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Give the gift of Scratchers from the California Lottery. A little play can make your day. Please play responsibly. Must be 18 years or older to purchase, play, or claim. Today on Radical Personal Finance, we have a real live case study of rent versus buy. Relevant numbers, relevant situation, up to date.

And real live financial advice, right now. Welcome to the Radical Personal Finance Podcast. My name is Joshua Sheets and I'm your host. Thank you for being with me today. Indeed, indeed, real live financial advice. Got a call over the weekend from a friend of mine saying, Joshua, my husband and I, we found the perfect house.

And we really want to buy it. And we think it's a good deal. Please help us pull the numbers apart a little bit and figure out if it's a good deal or not. One of the things that I do love doing, and I was so proud of my friend, actually a friend of mine, a former client of mine, I was so proud that she called me instead of not calling nobody.

And I told her later on the phone call, obviously I'll be protecting her identity in this conversation, but I told her later in the phone call, I said, good for you for calling a financial advisor when it comes to financial advice. Good for you for not calling your broke Uncle Joe and just asking him what he thought.

Or good for you, good for you, good for you for finding some new options. And lesson of the day number one for all of you who are listening, always please do that. Call good financial advice. I do my best. I get emails and questions stacked up everywhere, which I'll be getting out to you soon.

I'm working hard. Details, I'll be getting more of those out to you. But anyway, she asked me the question. And so I decided to answer the question. I already did have it in a private phone call with her. But I took all these real-life numbers and decided I would just turn it into a show today.

And let's do a real-life case study of how to analyze buy versus rent with some actual numbers on a prospective sale. The story is, my friends, they live in a rental townhouse. And formerly when they were clients of mine as a financial advisor, I had worked with them on a couple of different things.

But we had set out a plan for them to get out of debt. And so right now they are working hard on getting out of debt and paying off their student loans. As a component of that plan, they sold the house they were living in and they moved into a rental.

Well, they've been in the rental for a couple of years now. And the house that was just across the way from them, a dream unit, it's a luxury townhome community here in Palm Beach County, a dream unit has just become available on the market. And they're friends with the owners of that unit.

And their friends told them, "Hey, listen. We're going to be listing this thing soon. We know that you like the house. It's the end unit. It has all the luxury amenities that you guys are really into. We're going to be listing the house soon. Here's what we're going to be listing it for.

Would you like to buy it early for a discount? Save us some of the hassle. Save us the realtor fees and things like that." They made them the offer to sell them the house, the townhouse, for $350,000. Or if not, the seller said that they were going to be listing it for $365,000.

So my friends, they're currently paying $2,100 a month for rent for an equivalent unit. They're identical, which is why this scenario is such a cool case study for the show. And they're trying to figure out what should we do. Should we rent or should we buy? So we're going to cover that case study in today's show.

Before I do, I have three announcements, two sponsors, and one quick promotion for an online investing conference that I am participating in. Sponsor number one is Jay Fleischman. Jay is a student loan attorney. If you have student loans like my friends do, if you have student loans, you need to call Jay Fleischman and ask him about any options.

That you have on your student loans. Interestingly, my friends, when I got them on the plan to pay off their student loans, at that time, I didn't actually have the connection with Jay Fleischman. In hindsight, I wish I had because if I had had Jay in my back pocket as a practicing financial advisor, every single one of my clients would have gone to Jay for a consultation.

So if you have student loans, take my advice. Call Jay Fleischman. Go to studentloanshow.com/radical. Check out the information there. Check out his previous episodes on radical personal finance and if you have student loans, do a review with him. Sponsor number two is Trade King. Trade King is the official brokerage services company for radical personal finance.

I have to tiptoe around the words that I say because they are a financial advisor conference. There are certain key button words. If I sound awkward when I do these promos, it's because I'm back somehow dealing loosely with the regulated businesses of security. So I have to tiptoe around my words carefully here.

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So check that out, all the information is there at TradeKing.com/radical. Quick promo, I am participating in the first online conference I've ever participated in. It's called the Online Investing Conference. I got an email from a friend, Brian, an investor in the family, and he said, "Joshua, hey, would you be willing to participate in this conference?" Now, here's the kicker.

