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Evaluating alternatives in the shelter market U.S. DEPARTMENT OF LABOR Bureau of Labor Statistics Bulletin 1823 1974 U.S. DEPARTMENT OF LABOR Peter J. Brennan, Secretary BUREAU OF LABOR STATISTICS Julius Shiskin, Commissioner Bulletin 1974 1823 Preface The wide variety of choice in today’s shelter market, the mobility of American families, and the opportunities for returns on savings in investments other than housing have all contributed to the complexity of decisions on whether to rent or buy one’s shelter needs. As a result, the decision cannot be based on a simple comparison of the monthly outlays for owning and renting. This pamphlet describes a method of analyzing the financial costs and benefits of owning a home compared to renting in combination with a program of regular monthly savings over a specified period of time. The background information on shelter expenditures and price changes affecting shelter costs was developed from the regular pro grams of the Bureau of Labor Statistics in the area of prices and living conditions but also incorporates data from other sources. This pamphlet was prepared by Raymond W. Gieseman of the Divi sion of Living Conditions Studies in the Office of Prices and Living Conditions, with the collaboration of Georgena Potts and Rosalie Epstein of the Bureau’s Office of Publications. Fo r sale by th e S u p e rin te n d e n t o f D o c u m en ts, U .S. G o v e rn m e n t P rin tin g O ffic e , W ashin gton , D .C . 2 0 4 0 2 , G P O B ookstores, or B LS R egional O ffices. Price 8 0 cents. M a k e checks pa y a b le to S u p e rin te n d e n t o f D ocum en ts. Contents Page Introduction ..................................................................................... 1 Part I. Differences between owning and re n tin g ............................ 3 Part II. Analyzing shelter costs and returns.................................... 6 Part III. Comparing investment returns from owning and renting . . 13 Appendix. Supplementary tables for analyzing shelter costs and returns.......................................................... .............. 26 How homeownership trends have changed........... (inside back cover) Introduction Should I rent or buy? At some time in your life, you are likely to face a choice between owning or renting a house or other shelter. The decision to own or rent depends on many things. These can be looked at from three aspects: • What kind of shelter meets your preferences and needs? • How much is it going to cost and how much can you spend each month for shelter? • How can you make the best investment of your money while obtain ing shelter that meets your needs? The personal preference aspect. Looking at it from the first aspect, you will want to consider such factors as your age and family status, the stability of employment of the various members of the family, and the likelihood of your moving from one location to another. Beyond these, the choice has some highly subjective elements. Do you like to “ putter around” the house and yard on do-it-yourself proj ects, or do you dislike having to be responsible for maintenance, small repairs, lawn tending? Is the idea of “ putting down roots” and gaining homeowner status in the community important to you? Because shelter requirements and wants vary widely from individual to individual, from family to family, and from one time to another, it is not possible to make any blanket statement about the kind o'! shelter that is “ best.” It is not likely that anyone else can give you much guidance about the weight to be given to all the different subjective considerations which enter into the decision. The cost aspect. A second aspect of the shelter decision concerns the costs you will incur and how much you can afford to spend for the kind of shelter you want and need. How different are costs of owner ship and rental? Is there any way to compare them? What can you afford to spend? The amount you spend for shelter is influenced by personal con siderations and by your income, both your present income and what you expect it to be in the future. Information on what others spend for shelter is given on page 3. Costs when owning are analyzed in Part II, and Part III provides you with a basis for comparing the costs of owning and renting shelter. The investment aspect. The third aspect of shelter decisions con cerns the prudent investment of your money. Would you be better off investing your money in homeownership over a period of time, or saving your downpayment money and setting aside an amount each month, putting these funds into savings accounts or stocks and bonds, and so on? This pamphlet is designed to help you analyze these investment factors and apply them to your own situation, so that you can make a judicious decision as to the better course for you to follow. The pamphlet describes and illustrates a technique for estimating the vari ous costs and returns of being a homeowner or renter and then takes you step by step through the decision process with examples and Would you be better off investing in homeownership or putting your money into sav ings accounts or stocks and bonds? worksheets so you can determine what the alternatives are for you, on the basis of choices and market conditions in your own area. The appendix gives additional details which you will need in working out your examples. 2 Part I. Differences between owning and renting Can you afford to own? If you are thinking of buying a home, you will need enough money to make a downpayment on the purchase. This can be an important bar rier to homeownership for families and individuals who do not have adequate savings. On the other hand, when savings are sufficient to allow a choice between buying or renting, there is need to weigh the advantages of investing savings in shelter compared with other invest ment forms. Unlike buying, there is no shelter investment requirement when you rent. In addition to saving the downpayment required to buy shelter, renters also do not have the settlement costs that are involved in buying and selling a house. Renters do not have the long-term commitment to save regularly that homeowners have taken on through long-term financing of their home purchase. However, when the monthly cost to rent is less than to own, renters also have this same opportunity to save regularly. When these savings can be invested along with the savings from initial costs of ownership, returns while renting can be attractive. How much should you spend for shelter? Whether you buy or rent, you must consider the proportion of your income you want to spend for shelter. Many elements enter into the decision, varying with individuals, locations, and life styles. There are no hard and fast rules. Commonly heard rules of thumb suggest that the average family or individual should spend about one-quarter of income for shelter (sometimes stated as “ one week’s pay out of every month’’), and that a buyer ordinarily looks for a house within a market price 2 V times z his annual income. But none of the data available from studies of actual spending support these conventional rules of thumb, or the suitability of any generalization that would be applicable to all families. The rules cited above do not include outlays for utilities. However, when comparing homeownership costs with rental rate quotations, it is desirable to use a concept which includes these outlays. Therefore, the term “ shelter” as used in this pamphlet has been broadened to include utilities— heat, electricity, water and sewerage, but excluding telephone. Information on actual shelter expenditures obtained by the Bureau of Labor Statistics in a national survey of families and individuals in 1960 and 1961 indicates that, on the average, owners and renters spent 16 percent of their annual income after taxes on shelter, including utilities. For homeowner families, shelter expenditures included outlays for mortgage interest, property insurance, property taxes, maintenance and repairs, and utilities, and averaged 15 percent of income after taxes in 1960-61. This figure would have been about 20 percent if cash outlays including mortgage principal payments made by homeowners were included. For renter families, shelter outlays, including utilities, averaged 18 percent. Results of the survey also indicate that well-to-do families spend a 3 There are no hard and fast rules on how much to spend for shelter smaller proportion of income on shelter than families with smaller in comes. This applies both to homeowners and renters. How do tax benefits affect shelter costs? If you decide to buy shelter, you may benefit by being able to deduct a part of your ownership costs when filing your income tax returns. Amounts spent for interest and taxes are deductible items in Federal and many State and local returns. The amount you save will depend on your income and the amount of other expenses you