can see that it changes substantially from year to year. That has an impact on this calculation up top where we tried to figure out our benefit from the interest that we're paying. So notice I use 12,000 here and the interest is actually higher in year one. And we use 12,000, which is more like around here. So what you might do on the interest is try to say, how long am I going to live in the home and possibly pick the median interest like the one in the middle. If you think you're going to be there for 15 years, maybe you choose the one, you know, a number like in the middle or you take some kind of average type of number. Because if you use the first year interest, then that's a really high number, right? You're going to be using a number that you're overestimating because year one is going to be higher than any other year, right? And so that's why this table I think is a useful table, breaking it down. We've got the loan decrease. This is the amount of your payment that's going to pay down the principal or loan balance. And that's going to increase your equity because if we bought the home at a certain value and then we got a loan for it, then the difference between it at first was the down payment of the 60,000. As we pay down the loan, then we're going to have a bigger difference between the asset that we have on the books, the home and the loan, assuming the asset does not change in value or at least doesn't go down. And hopefully the asset then goes up, which would also increase the equity. And then we've got the loan balance. The loan balance represents the loan at the end of the 12 months, which is this 237-121. Notice how much more difficult it is to get from a table, an amortization table than the year by year table. So it's really nice to be able to summarize this data this way so you can do your calculations. Notice that this loan decrease we also used over here in our data where we said the estimated annual appreciation was 2007, which is kind of low here. But it was here and if you were to pull this from the data, you might do it this way. You might first do this amortization schedule. So you say I'm going to have a home for 300,000. I'm going to get the loan amount. And then I'm going to use this year by year schedule to pull something like the interest, which we said you could take some kind of average or median so that you can automate your worksheet. And then you can also try to save my estimated annual appreciation based on the loan amount could be based on some similar method here. You'd have to say how long am I going to stay in the home and I'll take the number in the middle so I can get a representation per year that's the same per year. You could get a lot more detailed and you could try to break this out on year by year and have a different interest per year and the loan balances per year and try to get the actual numbers on a year by year basis each year changing or being different. But that would get a lot more detailed to get an average for each year you might take like a number in the middle here pulling it from a table such as this. So that's how you could set this up. We make this table in Excel using formulas. We also do it using pivot tables. So if you want to see if you're really going to dig into something like this, I highly recommend you know building what you're going to do in Excel because that way you're not jumping around for multiple things. You actually get less unoverwhelmed once you actually put everything into the system and then you can make projections if you can tie everything together and you can customize it and get more detail from there. So we do do this in Excel to just get a feel for the tools that you might be able to apply to your own situation.