Most of this conference is dedicated towards stock picking. The bulk of the speakers, there are eight speakers who are all individual traders, and all of them are extremely accomplished when it comes to managing portfolios. I am not. But he said, "I know you don't really do this thing, but I'd love to put you in for a bonus session on investing in your favorite way of investing." I wrote him back and I said, "I want to do it on investing in yourself, a subject I constantly talk about here on Radical Personal Finance.

But I've got some unique ideas that I wanted to share in that format." He said, "Okay, let's do it. That would be cool." So if you have any interest in investing, I urge you to consider going to the link that is in the show notes for today's show. Use my affiliate link so that they can track your response here as a listener to the show.

But check out all the information. Here's how it works. There are eight speakers, eight conference speakers, and three bonus sessions. The eight conference speakers, one is Brad Thomas, Eric, who writes for Forbes and Seeking Alpha. He is the number one contributing analyst on Seeking Alpha, or he was in 2014.

Eric Parnell, who is the founder and director of Gehring Capital Partners, also a premium contributor on Seeking Alpha. Brett Jensen, who is the editor of the Biotech Forum, the number two subscribed to investment service on Seeking Alpha. By the way, some of you may not know about Seeking Alpha.

It's basically the go-to place for this type of investment management discussions. Chuck Carnevale, creator of Fast Graphs and co-founder of an investment management firm. Been working in the industry since 1970. Kirk Spano, founder of Blue Mound Asset Management and fundamental trends and writer at MarketWatch. David Stein, who has been on the show, host of Money for the Rest of Us, which is just an amazing podcast, doing a great job and has a long time history in portfolio management for pension funds.

Kirk Duplassis, who is a full-time options trader, founded Option Alpha in 2007 and is currently the head trader there. And then Andy Hecht, who is the chief market strategist for Garden Capital and Garden Futures. He's a commodity and futures trader and an options expert and analyst. And then there are three bonus sessions, one by Brandon Turner, co-host of Bigger Pockets, which is the biggest real estate investing podcast and website ever.

Then me, your little host here. And then Shailesh Kumar, who is the founder of the Value Stock Guide, which is – had an incredible portfolio since its inception, incredible return. He's the founder of Value Stock Guide and the VSG portfolio has had a 175.25% return since inception versus 119.54% for the S&P 500 over the same period.

That's the promo literature here. I have not checked the numbers on the volatility behind that or any of the other metrics of that portfolio. But hey, rate of return sounds impressive. So he's also doing a bonus session. If you have any interest in trading, check out the conference, and it's an online conference.

So the way it works is that each of us who are speaking has created two videos. The first video is basically an overall philosophy. It's about five minutes each. You can get those videos for free. You can get free access to those videos and kind of get an overview of each of us.

And then each of us who are speaking in the conference has put together an in-depth bonus. Now, all the investment gurus have put together one or two of their highest conviction investments for 2016. Those are about 15-minute videos. So the goal is that they're long enough to be – to get the content across but short enough that you can actually get through them in the time that we all have.

We all have limited amount of times. And then some of us who have done the bonus sessions, we've done videos that are a little bit longer. So if you have any interest in investing, check it out. There's a direct link in the show notes. Please use the link that is in the show notes or the blog post for today.

I'll put a standalone blog post and also you'll see the links in the notes. This conference goes live on February 15. As I record this show, it is 9:23 PM on February the 1st, Monday. Special early bird pricing is in effect at the moment. So make sure that you get in there early before the price increases go up and check it out.

I'm definitely excited to be participating in my first online investing conference. I'm partly participating and partly watching because I wanted to put something like this together for the early retirement financial independence crowd. Maybe I will at some point. So I get a sneak peek under the hood to see how it all works.

Now, let's dig into our case study. The first thing I did when asking my friend the questions was try to get a sense of what the reason for their considering moving was. I think it's always important not to start with numbers but to start with goals. One of the things that annoys me about the personal finance industry, some of what I'm in, is that oftentimes people want to jump up and down and say, "Well, you got to live in this cheap place.

Even though it's junky and you have a bad life, at least you got to live here." Or people – they try to put their values onto other people. My friends, they live in a luxury townhouse. That's what they want. That's the kind of lifestyle they want to live. And cool.