have to itemize. These savings tend to lower the cost of owning. Renters do not have similar tax benefits for any portion of their shelter outlays. Over time, costs of owning and renting tend to be affected similarly by price change How do price changes affect monthly costs of owning or renting? Over time, costs of shelter change in response to price change. Home purchase prices and mortgage interest rates have moved up ward in recent years, as have property taxes, property insurance rates, and prices of maintenance and repair items and services. In 1973, prices for these elements of shelter, as measured in the Con sumer Price Index, were 64 percent higher than in 1965. The price change measure cited above includes current-year home buyers. However, the vast majority of homeowners own homes or are paying for homes that were purchased in earlier years. Costs for these owners are not affected by changes in home purchase prices and mortgage interest rates. For these owners, shelter costs increased 25 percent over the 8-year period due to increases in taxes, insurance, and prices for repair and maintenance items and services. For renters, increases in costs were similar to those experienced by those who owned their homes, as landlords passed on increased costs resulting from higher taxes, insurance rates, and prices for repairs and maintenance. Available information suggests that, on average, contract rent levels rose about 27 percent between 1965 and 1973. Table 1 summarizes these changes in shelter costs for the period 1965-73. Table 1. Effects of price change on shelter costs, 1965-73 (Index: 1965 = 100) Homeownership costs 1 Year 1965 1966 1967 1968 1969 1970 1971 1972 1973 Including changes in purchase prices and mortgage interest rates 100.0 105.0 108.6 116.9 128.8 142.1 145.9 151.8 163.5 Purchase prices and mortgage interest rates held constant Contract rent 100.0 101.8 104.0 106.8 110.5 114.6 118.7 122.3 125.4 100.0 101.6 103.7 106.6 110.6 115.6 120.0 124.3 126.9 1 Includes home purchase and financing costs, property taxes, home ownership insur ance premiums, and outlays for maintenance and repairs. Note: Data are for December of each year. Source: Based on data from the Consumer Price Index of the Bureau of Labor Statistics. Over time, costs for existing homeowners and rental rates for oc cupants of the same unit tend to respond similarly to price change, although changes in housing needs and responsiveness of local hous ing markets to these needs may affect the relationship in particular places at particular times. The exception comes, of course, when a particular rental unit is sold. The decision to sell is a factor over which the owner has control; the renter does not. How does the type of shelter affect the comparison? The type of shelter you are interested in is an important factor affecting costs and, therefore, the decision to buy or rent. Recent trends in the shelter market have increased the variety of shelter types available for owning or renting. As a result, the comparison of costs and returns between buying and renting can involve similar or widely divergent shelter types. Between 1960 and 1970, many apartment units were constructed to accommodate large numbers of young people who were entering the job market for the first time, and young couples who were setting up housekeeping but lacked the resources to buy. Many of these have since acquired some savings and have started families, which make them likely candidates for homeownership. But rising construction costs and higher prices for homesites have made it more costly for them to buy. During the same period the numbers of older individuals and couples whose families were grown also increased. These factors encouraged a wider variety of shelter types. Typical is the trend toward combining the features of apartment-style living with homeownership. Ownership of condominium and cooperative apartments, which until recently was centered in a few metropolitan areas, is growing. Many of these units are attached townhouses or in multi-unit structures (garden style “ walk-up” apartments or elevator high-rises). In the condominium form of ownership, the owner-occupier owns a single unit within a structure and shares in the ownership of the grounds and common areas. Under the cooperative ownership plan, each owneroccupant owns a prorated share of the total project. Mobile homes offer still another option of ow nership to the prospective home buyer. Because shelter units for sale and for rent differ widely in type, size, age, location, underlying financing, and so forth, you may seldom have the opportunity or the need to determine whether, for the same quality or quantity of shelter, it is cheaper to own or rent. But there is need for some method of comparing costs and returns for types of shelter that meet your requirements. Parts II and III provide a basis for such a comparison. 5 You need a method for comparing costs and returns for various types of shelter Part II. Analyzing shelter costs and returns The amount you can spend for rent and be as well off— from the viewpoint of investment— as if you owned your home, over a specified number of years, depends upon a number of factors. These include (1) the terms of purchase for shelter that meets your needs; (2) the monthly outlays required to retain and maintain your home; (3) the tax savings you experience as a homeowner; (4) your estimate of net proceeds from the sale of your home after a given number of years; and (5) the plans you make for alternative use of your money. The following sections provide background information on each of these factors and several examples to illustrate the analysis. Most home buyers must arrange for a loan; government agencies may help 6 Terms of purchase Few home buyers can buy a house outright. They have to borrow, arranging for the purchase in one of the following ways: (1) conven tional financing; (2) financing guaranteed by the Veterans Administra tion (VA)— available only to veterans; and (3) financing insured by the Federal Housing Administration (FHA). Conventional loans are made by private lending institutions (primarily banks and savings and loan companies), according .to terms agreed to by the borrower and the lender. VA and FHA loans are also financed by private lenders, but are subject to Government regulation, and the lender is insured against possible default in payment. Downpayment. The downpayment depends on the appraised value of the property and the amount the lender agrees to finance. There are no minimum downpayment requirements for conventional loans, but the amount commonly runs between 10 and 25 percent of the appraised value. The downpayment for government-backed loans is also deter mined by agreement between the borrower and the lender, but mini mum requirements have been established by law. Under recently ap proved legislation governing FHA loans, the buyer must pay at least 3 percent down on the first $25,000, 10 percent on the next $10,000, and 20 percent on the excess over $35,000. The mortgage must not exceed $45,000. There is no minimum downpayment required for VA loans unless the asking price exceeds the appraised value of the property. Settlement costs. Another item of cost in buying a house is settle ment. These costs occur when property is exchanged. They include closing costs, loan discounts, prepaid items, and sales commissions. Closing costs are charges for obtaining the mortgage loan and trans ferring the real estate title. A loan discount is a charge assessed by a lender to improve his return (these are sometimes called mortgage poihts). Prepaid items are amounts required for advance payment of real estate taxes, insurance premiums, and other assessments such as fees paid for improvements to sidewalks, roads, and sewers. For buyers, settlement costs include closing costs and amounts re quired for prepaid items. The settlement costs for sellers are loan dis count payments and sales commissions. Settlement costs vary from locality to locality and with the purchase price of the house. In a study of applications received for Governmentbacked loans during March 1971, settlement costs (including loan dis count payment, if any) averaged $1,937 or about 10 percent of the contract sale price.' The report states: “ It is apparent that the two most expensive settlement cost items were loan discount payments, or points, and sales commission. Neither of these costs, however, was paid by the buyer at closing. Therefore, buyer settlement costs represented only about 23 percent of total settlement costs. The seller absorbed more than three-quarters of total settlement costs and probably attempted to recapture some or all of this expense through an increased sale price.” Thus, settlement costs amount to about 2 per cent of the market price for the buyer and 8 percent for the seller. Com parable data were not available for homes with conventional loans. Mortgage term. Most mortgages