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How to calculate the total return on buying a home, considering things such as :

  • home value
  • down payment
  • constant mortgage payment (going from mostly interests at the beginning to mostly principal at the end)
  • fixed mortgage rate (let's say 4.5%)
  • taxes deductions (interests + property taxes)
  • other monthly fees (maintenance, insurance, taxes ...)
  • PMI (usually only until reaching the 20% equity)
  • current salary and expected growth (let's say 5%)
  • inflation (~3%/year)

For example, a home bought cash $100,000 would have to be sold $242,726.247 30 years later just to make up with inflation, and that would be a 0% return.

But I can't figure, or find, a way of integrating all the above items to calculate how much I would have to sell a home x years from now to make y% return.

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I would not consider keeping up with inflation (3%) as a 0% return. I would interpret a 0% return as putting $100 in and 5 years later taking out $100. –  Alex B Sep 28 '10 at 19:48
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Don't forget to factor in the rent you would have been paying if you didn't have a house, plus any other fees associated with renting (renters insurance, parking, etc). –  KeithB Sep 28 '10 at 21:41
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@Alex B: Not keeping up with inflation is a loss - your $100 is worth less in 5 years as prices keep rising with inflation. It's still $100, but it buys less. –  JBRWilkinson Sep 28 '10 at 22:06
    
TVoM is a good read. en.wikipedia.org/wiki/Time_value_of_money –  Kara Marfia Oct 1 '10 at 12:50
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Alex - Jeremy is suggesting a zero "real" rate of return. Of course, his numbers only look at the house price, he ignores the rent he might receive or might save by living there. –  JoeTaxpayer Oct 2 '10 at 14:03
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4 Answers

To get the factors you want, start with a complete amortization calculator and a tax deduction calculator, filling in values for your down payment, purchase price, tax rates, and mortgage rate. If you are talking about a specific property, you should be able to get taxes for the current year, and perhaps using historical values estimate taxes going out. Some calculators will include PMI (which you should avoid like the plague in an actual purchase). Given some preliminary data, you can calculate your insurance.

So once you have your PITI (principal, interest, tax, and insurance) monthly payment and tax deduction, you can calculate how much you spend a month on the house minus the deduction.

To estimate maintenance costs, you could either figure out about what you'd need to replace in the given time you plan to stay put and use a rough estimate on what it is. You can also use some rough estimates like this (1% of the property value yearly!) or this (moving the number up to a whopping 2%).

Don't forget closing costs as a buyer and seller. You can find estimates for these as well, and they are a function of the purchase price (usually around 2%).

So to figure out how much it costs you to live in a house for X months, you can do

Sum(PITI - deductions) over the months of owning from the calculators

So your total cost is

down payment + closing costs as buyer + cost per X months + total maintenance cost

Total Return Is:

sale price - closing costs as seller - amount left on mortgage

You can adjust that total return for inflation using this calculator to get your total return adjusted for inflation. If projecting into the future, you can try a formula found here.

To figure out the return on your investment, use

(total return adjusted - total cost) / total cost

So to figure out the total return adjusted you need for a given ROI, find

(ROI * total cost) + total cost = total return adjusted
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I suppose you can calculate the rate of return on buying a home in terms of appreciation, expenses, inflation, taxes, etc. Nothing wrong with that.

The method justkt came up with is accurate, but when you get the number out I wouldn't worry if the return is negative.

Why? Because you've lived there and enjoyed the house the whole time (I'm assuming anyway that this is your residence you're purchasing). If you come out even the slightest bit ahead, congratulations! You had a free place to live the whole time, plus you made a little money on the deal.

If you lost money, then oh well. You still had a place to live.

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I completely and totally agree with you for a first home. Personally I find out at what point I break even over comparable rent using the NYT calculator (nytimes.com/interactive/business/buy-rent-calculator.html) and call it a day. Not sure about if the poster was talking an income property, though. –  justkt Oct 1 '10 at 12:07
    
@justkt He didn't mention rent income so I didn't think it was an income property. –  mbhunter Oct 3 '10 at 2:01
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Not to state the obvious, but you realize this can only be done in hindsight? Sure, you can project out to get a range of expected return, but the tax laws can change every year, your own income changes so your marginal rate will change. You may have started with a 7% mortgage, and refinanced now to 4.5%, so you are far better off than the original plan.

I'll repeat what others mentioned, for your own home, the rent you are "not" paying is most of your return. A $100K home may appreciate at whatever rate 3-5%, say. But the $800/mo rent you don't have to pay is $9600/yr, nearly 10%. So when you imply that a house merely rising with inflation is a zero real return, I'd suggest that's far from accurate, all other expenses taken into account of course.

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There is a fundamental flaw in this statement:

For example, a home bought cash $100,000 would have to be sold $242,726.247 30 years later just to make up with inflation, and that would be a 0% return.

You forgot to deduct rent from your monthly carrying costs. That changes the calculations significantly.

Your calculations are valid ONLY if you were to buy a house, and let it sit empty, which is unlikely. Either you are going to live in it, and save yourself $1000 a month in rent, or, you are going to rent it out to someone, and earn an income of $1000 a month.

Either way, you're up $1000 a month and this needs to be included.

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