All good for them. I don't think that money should be the primary – the beginning deciding factor. Rather, we should think carefully about our lifestyle and what is the ideal lifestyle. So that's the first thing I tried to get a sense of was what is the reason for considering moving.

Now, as a component of lifestyle, money is important. If you buy a house that's far beyond your means, you're going to spend all your time working and none of your time enjoying the house. So obviously, the money matters. But what I found out was that they're pretty happy with where they're living.

They love the neighborhood. They love the community they're a part of. They want to be there forever. And the challenge is that they feel some pressure because they've been renting for a few years, high-income couple. And they feel like we maybe should be back in the land of ownership because we don't want to be throwing all of our money away on rent.

Sound familiar? And then also this deal came up. And even though it was before they want to buy, they don't want to pass a good deal by. So I asked for some numbers. They had already spoken with a friend of theirs who was a mortgage broker. And they found out that they would be able to qualify for buying the house.

The house, again, was going to be listed for – they would have the offer for $350,000. So they would pay 5% down. So that would mean they would have a mortgage of $332,500. But they would need a total of about $28,000 out of pocket in the beginning. So $17,500 down and about $10,500 of closing costs was the estimate from the mortgage broker.

And that would have entitled them to a 30-year 4.3% loan. That was all the information they had to go on. Now, the problem was they didn't really have the $28,000 available. And in order to get it, they would need to do a 401(k) loan in order to get out the down payment.

Now, 401(k) loans are tricky. I'm not dead set against ever using them. They can be useful. And this company, my friend, they've been there at the company for a very long time, very stable situation, reasonable numbers. It could work. So I didn't jump up and down on the 401(k) loan.

I just said let's dig into the numbers. I went back later and I ran some more math and I figured out that with a 4.3%, 30-year fixed payment, their total monthly mortgage payment would be $1,645. And I had to do some quick digging on the taxes and the insurance and the HOAs.

The mortgage broker had quoted them a monthly payment of $2,440 a month. That would include principal, interest, taxes, insurance, and HOA fees. And so we were going based upon that number as our starting point. And we're comparing that to the $2,100 a month of rent that they're currently paying.

So first off, obviously, the monthly payment for a mortgage would be higher than the monthly payment for the rent. But they felt they could do that and not hurt their get-out-of-debt plans too badly by doing that. So I did some reverse math and what I did was I took the $2,440 number.

I pulled out the $1,645 of the principal and interest payments only. And that gave me a good starting point to understand what those other costs were because really what I was trying to figure out was what were the HOA costs. And my friends weren't exactly sure what the HOA costs were.

So I had to back them out. I pulled up the Palm Beach County Property Appraiser's website, put in the address for the property in question. And in doing so, I was able to find the taxes. The annual taxes on that property are $4,762. That's what the 2015 tax bill was.

Then I divided that out by 12 and that gave me $396.83 a month. So $397 among friends. I then knew because I knew the tax bill and I knew the insurance and the HOA bill and I could back into it. So I figured out what the tax bill was, $397.

The insurance and HOA combined, I couldn't be exactly sure, was $398 because they couldn't have all the numbers from the prospective buyer. So the total cost was $795 plus the mortgage, principal, and interest payments. And then I went and looked at the amortization schedule. Now, the reason that I backed all these costs out is because most people view their rent versus buy decision as I'm either throwing away $2,100 a month on rent or I'm investing $2,440 a month in a house that I own and I'm getting equity.

But that's not the case. Rather, what it is is that you have a small amount of money that's going toward principal or equity and the rest of the money is going away in cost. And so to get an accurate comparison, we've got to really dig into those numbers and figure out how much of the $2,440 is actually going toward paying off principal.

And so what I calculated was I said, "Well, let's do the very first payment and then let's look five years in, 10 years in, 15 years in and kind of figure out where these break-even points are." So I just did a quick duck-duck-go search for amortization schedule, grabbed the first amortization calculator I found, put in the data, put in the $332,500 mortgage, 30-year fixed, 4.3%.

And I calculated out the amortization schedule. The very first payment would be – let's see it here – $1,645 of which $1,191 would be going to interest and $454 would be going to principal. Let's pause there for a moment and check. This is the worst it's going to be, but it's good to know this in the beginning.