commonly run between 20 and 30 years in length. The term of the mortgage may differ with the three types of loan programs. For example, in 1971, mortgage terms for con ventional loans averaged 26.2 years for new houses and 24.2 years for existing houses while 99 percent of the VA-guaranteed loans on new houses and 87 percent of the loans on existing houses had mortgage terms of 26 to 30 years. The average length of the full term for FHA loans on homes purchased in 1971 was 29.9 years and 28.9 years, respectively, for new and existing homes. The average mortgage term on all three types of loan programs has been increasing in recent years. Differences in length of term among the programs have, however, been diminishing. Mortgage interest rates. In recent years mortgage interest rates have fluctuated considerably for all types of loans. Rates are usually different for government-guaranteed loans and conventional loans. Ceiling rates for FHA- and VA-guaranteed loans are established jointly by the respective agencies and are announced by the Secretary of Housing and Urban Development. Rates on conventional loans are reg ulated by State governments. Ceiling and contract interest rates for loans on existing houses since 1970 are shown in table 2. When the going interest rate is above the State or Federal ceiling rate, it is sometimes necessary to pay a loan discount, or “ mortgage points” , in order to obtain a loan. The additional charges for mortgage points are norm ally assessed at the tim e of settlem ent and are in cluded in settlement costs, discussed earlier. FHA-backed loans are subject to an annual insurance premium of one-half of 1 percent of the mortgage balance owed. Some lenders may also require private mortgage insurance on conventional loans. Premiums will vary with the individual insurer. Effects of terms on cost of financing. The price and amount paid down on a home determine the size of loan required. The mortgage term and the rate of interest determine the cost of financing such a loan. The following example illustrates how the cost of financing is affected by the mortgage term and the interest rate. Suppose a $30,000 home is purchased with a $3,000 downpayment and the balance is financed for 20 years at 7 percent interest. The monthly mortgage payment will be $210 and the total cost of the loan is $50,300. Increasing the mortgage term from 20 to 30 years lowers monthly payments to $180, but increases the amount paid in interest by $14,500, making the total cost of the loan $64,800. Similarly, in-1 1 Report on Mortgage Settlement Costs (Washington, U.S. Department of Housing and Urban Development and Veterans Administration, January 1972). Costs of home loans vary with the mortgage term and the interest rate Table 2. Rates for FHA, VA, and conventional loans, 1970-74 FHA Date set January 1970 December 1970 January 1971 February 1971 August 10, 1973 August 25, 1973 January 1974 April 1974 May 1974 July 1974 August 1974 VA Conventional Ceiling rate Date set Ceiling rate 8 V2 January 1970 December 1970 January 1971 February 1971 July 1973 August 1973 81/2 8 8 7V2 7 73/4 8 V2 8 V4 8 V2 83/4 9 91 /2 January 1974 April 1974 May 1974 July 1974 August 1974 71 /2 7 73/4 81/2 Year Contract interest rate 1970 8.20 1971 1972 7.54 7.38 1973 7.86 1974 1 8.51 81/4 81 /2 83/4 9 91/2 ' January-June. Sources: U.S. Department of Housing and Urban Development and Veterans Ad ministration. Contract interest rates for conventional loans were tabulated from monthly rates for existing homes published in Federal Home Loan Bank Board News and were not adjusted for differences in loan volume between months. creasing or decreasing the mortgage interest rate affects both the monthly payment and the total cost of the loan. For additional information to help evaluate the cost of financing home loans, see table A-1 in the appendix. Gross monthly outlays of homeowners In addition to the monthly mortgage payment, other shelter outlays incurred on a regular basis are those for real estate taxes, property insurance premiums, costs of maintenance and repairs, and allowances for fuel and utilities. Excluded from this discussion are major improve ments to house and grounds. Estimates for some types of costs— taxes, insurance, and utilities— usually can be obtained from the seller or the real estate agent. (Also, tax payments are public records and can be verified in the appropriate office of local government). Maintenance and repair costs are more difficult to estimate for a particular house. In a 1968 study, annual maintenance and repair costs were estimated to run from % to 1 percent of the value of the property.2 Monthly mortgage payments for principal and interest established at the time of purchase do not change during the life of the mortgage unless the loan is refinanced. Property taxes, however, as well as insurance rates and prices of maintenance and repair items and serv ices, are not fixed. Table 3 shows year-to-year changes over the last decade for these items and for fuel and utilities. One of the potential benefits of homeownership is a reduc tion in income taxes Effects of tax savings on shelter costs of homeowners One of the potential benefits of homeownership is a reduction in the amount of personal income tax that must be paid. Interest paid on the mortgage and the real estate taxes assessed against the property Table 3. Changes in Consumer Price Index for all items, selected shelter components, and fuel and utilities, 1964-73 Consumer Price Index item All items Shelter item: Property taxes Insurance Maintenance and repairs Fuel and utilities Percent change from preceding year Percent change, 1965 1966 1967 1968 1969 1970 1971 1972 1973 1964-73 1.9 3.4 3.0 4.7 6.1 5.5 3.4 3.4 4.4 6.9 3.7 4.9 6.7 5.8 6.1 4.8 5.5 10.1 5.2 2.5 9.1 6.1 .7 71.1 9.4 2.1 -1.0 43.7 3.0 .2 5.4 4.6 7.0 .2 .9 2.0 9.2 2.7 7.2 5.7 4.9 8.8 3.7 11.5 7.6 5.9 8.8 48.0 74.5 37.3 Note: Changes calculated from published indexes for December of each year. Source: Bureau of Labor Statistics. are tax deductible under Federal and most State and local income tax regulations, if deductions are itemized. The effect of these tax savings when prorated monthly is to lower the homeowner’s gross monthly outlay for shelter. The amount of such savings depends on the amount of income that would be taxed if de ductions were not itemized and on the rate of taxation on this income. Typically, the amount of interest paid on home loans is highest in the first year and declines over time as the loan balance declines. On the other hand, property taxes tend to rise, due to higher property values and changes in tax rates. Having more property taxes to deduct tends to offset the smaller amounts of interest that can be deducted each year a house is owned. Estimating net proceeds from sale of house The decision to purchase a house should include an estimate of what the net proceeds would be if the house were sold at some future date. Buying a house usually requires investing some savings at the time of purchase. Further, additional money is regularly invested through the monthly principal payments— sometimes referred to as “ forced savings.” The value of a homeowner’s savings in the house depends on the market price of the house at the time of sale, selling costs, and any debts or liens against it. If a house is sold at the original purchase price, net proceeds will be amounts initially invested in downpayment and settlement, plus whatever portion of mortgage payments has been applied to reducing the principal, and minus selling costs and any taxes owed. However, if the value of the house has risen, the net pro ceeds from its sale may amount to more than the owner’s purchased equity. For example, assume a $25,000 house is purchased with a downpayment of $2,000, and the remaining $23,000 is financed at 7 percent for 30 years. Settlement costs are $500. After 10 years, the house is sold for $34,000 and selling costs are $2,700 (8 percent of market2 2 John P. Shelton, “ The Cost of Renting Versus Owning a Home” , Land Economics, February 1968, pp. 59-72. value). The net proceeds and gain from the sale of the house might look like this: Sale price of h o use .................................................................. $34,000 Less amounts owed at time of sale: Selling c o s ts ......................................................................... 2,700 Mortgage balance owed ....................................................... 19,800 Net proceeds from sale of h o u se ........................................... $11,500 Less amounts invested: Downpayment and settlement c o s ts .................................... 2,500 Reduction in mortgage balance(principal payments)......... 3,200 Gain from appreciation ............................................................ $ 5,800 The long-term trend is for houses to appre ciate in value, but there is no guarantee that a particular house will do so Rate of change in market value of owned home. The future market value of a house depends on its location, its age and structural condi tion, its adaptability to the needs of buyers, the overall need for housing, and general economic conditions. Neighborhood and com munity characteristics also have an effect on its future market value. In some localities, houses on an average may appreciate as much as 5 or 6 percent a year, or more; in others, they may bring less than the amount originally paid. In the example above, the house increased in value from $25,000 to $34,000 in 10 years, or an average of approxi mately 3 percent a year. Two factors that tend to make homes appreciate in value are (1) ris ing costs of building new houses and (2) the higher cost of land suit able for housing. When the total cost of new houses goes up, home buyers tend to bid up the prices of existing houses. The cost of construction for residential structures increased sharply between 1960 and 1972, rising nearly 80 percent during the period— an average annual increase of 5 percent a year This means that a house built for $10,000 in 1960 would have cost about $18,000 to build in 1972. Another reason for rising home prices is the rise in the value of the land on which the house is situated. In recent years, the scarcity of suitable sites for building in major metropolitan areas has caused land values to increase. Prices for new homesites under FHA-insured loans doubled between 1960 and 1972, and market value of sites occupied by existing homes increased by more than 80 percent. Rising construction costs and site costs are reflected in the prices of new and existing one-family homes purchased with FHA-backed loans. Between 1960 and 1972, the average sale price for new homes increased nearly 70 percent, or an average of about 41 percent a year. /2 Prices for existing homes sold in 1972 were almost 50 percent higher than prices for existing homes purchased in 1960, which represented almost a 31 percent annual rate of increase. These rates compare /2 with an average annual increase of about 3 percent in the price of all consumer goods and services over the same 12-year period. The long-term trend is thus for houses to appreciate in value, but of course there is no guarantee that a particular house will do so, par ticularly during periods of recession. For example, one-family houses in 22 cities declined almost 29 percent in market value between 1925 and 1933. Selling costs. Amounts that have to be paid at the time a house is sold are called selling costs. These usually include a brokerage fee paid to the real estate agent and may include a loan discount payment to enable the buyer to obtain a loan, if the house is sold to a buyer who finances his purchase through a government-backed loan. The cost of selling a house can reduce the advantage of home pur chase. How the buyer fares depends on the length of stay in the house and the rate of appreciation. For instance, if the selling costs amounted to 8 percent of the market price, the owner would have to realize an increase of 8 percent or more in the price of the house in order to recover his investment. If the rate of appreciation was approximately 3 percent a year, the owner would have to keep the house for 3 years or more in order to get back enough to balance out his initial downpayment and settlement costs. How the home buyer fares depends on the length of stay in the house and the rate of appreciation Mortgage balance owed. A final deduction, before net proceeds from the sale of the house can be estimated, is the amount owed on the mortgage. In most home financing, loans are amortized, or paid off, by a sequence of equal payments over a number of years. Since the loan balance is highest when the loan is first obtained, the amount applied to interest consumes a major portion of the regular monthly payments in the first few years, and only a small amount of the monthly payments goes to the purchase of additional equity. Thus, if a house is sold within 5 or 10 years of purchase, a substantial portion of the proceeds may be needed to retire the balance of the mortgage. For example, on a 30-ye^, 7-percent loan, 94 percent of the initial loan amount would still be owed after 5 years of ownership. Even after 10 years of ownership, 86 percent of the principal would remain to be paid. The percent of the loan balance still owed on this loan at different times is shown below: Percent of mortgage balance still owed After 5 years .................................... 94 After 10 years .................................... 86 After 15 years .................................... 74 After 20 years .................................... 57 After 25 years .................................... 33 After 30 years .................................... 0 Appendix table A-2 shows similar percentages for 20-, 25-, and 30-year loans at different interest rates. Alternative investment opportunities Some may prefer to put their money to work in other forms of in vestment, rather than buy a house. Other types of investment generally make it easier to respond to a change in circumstances or to take advantage of changing rates of return. Downpayment and settlement costs. Invested in a savings account, funds (the equivalent of which the homeowner uses for downpayment Renters can invest the funds not used for buying a house and settlement costs) may earn 4, 5, or 6 percent a year, or more. The value of an investment of $2,500, compounded annually, is shown in table 4 for selected periods and rates of return. For further details on how these amounts were determined, see appendix table A-4. Table 4. Value of $2,500 compounded annually at selected rates of return Period 1 5 10 20 30 year years years years years 4 percent 5 percent 6 percent $2,600 3,042 3;700 5,477 8,107 $ 2,625 3,190 4,072 6,632 10,805 $ 2,650 3,345 4,477 8,017 13,357 Thus, at the end of a year, $2,500 invested at 5 percent would have returned $125 in interest. To gain this same amount in one year, the purchaser who used the $2,500 to buy a $25,000 house would have to sell it for enough to recover his investment (downpayment and principal payments, and selling costs), plus the $125 he could have earned by investing the money at 5 percent. Renters may add to their returns by econo mizing on the amount they spend for rent and investing more Regular monthly saving. When renting, additional savings may be needed to offset benefits homeowners have in being “ forced” to save regularly through monthly mortgage principal payments and having houses that appreciate in value over a period of years. These savings are possible when the total cost to rent per month is lower than the monthly shelter outlay to own. A regular savings program for renters may require more self-disci pline than for those who buy. However, the cumulative effect of savings — often overlooked— might provide an incentive for such self-discipline. Regular savings of as little as $25 a month ($300 a year) could earn the amounts shown in table 5 if invested for the periods and at the rates of return illustrated. These values are based on information pro vided in appendix table A-5. Table 5. Value of savings of $25 per month at selected rates of return Period 5 10 20 30 years years years years 4 percent 5 percent 6 percent $ 1,650 3,675 9,100 17,125 $ 1,700 3,850 10,150 20,375 $ 1,725 4,050 11,325 24,375 The combined value of the $2,500 investment and of savings of $25 a month over a 10-year period at 5 percent interest is $7,922 ($4,072 plus $3,850). This amount would accrue to the renter and could partially or fully offset net proceeds from owning and then selling a home. If it were possible to save as much as $50 per month by renting, the invest ment amount would total $11,772 ($4,072 plus $7,700) after 10 years, and would compare favorably with the net proceeds from owning illus trated in the example on page 10. Average annual yields for selected types of investments are shown in appendix table A-6. Part III. Comparing investment returns from owning and renting The following section outlines procedures which can be used to estimate how much you could spend for rented shelter and be as welh off, from the viewpoint of investment, as if you bought a house. Over time, as your income and shelter needs change, or if your job requires that you move, you may wish to reconsider your shelter requirements. At that time, regardless of whether you are an owner or a renter, these procedures can be applied to evaluate your new alternatives. There are six steps in the procedure: 1. Determine the purchase price and terms of financing for a house you would consider buying; 2. Estimate your gross monthly shelter outlay as a homeowner; 3. Estimate your net monthly shelter outlay as a homeowner; 4. Estimate your net proceeds if you were to sell the house at a specified price after a given period; 5. Estimate the amount of monthly savings required to offset net proceeds from