Housing: Time to Buy?

Good news: It's now cheaper to buy a home than rent one in 98 of the 100 largest American cities, according to real estate site Trulia.com.

Between plunging home prices, mortgage rates at all-time lows, and rents starting to rise considerably in some cities, nationwide price-to-rent ratios are now below pre-bubble levels. As a rough rule of thumb, buying becomes preferable to renting when the ratio of home prices to annual rents fall below 15, and vice versa. Here's where we are today:

Sources: Bureau of Labor Statistics, S&P Case-Shiller, author's calculations.

Like any real estate statistic, nationwide numbers don't mean much. What matters is where you live. Interestingly, though, after crunching the numbers, Trulia found that price-to-rent ratios favor buying in every major U.S. city except Honolulu and San Francisco.

Among those where buying is most favorable:

Source: Trulia.com.

Even in cities where renting still favors buying, the gap isn't big. The worst, Honolulu, had a price-to-rent ratio of 17. San Francisco came in at 15.5. Even New York is now 14.5, favoring buying over renting just slightly.

One of the big factors moving these numbers is rising rental prices. "Median rents rose 3% from January 2011 to January of this year, while home values fell 4.6% during that period," The Wall Street Journal wrote last week. According to Zillow's Rent Index, 69.2% of metropolitan areas saw rental prices rise last year, while only 7.2% saw home prices rise.

Those are the numbers. So should you rent or buy?

That's a more complicated question than some make it out to be. Beyond playing the "can-I-afford-it" game, I think you should ask yourself two questions before deciding whether to rent or buy:

1. How long will I stay in one place?
A typical mortgage lasts 30 years, but the average homeowner sells after about eight. That changes the ownership dynamic in a big way.

The way mortgages amortize, or are paid off over time, combined with short periods of ownership means the vast majority of an average American's mortgage payment goes toward interest, not principal. On a 30-year mortgage at 6% interest, 83% of your monthly payment goes to interest in the first year. By year five, it's 77%. At year 10, still 70% goes to interest.

The tax deductibility of mortgage interest is a benefit, but I think many homeowners overestimate how much equity they're building in their homes. Unless you can reasonably expect to live in the same home for perhaps 10 years or more, the financial benefits of owning are questionable, particularly once transaction costs, real estate fees, taxes, and upkeep are factored in. People overlooked this in the past because they could count on seeing home values go up 10% to 20% a year. That's not the case anymore. You have to think long term.

2. What kind of life do I want?
This is more emotional than analytical, but I think it's important. Late last year I interviewed Yale economist and housing expert Robert Shiller. When asked who should buy a home, he advised treating it as less a profit-seeking endeavor and more a lifestyle choice:

Basically, if I were in the market right now because I wanted a house, I would buy a house. I think most people have a sense of what kind of life they want to live and where they want their family and where they want their kids to go to school. It depends on your position in life and what you are thinking, but quite likely you are living in a neighborhood with a street, with sidewalks, with a playground nearby, a school that's convenient, and you end up buying a house because you want those things. I wouldn't let speculative concerns dominate that decision.

Adjusted for inflation, home prices were flat for almost then entire 20th century. Searching through more than 100 years of newspaper archives, Shiller found almost no discussion about even the prospect of rising home prices. It just wasn't on people's minds. "One expected to buy a home as part of normal living, and didn't think to worry about what would happen to the price of homes," he wrote in his 2004 book Irrational Exuberance.

Most of us would be better off with that kind of mind-set. Price-to-rent ratios now favor buying. That's great! But don't let it push you back into an "I-must-buy-now" mentality. Homes are not a place to make money. They're a place to live.

Disagree? Sound off in the comments section below.