So we take $1,191 of interest. We know that's a pure cost. It is a deductible cost, which we'll get to later. But we know that's a pure cost and add that to all the other costs of the monthly HOA fees, insurance costs, and taxes, which we calculated to be $795.

Add those two numbers together and you get $1,986. So $1,986 of total cost versus $2,100 of current rental cost, and that would be the situation they're in at the first year. So you can see all of a sudden now you realize, well, you're not building all that much equity in the beginning.

Those of you who are very astute students would recognize, well, that's not the only thing. You do control the property, so you can potentially benefit from appreciation of the property. Yes, we'll cover that in a minute because this is a complicated decision to make. But let's start with just the numbers.

We know that in the very first month of ownership, we're going to have $1,986 of pure cost money that's not going into equity in the property as compared to our $2,100 a month of rental cost. That's starting. Now, it's a good place to start but recognize that those numbers change as the mortgage balance is paid down.

In a 30-year loan, if you're there for 30 years, I mean the second to the last payment, you have a total of $12 of interest and $1,634 goes to your principal cost. So you've got to recognize where are you in the cycle. But this is what's so deadly about 30-year loans is all the interest is front-loaded.

Go down, for example, five years and figure out where would we be in the year 2021. Well, we've got that same mortgage payment of $1,645, and yet at that point in time in January of 2021, we've got $1,085 of interest and $561 of principal. So let's add $1,085 of interest to $795 and we're out to $1,880.

$1,880 of pure cost plus the – plus $1,880 of pure cost, the balance is going to equity. So when you do it in that context, it makes the buy versus rent decision a little clearer. And that's where I recommend you always start. Now, let's add a few additional factors in.

First, we have $10,500 of closing costs. That's lost money. It will never be recouped. We've got $10,500 of closing costs. So if we're going to factor that in, let's say that – if we go back to our original first month and we say, well, we're saving a couple hundred bucks – we're getting a couple hundred bucks of discount as compared to rent versus pure cost of ownership.

Well, $10,500 divided by $200 comes out to be 52 months. It would be quite a long time at a couple hundred bucks a month for us to ever see the benefit of those $10,500 of closing costs. Plus if we look at it and say, all right, I've got to put the $17,500 down and in total I need $28,000.

What about the interest that I'm losing by not having that money invested? Depending on the terms of the 401(k), you'd have to figure out what is the interest rate that you're paying on the money, but let's just keep it simple and say that you're earning 5% and by pulling $28,000 off of an investment account, you're giving up $1,400 per year of potential interest or earnings or increase in the money.

It comes out to be about $117 a month. So at this point in time, all of a sudden you find out that the costs are actually in some ways very similar if you're buying with debt. And especially – I think actually the rental is the better deal. After all, remember, these units are comparable.

They're the same basic unit. It's hard to find a teaching example this perfect. In my house move, I moved from a house to an apartment. Most people are doing that type of move. Here we're just talking about one townhouse to another one that's a stone's throw away. So what about the other factors?

Well, the big one is – the big one in favor of renting is if you were to buy, you would have the added risk of all of the ownership costs. If the roof goes bad and you're assessed your share of the roof costs, that bill goes to the owner.

If your appliances go bad, you got to fix that. Whatever the costs of ownership are, you are responsible for those, and they add up. They really do. In this living situation, they would add up less than a single-family house. You have a shared units. These units are fairly new.

So there's less of a risk than in some other situations, but you still have it. A big one, though, is also the risk of the loss of flexibility. Ownership versus renting, the rent is much more flexible. You can get out. So what about the risks on the other side?

Well, one of the concerns that my friend had is what about the risks of rent increases? They had lived in this place for two years. The landlord had not yet increased their rent, so they're expecting, and I said you should expect a rental increase. So they have the risk of that, and then how does that skew the numbers?

Well, if we assume a 5% rental increase, then what it will do is it will take our $2,100 and it will increase it. We'll just run 105%. It will increase it to $2,205. So you might have a $100 a month rent increase. Compare that to the cost of owning.

It doesn't sound like quite that much compared to the cost of owning, especially when you factor in that with ownership, you still are subject to increases in some of those expenses, not to the same degree. Your interest costs wouldn't go up. Your mortgage payments with regard to principal and interest wouldn't go up, but you might be subject to the risk of increasing insurance premiums or to the risk of increasing property tax premiums or to the risk of increasing HOA fees, and those are a substantial portion of the cost of ownership here.