owning, if you decide to rent; 6. Estimate the rent level which, in combination with a savings pro gram, would equal your net monthly shelter outlay as a homeowner. The first three steps help you establish the costs of owning a specific shelter unit that meets your needs and circumstances. Step 4 helps you determine the expected return from owning and then selling the unit after a period of time. Step 5 develops an alternative plan for saving the equivalent of these returns. In Step 6, you determine a rental rate that is comparable with the monthly cost of owning after allowing for the savings plan. Examples are given to illustrate the procedures. Space is provided to assist you in working through the steps for your own situation. Step 1. Determine the purchase price and terms of financing for a house you would consider buying. In Example A, page 14, the price of the house is the average price for new homes purchased in 1971 with FHA-insured loans. The terms of financing— loan ratio, interest rate, and mortgage term— were typical of FHA-insured loans in that year. Example B shows a house with the same purchase price and terms of financing as in Example A, but with a larger downpayment. The lower cost for debt service in Example B ($128.80 compared with $156.10) is due entirely to the larger downpayment. For your example, you will need to determine the price of the house or condominium apartment to be analyzed and the amount of downpayment required (or that you plan to make). After you subtract the downpayment, the balance of the sale price remaining is the amount to be borrowed. Sometimes part of the settlement costs are also financed; if this is true in your case, this sum should be included in the amount to be borrowed. How much will it cost to buy a house of your choosing and how are you going to pay for it? To determine the monthly payment you need to know the rate of interest on home loans and the number of years over which you plan to finance the balance. Then, using the rates in appendix table A-1 and the example illustrating its use, you can determine the amount of the monthly payment. For your example, you may have an actual estimate of settlement costs received from a realtor or other source. If this is not available, you may want to use an estimate based on a percent of the sale price of the house, such as the 2-percent estimate discussed on page 7. Terms of purchase and financing Example A Sale price of u n it.......................... Terms of financing: Downpayment: Amount .................................. Percent of sale p ric e ............. Characteristics of the mortgage: Amount borrowed ................. Interest rate (percent)........... Mortgage term (years to maturity) ............................ Monthly cost of debt service: Payment to principal and interest .............................. Mortgage insurance premium (if a n y )................................ Total to debt service per m onth.......................... Initial outlay required to purchase: Downpayment .......................... Settlement costs ....................... Total initial outlay required .. Example B $23,835 $23,835 1,535 6.4 5,435 22.8 22,300 7V2 18,400 7V2 30 30 156.10 128.80 — Your example — 156.10 128.80 1,535 532 2,067 5,435 532 5,967 Step 2. Estimate your gross monthly shelter outlay as a homeowner. How much will it cost you per month to own? In addition to regular monthly payments to service the home mort gage, your expenses will include property taxes, insurance, and main tenance and repair bills. You may not be billed each month for these costs, but they can be prorated on a monthly basis. You should also estimate average monthly outlays for utilities that would be included in the monthly rent check if you were renting. In the table on page 15 the “ other monthly costs” are 1971 average costs estimated by FHA for a house with an average price of $23,835. You will find suggestions to help you estimate monthly amounts for property taxes, insurance, and maintenance and repairs for your ex ample on page 8. Gross monthly shelter outlay to own Example A Monthly debt service: Mortgage payment..................... Mortgage insurance'premium (if a n y ).................................... Total to debt service each month ............................ Other monthly costs: Real estate ta xe s ....................... Property insurance ................... Maintenance and re p a irs '........ Utilities ...................................... Total other costs each month ............................ Estimated shelter outlay per month: Debt service (principal and interest).................................. Other c o s ts ................................ Gross monthly shelter outlay ............................ Example B $156.10 $128.80 — Your example $. — 156.10 128.80 34.79 10.16 13.29 26.87 34.79 10.16 13.29 26.87 85.11 85.11 156.10 85.11 128.80 85.11 $241.21 $213.91 15 1 Include monthly fees if the unit is a condominium or cooperative. Step 3. Estimate your net monthly shelter outlay as a homeowner. Both mortgage interest and property taxes paid are tax deductible. This frequently makes it worthwhile for homeowners to itemize rather than to use the standard deduction when figuring their income taxes. Examples on page 17 illustrate the potential savings in Federal income taxes for homeowners at different levels of income, if they itemize their expenses for mortgage interest and real estate taxes. Not shown here are additional savings which may accrue to homeowners from similar deductions when filing State and local income tax returns. In the table on page 16 taxes are figured when there are no deductions for homeownership expenses. The calculations use 1972 rates applicable for married persons filing jointly and claiming four personal exemptions ($750 each). The standard deduction amounts to 15 percent of adjusted gross income, or a maximum of $2,000. In the table on page 17 the tax liabilities with deductions for homeownership expenses are based on the monthly amounts for real estate taxes and mortgage interest shown in Step 2 for Examples A and B. The $417 deduction for real estate taxes is the $34.79 shown in Step 2, converted to an annual basis. The $1,667 deduction for mortgage interest in Example A was obtained by annualizing the mortgage pay ment shown in Step 2 ($156.10 x 12 = $1,873.20) and calculating the amount for mortgage interest as a percent of the annual mortgage payment. (According to appendix table A-3, 89 percent of the first year’s payment goes to interest. Thus, $1,873.20 x .89 = $1,667.15. By the same process, mortgage interest for Example B was $1,375.58. How much would you benefit from tax savings as a homeowner? Tax liability without deductions for mortgage interest and real estate taxes Your example Income before taxes . . . . $10,000 $15,000 $25,000 Less deductions: Standard or “ other” '. 1,500 2,000 2,000 Less personal exemptions............... 2,000 3,000 3,000 Equals taxable income . $ 5,500 $10,000 $20,000 905 $ 1,820 $ 4,380 75 $ $ Tax liability: Annual ........................ $ Monthly ...................... $ 152 365 ' Examples assume the standard deduction equals or exceeds amounts for “ other” deductions which can be itemized, excluding all mortgage interest and property taxes. Based on 1972 rates. Amounts for “ other” itemized deductions in Examples A and B— charitable contributions, medical and dental expenses, other deduct ible interest and taxes, and other losses or expenses that can be item ized— were assumed to total 80 percent of the standard deduction ($1,200 and $1,600, respectively, of the $10,000 and $15,000 income levels), and 100 percent ($2,000) when income is $25,000. The monthly saving by itemizing mortgage interest and taxes shown for Examples A and B was obtained by comparing the tax liabilities with and without allowable deductions for homeownership expenses. Tax liability with deductions for mortgage interest and real estate taxes Your example For Example A (larger monthly mortgage payments): Income before taxes .. . . $10,000 $15,000 $25,000 417 417 417 Mortgage interest .. , 1,667 1,667 1,667 Other ..................... 1,200 1,600 2,000 3,000 3,000 3,000 Equals taxable income . $ 3,716 $ 8,316 $17,916 $ 1,450 $ 3,796 Less deductions: Real estate taxes .. Less personal exemptions ............. Tax liability: Annual ........................ $ 572 Monthly ...................... $ 48 $ 121 $ 316 Monthly tax saving by itemizing mortgage interest and taxes1 . . . . $ 27 $ 31 $ 49 For Example B (smaller monthly mortgage payments): Income before taxes . .. . $10,000 $15,000 $25,000 417 417 417 Mortgage interest . . . 1,376 Other ...................... 1,200 1,376 1,600 1,376 2,000 Less personal exemptions ............. 3,000 3,000 3,000 Equals taxable income . $ 4,007 $ 8,607 $18,207 $ 1,514 $ 3,878 Less deductions: Real estate taxes . . Tax liability: Annual ........................ $ 621 Monthly ...................... . $ 52 $ 126 $ 323 Monthly tax saving by itemizing mortgage interest and taxes 1 . . . . $ 23 $ 26 $ 42 1 Tax saving equals the difference between monthly tax liability without homeownership deductions (p. 16) and monthly liability with deductions. Based on 1972 rates. Net monthly shelter outlay can then be figured by subtracting the estimated tax saving from the gross monthly outlay estimated in Step 2. The results for Examples A and B are shown below. Net monthly shelter outlay to own Income before taxes $10,000 $15,000 $25,000 Example A: Gross monthly shelter outlay (p. 15) .............................. .. $241 Your example $ $241 $241 27 31 49 Net monthly shelter outlay . . $214 $210 $192 $ Example B: Gross monthly shelter outlay (p. 15) .............................. .. $214 $214 $214 $ 23 26 42 Net monthly shelter outlay . . $191 $188 $172 Less tax saving (from p. 17) Less tax saving (from p. 17) $ $ In your example, you can estimate your potential tax savings by refiguring your last year’s tax return, using the mortgage interest and property tax rates for your situation. If you used the standard deduction last year, you will need to compile a list of other deductions you could have used and their amounts. When the amount for “ other items’’ you have to deduct equals or exceeds the standard deduction, you benefit from every dollar paid out for mortgage interest and property taxes by itemizing. Estimated tax savings shown above are based on amounts of mort gage interest and property taxes paid in the first year of purchase. This gives maximum write-off allowance to homeowners, since the amount of mortgage interest paid will decrease as the loan balance declines. It is likely, however, that part of this loss of mortgage interest write-off will be offset by higher property taxes, as the assessment rate and the value of the house change with time. Step 4. Estimate your net proceeds if you were to sell the house at a specific price after a given period. What would your net proceeds be if you bought and then sold a house after a period of time? Before you proceed with this step and the steps that follow, it is necessary to determine the length of time over which you want to compare your alternatives when owning and renting. The time span you select becomes your “ planning period.” In the examples that fol low, values for planning periods of 5, 10, and 20 years are shown. Information has been provided to help you work through your own example for a 5-, 10-, 20-, or 30-year period. Net proceeds represent the amount received from sale of the house, less the costs of selling and less the balance owed on the mortgage. Any proceeds in excess of these expenses represent 1) the return of your equity and 2) gain from appreciation. It may seem unrealistic to attempt to estimate proceeds from the sale of a house you have not yet purchased, but this step is necessary if you wish to evaluate your likely returns as well as your costs. It re quires an estimate of the future market value of the house at the probable time of sale. Future market value of dwelling unit and selling costs Several different rates of appreciation are used below to illustrate the future market value of a house priced at $23,835 in 1971, after 5, 10, and 20 years. Your estimate of the rate of appreciation for the house you are considering should be based on local market conditions, pres ent and expected, and should allow for changes in general economic conditions. The data in appendix table A-4 will assist you with your example. Estimated future market value of house 0 2 4 6 __ percent percent percent percent percent, your example After 5 years After 10 years After 20 years $23,835 26,300 29,000 31,900 Appreciation per year $23,835 29,100 35,300 42,700 $23,835 35,400 52,200 76,400 ______ For the future market prices shown above, the selling costs (at 8 percent of the market value of the house) would be: Estimated costs of selling house Appreciation per year 0 2 4 6 __ percent percent percent percent percent, your example After 5 years After 10 years After 20 years $1,907 2,104 2,320 2,552 $1,907 2,328 2,824 3,416 $1,907 2,832 4,176 6,112 Amount still owed on house A mortgage loan is paid off at a very slow rate in the early years, but the rate accelerates as the year of final payment approaches. In Ex ample A, page 20, after 10 years the balance remaining to be paid off on the $22,300 loan is approximately $19,400. After 20 years, the balance owed is $13,150, all of which would be retired in the last 10 years of the mortgage. Appendix table A-2 will help you to determine the amount that would still be owed on your mortgage after different periods of time. Estimated balance owed on mortgage Example A Mortgage term (in years) (from p. 14) ....................... Rate of interest (percent) (from p. 14) ....................... Mortgage balance owed: Initial balance ................. After 5 years ......... After 10 years ................. After 20 years ................. Example B 30 30 71/2 IV 2 . . . . $22,300 Your example $18,400 . ... 21,200 17,500 . ... 19,400 16,000 . ... 13,150 10,850 Net proceeds from sale of house The calculations shown here are for a $23,835 house with a $22,300 loan (see Step 1, Example A) and a hypothetical 4-percent annual rate of appreciation. The net proceeds follow from estimates made above. Net proceeds from owning After 5 years After After 10 years 20 years $52,200 2,320 $35,300 2,824 21,200 19,400 13,150 Net proceeds .......................... . $ 5,480 $13,076 $34,874 $35,300 2,824 $52,200 4,176 17,500 16,000 10,850 Net proceeds .......................... . $ 9,180 $16,476 $37,174 Net proceeds for Example A: Market value of house (from p. 19) . . $29,000 Less selling costs (from p. 19) . . . Less mortgage balance owed (from p. 2 0 ) .............................. . 4,176 Net proceeds for Example B: Market value of house..................... . $29,000 2,320 Less selling costs ...................... Less mortgage balance owed . . . . . Your example: Market value of house ..................... Less selling costs ........................ Less mortgage balance owed Net proceeds ............................ The net proceeds shown in the examples do not take into account the possibility that you may have to pay capital gains taxes on part of your gain. The gain you realize by selling is not taxed if, within one year of the date of sale, you buy and occupy another house whose market price equals or exceeds the price you received for your old house, less selling costs and allowable expenses for improvements. Step 5. Estimate the amount of monthly savings required to offset net proceeds from owning, if you decide to rent. If you do not buy a house, you presumably have available the amount of money you would have spent on downpayment and settlement costs. This amount has potential for growth in other types of investment. In the example below, a $2,067 investment— the amount of downpayment and settlement costs in Example A, Step 1— grows to $2,637 in 5 years and to $5,483 in 20 years, at 5 percent interest a year. A $5,967 investment (from Example B) grows to $7,613 in 5 years and to $15,830 in 20 years. You can determine this growth potential, at the rate of return you specify, by using the table of compound interest (see appendix table A-4), applied to the amount of the downpayment and settlement costs you specified in Step 1. Appendix table A-6 shows the average an nual returns on selected types of investment. Interest and dividends received during the year are subject to taxation as personal income. You may want to allow for this by specifying a rate of return that is roughly net after taxes. For example, if you anticipate a 5-percent return per year on your money, you may want to use 4 percent when working through your example. Value of savings not used for downpayment and settlement Initial investment and rate of return per year Value of initial investment After 5 years After After 10 years 20 years $ 3,059 $ 4,528 Example A, investment of $2,067: 4 percent ........................................... $2,515 5 percent ........................................... 2,637 3,367 5,483 6 percent ........................................... 2,765 3,702 6,628 4 percent ........................................... $7,261 $ 8,831 $13,073 Example B, investment of $5,967: 5 percent ........................................... 7,613 9,720 15,830 6 percent ........................................... 7,983 10,686 19,136 Your example, investment of $______: __-_ percent ...................................... $ How do the net pro ceeds from owning compare with an al ternative investment of your savings? Advantage (or disadvantage) of investing in a house The value of money not invested in a house (downpayment and settlement costs) plus the interest earned thereon for an appropriate number of years is deducted from net proceeds from owning a house, as estimated in Step 4, to determine the additional savings, if any, needed to balance the investment gain from owning. The examples below are based on net proceeds shown in Step 4 and on initial in vestments of $2,067 (Example A) and $5,967 (Example B), com pounded at 5-percent net return per year. Additional savings needed when renting 10 years 20 years $13,076 $34,874 2,637 3,367 5,483 Net advantage from investment in house................................ . . $2,843 $ 9,709 $29,391 $ $ 5 years Example A, initial investment of $2,067: Net proceeds from sale of house (p. 20) ....................... . . $5,480 Less alternative investment, at 5 percent (p. 21) ............... . . Additional saving required each month (at 5 percent interest) to offset net advantage of owning ’ ....................... $ 42 Example B, initial investment of $5,967: Net proceeds from sale of house . . . . $9,180 Less alternative investment, at 5 percent ................................ 7,613 Net advantage from investment in house.................................... Additional saving required each month (at 5 percent interest) to offset net ad vantage of owning1 .......................... $ 72 $16,476 $37,174 9,720 15,830 6,756 21,344 1,567 23 63 $ 44 $ 53 Your example, with initial investment of $____: Net proceeds from sale of house . . . _ Less alternative investment, at____ percent .................................... _ Net advantage from investment in house ....................................... Additional saving required each month ( a t____percent interest) to offset net advantage of owning' ..................... 1 Obtained by dividing the net advantage from investment in house by factors given and explained in appendix table A-5. For short periods of ownership of 1 to 3 years, the costs of buying and selling a house can use up much or all of the equity acquired. Savings not used for downpayment and settlement costs by renting, plus the investment return on these savings, in many cases will equal or exceed the net proceeds from buying and then selling a house. For longer periods of time, as in the 5-, 10-, and 20-year periods in the illustration on page 22, the renter may need to supplement his initial saving from downpayment and settlement costs with a regular monthly amount to maintain parity with the owner. In 10 years, the net proceeds from sale of the house, when pur chased with an initial investment of $2,067 (Example A), exceed the alternative investment of the same amount invested over the 10-year period by $9,709. However, the advantage can be offset, while renting, by saving an additional $63 a month. These savings, when regularly invested, plus the alternative investment, balance the returns when renting with those from homeownership over the 10-year period. The monthly savings requirement in Example B over the 10-year period ($44) is lower than for Example A, due to the larger initial investment and interest earned ($9,720 compared with $3,367). Will additional savings be needed to balance the investment gains while renting with those from owning? Step 6. Estimate the rent level which, in combination with a savings program, would equal your net monthly shelter outlay as a homeowner. The difference between net monthly shelter outlay as a homeowner (Step 3) and the amount of monthly savings required to offset the gain (or loss) from investing in a house (Step 5) is the monthly out lay for rent which would leave the renter as well off, from an invest ment viewpoint, as if he had bought a house. In other words, to come out even with the homeowner over a period of time, the renter can spend for shelter only an amount equal to the difference between his investment program and the homeowner’s shelter outlay. Of course, there is no assurance that rental shelter will be available in any given locality at a rate which makes this possible. Results for Examples A and B are given on page 24, when the net shelter outlay per month is based on tax savings for a family of four per sons with $15,000 annual income. In each case, the monthly saving and the balance available for monthly rent equal the net outlay per month to own. The results indicate that the anticipated time interval is crucial. Thus, a renter who wanted to break even with an owner over a 20-year period would have to save more per month and spend less for rent than a renter who wanted to break even with an owner over a 5or 10-year period. In Example B, the lower net monthly outlay to own is due to the larger initial downpayment, which reduces the size of loan required and thereby reduces monthly payments. Alternatively, a renter in vesting an equivalent larger initial amount has to save less each month to break even with owning, so the monthly rental rate is nearly the same in the two examples. Note that, in both examples, calculations are based on 4-percent appreciation for the house and 5-percent net return on alternative in vestments. Changing the expected rate of appreciation, as for example to 5 percent, would have increased the need for regular savings when How much can you spend for rent and still match the invest ment expectations from owning? renting and lowered the balance available for monthly rent. On the other hand, increasing the rate of return on alternative investments tends to lower the need for regular savings and to increase the balance available for monthly rent. Balance available for monthly rent* 5 Planning period 5 years From Example A, with income of $15,000: Net monthly shelter outlay per month to own (p. 1 8 )........................................................... $210 Less monthly saving for alternative investment if renting (p. 2 2 ) .......................................... 42 Balance available for monthly r e n t.................. $168 From Example B, with income of $15,000: Net monthly shelter outlay per month to own (p. 1 8 )........................................................... $188 Less monthly saving for alternative investment if renting (p. 2 2 ) .......................................... 23 Balance available for monthly r e n t.................. $165 10 years 20 years $210 $210 63 72 $147 $138 $188 $188 44 53 $144 $135 Your example, with income of $______: Net monthly shelter outlay per month to own (P-1 8 )........................................................... ....... ...................... Less monthly saving for alternative investment if renting (p. 2 2 )............. ............................ Balance available for monthly re n t................... The results of these calculations as shown in Steps 1 through 6 will not, of course, in themselves determine your shelter decision, but they may help you, along with other considerations, to decide among your alternatives. One closing note. It is important to remember that • Over time, the personal factors involved in your shelter decision change. • Over time, the cost factors involved in your shelter decision change. • Over time, the investment factors involved in your shelter decision change. • Over time, general economic conditions and the options avail able in the shelter market change. If you keep these factors in mind, you will be far more likely to choose wisely when you come to decide whether you will be better off financially to RENT OR BUY. 25 Appendix. Supplementary tables for analyzing shelter costs and returns. Cost of financing home loans Data in table A-1 can be used to estimate the amount of the monthly mortgage payment for any size of home loan. The following example illustrates its use. EXAMPLE: John Jones needs a $24,500 home purchase loan, which he can obtain at 8 percent per year, for 30 years. What are his monthly mortgage payments? ANSWER: $7.34 X 24.5 = $179.83. Table A-1. Cost to finance $1,000, selected years and rates of interest Years financed Rate of 20 years 25 years 30 years interest Monthly cost Total cost Monthly cost Total cost Monthly cost Total cost 5* 1 /2 $6.88 $1,651 $6.15 $1,845 $5.68 $2,045 6 7.17 1,721 6.45 1,935 6.00 2,160 61 /2 7.46 1,790 6.76 2,028 6.33 2,279 7 7.76 1,862 7.07 2,121 6.66 2,398 71 /2 8.06 1,934 7.39 2,217 7.00 2,520 8 8.37 2,009 7.72 2,316 7.34 2,642 81 /2 8.68 2,083 8.06 2,418 7.69 2,768 9 9.00 2,160 8.40 2,520 8.05 2,898 10 9.66 2,318 9.09 2,727 8.78 3,161 Source: Based on rates published in such sources as Payment Table for Monthly Mortgage Loans and Comprehensive Mortgage Payment Tables, publications Nos. 292 and 392, respectively (Boston, Financial Publishing Co.). Mortgage payments The tables presented here help determine the rate at which home loans are retired and the percent of mortgage payments used to pay interest in selected years. The following example shows how table A-2 can be used: 1. To estimate the amount still owed on a mortgage after mort gage payments have been made regularly for a specified number of years. EXAMPLE: John Jones just financed $20,000 through a 30-year home loan at 7 percent. How much will he still owe on the mortgage