So we have factors on both sides that can be really challenging to figure out. So far, pretty much I think these deals are in some ways comparable. I think in the short term, the buying option is less favorable. But over the long term, perhaps it would become more favorable, especially as those interest costs go down and you start to benefit from the fixed costs of owning the house.

I did ask my friends how long would they want to stay there and the response was forever. So by that, they said forever. I believe them. I inserted in my mind five years because none of us in today's modern world, none of us stay in the same place we are forever.

Now, is it possible? Of course it's possible, but that's not generally the – that's not generally the – I thought I was going to stay in my house forever and I moved in two and a half years. So you always – you do have to figure in how long am I going to be there.

What about the value of actually the deal though because that's one of the factors that I haven't touched on yet. They heard from the seller of the property. They were going to be listing the property for 365 and they were being offered to buy it for 350. Is that a deal?

Well, here's where you got to look at your local market and you got to ask some more questions. Remember that the seller – if the seller can arrange a private transaction between them and my friends, the prospective buyers, the seller can save the money on the real estate commissions.

They're planning to list it with a real estate agent and so they could save the money on that. Let's just assume 6%. They could also possibly save some other costs, although not all of them. So I just want to be conservative and use a number of 6%. That means assume they sold the property for 365.

The selling costs are going to be 6% commissions of $21,900. So take 365, pull off $21,900, and you wind up with $343,100. So is the 350 a deal? Well, I don't think it's a great deal. It's a little bit of a deal. It would save my friends $15,000, which is nice.

The buyer is – so the buyer is better off. The seller is also better off. But the concern that I had was is it really a deal with regard to the benefits of moving that quickly? The advice I gave my friend was I said if you go for this, if you want to buy the house, I would try to negotiate a little bit more of an aggressive deal because, number one, the 365, that's the price they're going to list it at.

Are they going to get a full-price offer from a buyer with closing quickly with minimal hassles? That's worth something. So as a buyer, I would encourage my clients to negotiate a little bit more and just see if they could press that a little bit, save some additional money. It's also possible – we checked the data.

What we found was that this particular seller had bought the house – or I checked the data. I checked the property appraiser's website. They bought the house in about 2012 and so they were looking to – obviously, they bought the house for about $100,000 for $220,000 or so, and they're looking to gain some of the – to harvest their profits.

So they probably have a little bit of wiggle room. They're probably trying to time the sale of the market a little bit. They got some wiggle room. And so it's possible to still create a win-win deal by being a little bit more aggressive. The benefit that the seller gets is close the deal quickly at a fair price, save all the costs and the hassle of listing it.

The benefit that the buyer gets is a discounted price and knowing the property in advance. So what do you do? Well, two other factors and then we're done with this case study. Number one, we talked about placing a bet on the direction of real estate prices. Obviously, I gave them my specific analysis and gave a very clear prediction of what would – no, I didn't.

It would be better than that. I have a crystal ball, but for some reason every time I look at it, it's completely clouded over and I just can't even see past the surface. What do you do? Because that's a big factor. If they bought the property, they would control the property, and even if the costs were equivalent, let's say that the cost of renting and the cost of ownership were really the same.

At least if they own the property, they can benefit from potential appreciation of the prices. They buy the property for $350. It grows to $400, and then they want to sell. Well, that's one factor. But what about the other way? That's where in looking at their situation, I would be less worried about property appreciation in this case because their idea of buying it was that it's a forever home.

So the short-term price appreciation in my mind is less important. They're not going to want to move in three or four years and take profits. So we're looking at the longer term. In the longer term, will prices go up? Yes, they will. But what about the other factor, them having to slow down their debt payoff plans and then satisfy this 401(k) loan before making the student loans and kind of interrupting their plans?

What's that worth? This is where it's so challenging because even after on a financial decision like this, even after you work through all of these scenarios, at the end of the day, you still got to make a decision. Now, hopefully, some of these factors will stand out as more important to my friend than others.