after 10 years? ANSWER: $20,000 x .86 = $17,200. Table A-2. Percent of original loan amount still owed after specified number of years, selected mortgage terms, at different rates of interest Interest rate After 5 years After 10 years After 15 years After 20 years After 25 years After 30 years Life of mortgage— 30 years 5 51 /2 6 61 /2 7 71 1 /2 8 9 10 92 92 93 94 94 95 95 96 97 81 83 84 85 86 87 88 89 91 68 69 71 72 74 75 77 79 82 51 52 54 55 57 59 60 63 66 28 30 31 32 33 34 36 39 41 0 0 0 0 0 0 0 0 0 Life of mortgage— 25 years 5 51 /2 6 6V2 7 71/2 8 9 10 89 89 90 91 91 92 92 93 94 74 75 76 77 79 80 81 83 85 55 56 58 59 61 62 64 66 69 31 32 33 34 36 37 38 40 43 0 0 0 0 0 0 0 0 0 Life of mortgage— 20 years 5 51 /2 6 61/2 7 7V2 8 9 10 83 84 85 86 86 87 87 89 90 62 63 64 66 67 68 69 71 73 35 36 37 38 39 40 41 43 45 0 0 0 0 0 0 0 0 0 ' Percentages at this rate of interest are used to determine the mortgage balance owed on 30-year loans in Examples A and B, discussed on p. 20. Source: See table A-1. The following example shows how table A-3 can be used: 1. To estimate the amount of mortgage interest paid in a given year. EXAMPLE: John Jones has a 30-year, 7-percent loan. His mortgage payments are $150 a month ($1,800 a year). How much of the $1,800 was used to pay interest in the first year? ANSWER: $1,800 x .87 = $1,566. Table A-3. Mortgage interest as a percent of annual mortgage payments in selected years, selected mortgage terms, at different rates of interest Interest rate 1 st ye a r 1 5th year 10th year 15th year 20th year 25th year 30th year 40 43 47 49 52 55 57 61 65 24 26 28 30 32 34 36 39 42 3 3 3 3 4 4 4 5 5 24 26 28 30 32 34 36 39 42 3 3 3 3 4 4 4 5 5 Life of mortgage-— 30 years 5 51/2 6 6V2 7 7V2 8 9 10 77 81 83 85 87 89 91 93 95 72 75 78 80 83 86 88 90 92 64 68 71 73 76 79 81 84 87 54 57 60 63 66 68 71 75 79 Life of mortgage-— 25 years 5 51 /2 6 6V2 7 71/2 8 9 10 71 74 77 79 82 84 86 89 92 64 68 71 73 76 79 81 84 87 54 57 60 63 66 68 71 75 79 40 43 47 49 52 55 57 61 65 Life of mortgage-— 20 years 5 51 /2 6 6 I/2 7 71 /2 8 9 10 62 66 69 72 74 77 79 82 85 54 57 60 63 66 68 71 75 79 40 43 47 49 52 55 57 61 65 24 26 28 30 32 34 36 39 42 3 3 3 3 4 4 4 5 5 1 Only the first-year percentages shown here are used to compare the investment advantages of owning and renting. Source: See table A-1. Future value of an investment Table A-4 can be used to determine the future value of an initial investment of any given sum, at different rates of return and over different time periods. The table may also be used to determine the future cost of an item (or group of items) whose price is changing by a certain percentage each year. The following examples show how table A-4 can be used: 1. To estimate the future market value of any house or property. EXAMPLE: The current market value of a house is $25,000, and it is expected to appreciate 4 percent a year over the next 10 years. What would be its value in 10 years? Answer: $25,000 x 1.480 - $37,000. 2. To estimate future value of a fixed sum of money invested at dif ferent rates of return for a given number of years. EXAMPLE: The sum of $2,000 is invested for 20 years at 51 per /2 cent return per year. What is the value of the $2,000 in 20 years? ANSWER: $2,000 x 2.918 = $5,836. 3. To estimate the future cost of any items of expenditure or expendi tures for groups of items whose prices are subject to an expected percentage change (increase) each year. EXAMPLE: John Jones spends $30 a month ($360 a year) for utilities, and he expects this outlay to increase 1 percent a year due to price change. What would his monthly utility bill be in 5 years, due to this price change? ANSWER: $30 x 1.051 = $31.53. Table A-4. Factors for compounding returns and costs, selected interest rates and time periods Interest rate 5 years 3 4 41 /2 5 51 /2 6 7 8 20 years 30 years 1.051 1.104 1.159 1.217 1.246 1.276 1.307 1.338 1.403 1.469 1 2 10 years 1.105 1.219 1.344 1.480 1.553 1.629 1.708 1.791 1.967 2.159 1.220 1.486 1.806 2.191 2.412 2.653 2.918 3.207 3.870 4.661 1.348 1.811 2.427 3.243 3.745 4.322 4.984 5.743 7.612 10.063 Source: Derived from compound interest tables. For example, see C.R.C. Standard Mathematical Tables, (Cleveland, Chemical Rubber Publishing Co.). Accumulated savings Table A-5 presents the factors to be used in estimating the total amount of savings accumulated, over varying periods of time, by in vesting a fixed amount of money each month at one of three different rates of return. The examples below show how the table can be used: 1. To estimate the worth of a regular program for saving money. EXAMPLE: John Jones saves $50 each month which he invests in a program which he estimates will yield a 5 percent return com pounded annually. If he does this each month for 20 years what will be the approximate value of his savings? ANSWER: $50 x $406 = $20,300. Of this, $50 x 240 months $20,300 — $12,000 = $12,000 savings = $8,300 interest earned. 2. To estimate the monthly savings needed to accumulate a speci fied sum of money over a period of years. EXAMPLE: Edna Smith wants to accumulate $5,000 in savings by setting aside a fixed amount each month for 10 years. If her savings earn 5 percent compounded annually, how much does she set aside each month to acquire the $5,000? ANSWER: $5,000 -^$154 = $32.47. Table A-5. Factors for use in estimating accumulated savings, selected interest rates and time periods Interest 5 years 4 5 6 7 8 $66 68 69 71 73 Value of savings of $1 per month in number of years 10 years 20 years $147 154 162 171 180 30 years $364 406 453 508 569 $ 685 815 975 1,169 1,409 Source: See Paul M. Hummel and Charles L. Seebeck, Jr., Mathematics of Finance (New York, McGraw-Hill Publishing Co., 1956), pp. 77-88. Yield on selected types of investment Table A-6 can be usefu I in comparing alternative ways of investing a given sum of money. Table A-6. Average annual yield on selected types of investments, 1960-73 (Percent) Year High-grade Aaa corporate municipal u.s. bonds 1 bonds ' Government (Moody’s) ( ^Standard & Poor’s) bonds 1 1960 1961 1962 1963 1964 1965 1966 1967 1968 1969 1970 1971 1972 1973 4.41 4.35 4.33 4.26 4.40 4.49 5.13 5.51 6.18 7.03 8.04 7.39 7.21 7.44 3.73 3.46 3.18 3.23 3.22 3.27 3.82 3.98 4.51 5.81 6.51 5.70 5.27 5.18 ’ Economic Report of the President, February 1974, 4.01 3.90 3.95 4.00 4.15 4.21 4.66 4.85 5.25 6.10 6.59 5.74 5.63 6.30 Savings accounts in savings associations 2 3.86 3.90 4.08 4.17 4.19 4.23 4.45 4.67 4.68 4.80 5.06 5.33 5.39 p5.55 p. 317. 2 Savings , nd Loan Fact Book, 1974 (Chicago, U.S. Savings and Loan League, a 1974), p. 17 P = Preliminary. U. S. GOVERNMENT PRINTING O F F IC E : 1974 O - 559- 404 How homeownership trends have changed During the first half of the 20th century, more Americans rented than owned their homes, as shown in the accompanying chart. Large downpayment requirements and the lack of long-term financing, where buyers could pay for the rest of their home out of regular monthly savings, discouraged homeownership. Federal legislation enacted during the 1930’s was the first step toward changing this pattern. In 1932, the Federal Home Loan Bank Act established a nationwide system to provide a credit reserve for savings and loan associations. This was followed in 1933 by the establishment of the Home Owners Loan Corporation to finance long-term loans at low interest rates for homeowners unable to refinance delinquent loans through normal channels. Further legislation in 1934 established the Federal Housing Administration and the system of mutual mortgage insurance. As a result of the mortgage insurance system, residential loan practices were substantially changed. The long-term amortized loan quickly became almost universal for both insured and noninsured loans. Economic conditions of the 1930’s and the war years of the early 1940’s delayed public response to these changes. By 1946, how ever, a backlog of housing needs, coupled with savings accumulated by families and individuals during the war years, touched off a boom in residential housing construction. This trend was further accelerated by the institution of VA-guaranteed loans under the Servicemen’s Re adjustment Act of 1944. Further increases in purchasing power during the 1950’s helped to bring homeownership within reach of many more families. During the latter half of the 1960’s the movement toward homeownership leveled off. Rising home purchase prices coupled with higher financing costs were important factors influencing this change in trend. Percent of housing units occupied by owners, 1920-1970 Percent 100 ---------------------------------------------------------------------------------------- 50 0 1920 1930 1940 1950 Source: Decennial census data, Bureau of the Census. 1960 1970 U.S, DEPARTMENT OF LABOR BUREAU OF LABOR STATISTICS WASHINGTON, D. C. 20212 OFFICIAL BUSINESS PENALTY FOR PRIVATE USE, $300 THIRD CLASS MAIL POSTAGE AND FEES PAID U .S . D E P A R T M E N T O F L A B O R L A B -441