That's usually what happens. Sometimes, no, this is the house. We want to own it. We think it's going to work. We're going to be there for a long time. If they buy the property and let's say that property prices decrease in four years, that's not going to impact them all that much because they're going to live there for the next 30 years.

And this community is well-liked. It will have long-term price appreciation. It's going to be a desirable community for quite a while. And if you get enough time, time has a way of smoothing out your inopportune buying decisions, the bad timing you made in the beginning. But sometimes we just don't know.

So ultimately, I mean my input to them, it's not my decision. It's their decision to make. My input to them was I don't think it's a screaming deal. I personally think that now is a good time to be selling property and there should be opportunities coming in the coming years.

Here, the luxury home market has been large appreciation. Is it sustainable? Who knows? That's where we always run the question. Who knows? In this particular situation, I think the personal finance case is compelling to say get rid of the student loans. That will free up a ton of cash flow.

It will continue to be more settled. There will be other opportunities in this neighborhood. It's not a screaming deal. There will be more deals there in a couple of years, and if there aren't, you'll still be in a place where you can easily take advantage of other market value prices, and you have done well in the meantime.

I just don't see the screaming deal on this property. But if they wanted to do it, here's my advice to them. How could they make it a great deal? Because sometimes you can take an okay deal and try to figure out how can I make this a great deal?

Well, number one, maybe they can buy a house with very low maintenance costs. So if this house – if they go through and say, "Look, the roof was replaced a few years ago. We know the appliances are new. It's a townhouse. It's well-maintained. It's quality construction." Maybe the house could have very low maintenance costs.

That's an advantage. And so now all of a sudden, they're taking and locking those advantages in. If they press a little bit, and maybe they can buy it way below market, anything they can do to push that price lower by being willing to move fast, close hassle-free, maybe that could help it be a better deal.

Ideally, I'd love to buy it at a time when the housing market is in a dip. Time will tell. If we go into a dip, at some point there will be a dip. It's just a matter of when. I don't know when it will be. And then you want to look and say, "Is there a way that I can force appreciation with appropriate improvements and renovations?" A key factor is the financing.

So if they choose to buy the house now, maybe they can finance it with very favorable long-term low fixed-rate financing. 4.3 percent is a historically great mortgage rate. And if they really are going to hold it for a very, very long time, it could work out really well. So, what do you do?

Welcome to the world of personal finance where you go around and around and around and around trying to figure out what's right for you. Some of those factors that I've just outlined in this case study will appeal specifically to my friends. Some of those factors will be very, very strong.

Maybe it's the, "Hey, we like the flexibility and we really are getting a great deal with renting now." Oftentimes, renting a luxury house can be a better deal than buying one. So, maybe that's what stands out to them. Or it might be the factor that they say, "No, this really is our forever house.

We're really going to be there for 30 or 40 years. We can lock it in with low fixed-rate financing now. We're going to be there forever." And yes, right now it's kind of comparable. But 10 years from now, it's going to be dramatically different. All those closing costs, all that cost is going to be gone.

And now we're going to be substantially ahead. I don't know. What would you do with those numbers that I laid out? Feel free to come by the blog and tell me about it. I'd love to know. Two quick announcements as we go. Number one, this Thursday, February 4, 1 o'clock p.m., I will be hosting a Q&A conference call.

I am working on updating the patron program with some new levels and platforms and things like that. This conference call will be open, this one, to all patrons. So, that one will be open to all patrons on Thursday, February 4, 1 o'clock p.m. Make sure, if you're not a patron, get over there.

And if you'd like to ask me questions, I intend to start doing a weekly conference call, which will be our Friday Q&A call. I'd like the live call. Details on that soon. Number two, if you're not a patron, why not? Get over to RadicalPersonalFinance.com/patron. We'd love to have you there.

Learning as we go. I am making a couple of changes to that program, but learning as we go. So, RadicalPersonalFinance.com/patron. Thank you all so much for listening. If you've got comments or suggestions for my friends, did I miss anything? Did I miss out on any major factors in my analysis?

As the closing music winds down here, I didn't talk a lot about deduction of interest. That can be a factor of this higher interest payment. That does have to be calculated. I didn't do the specific calculations on their tax returns, but that's the only thing I didn't talk about.

But if I missed anything, come by and tell me. Be back with you soon. (upbeat music)